Volatility swap
Definition · Level 10 · Derivatives pricing
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Pays (realized vol − strike) × notional: linear in vol, so its fair strike sits below the variance-swap strike.
Example
$100k notional, strike 20, realized 15 → −$500,000.
Where Tradecraft teaches it
Level 10 · Derivatives pricing, in the lesson “Asians, worst-ofs, quantos & variance swaps”: Path-dependent and multi-asset payoffs, who is long correlation, and how variance swaps pay.
Related terms
- Asian optionAverage-price option: payoff on the average over a set of fixings.
- Basket optionOption on a weighted average of several assets; cheaper than the sum of single-asset options, and worth more as correlation rises.
- Exotic optionAny option whose payoff differs from a plain (vanilla) call or put: it can depend on the path (barriers, averages, lookbacks), on several assets…
- Lookback optionPayoff uses the best maximum or minimum reached during the life — perfect hindsight, so it costs more than the vanilla.
- QuantoOption on a foreign asset paid in the investor’s currency at a fixed exchange rate: no currency risk, but the price depends on the asset/FX…
- Variance swapForward on realized variance: pays variance notional × (σrealized² − K²).