Well, think of it this way - if you buy a straddle that is priced with implied vol of 16% and are delta-hedging it, you are long realized volatility vs the "strike" of 16%. However, along the way your P&L depends on both what you have already realized and whatever implied is priced in for the remaining period. Same with variance swap futures - if you intend to hold them to expiration, you are long variance at the level where you bought it, but your daily P&L will depend on both realized variance from the point of purchase to the current moment and the implied variance for the remaining period. Am I making sense?
You are to me, yes. I've also been thinking about it this way. If I purchase a var swap today with implied at 16%... and you purchase a var swap tomorrow with implied now at 20%, then clearly the price we paid should be different: you should have paid much higher than me. Indeed, I should be able to sell you my var swap future and book those profits.
I don't like this example at all! All I want for Christmas Is my two front teeth My two front teeth Just my two front teeth Gee, if I could only have My two front teeth Then I could wish you Merry Christmas
Cdcave, implides do matter if youre trading in and out before expiry. As you approach mexpiry the contract should converge to its fair value, or the realized vol over the determination period. Does this make sense? Hope this helps u think about it
i'm starting to get it... this statement i was wondering about.. "However, along the way your P&L depends on both what you have already realized and whatever implied is priced in for the remaining period." so.. where does the "whatever implied is priced in" number come from... supply and demand? so even if alot has been realized against the original snapshot issuance number (strike) the market could keep bidding up variance.... where is this implied derived from... is it just the spx implieds? such that your looking to see how much implied volatility is priced into the options and how that relates to whats left to be realized against your strike in calender days then see how that reflects in price of varswaps.. its like upon entrance your looking at whats left in implied against whats you speculate to be left to be realized. let me ask this... is the price of the varswap what the market is speculating will be the realized variance and the implieds of the spx the same thing? sounds like a stupid question.. this delta hedged straddle really helps me conceptualize it... because i can picture the changing parameters .. if implieds get bid up.. your long premium and it helps, that is unless implieds go up and almost no variance is realized at all.. or in a different way implieds go down yet variance goes up faster.. markets can go down without implieds going up.. implieds are the price of options.. just because a market moves doesn't mean people willl bid the options up.. sat around chewing on it for a while..
what number ends up being the fair value.. realized vol over the determination period.. that doesn't relate to a closing vol vix number at expiration does it.. its more like a accumulation of all the volatility realization for the period of the contract.. i think about it like a floating market price of cumulative variance against a handle/strike .. its Cumulative in variance and subtractive in time against the strike.
you're on the right track. yes the implied is derived from the underlyings option market. i think you need to go one step back... how would you price a variance swap today to date x? simplistically you would look at the implied vol for the underlying until date x (which is why the var swap is priced with strike weighted implieds from 0 to inifinity) and that would be your best estimate. this make sense because the implied vols used to price options are the markets best guess of realized volatility until that date. i think understanding it like that will help you to understand why the implieds matter in the market price. if a few days go by after you've entered your var swap, assuming its a longer term swap, there is still a large degree of uncertainty of what the market will realize to date x and (sorry to repeat myself) you should consider your best guess of the future realized vol is the implied vols for the same time period.
repetition helps.. you explained it to me once and i lost it remember.. haha then you told me to go read some papers haha so i did..
I am sure that sle will be involved in arbing this product. I am very appreciative for sle's input on "swaps 101" here, and would be interested to hear where you would be bidding or offering any tenor here in a switch market, based upon mids of course. cboe calculators: http://cfe.cboe.com/VarianceFuture/VarianceFuture.aspx http://cfe.cboe.com/VarianceFuture/VarianceFutureDelayedQuote.aspx