Thank you @Same Lazy Element for taking the time to explain this to us. Very helpful to me in formulating my trades.
I think that poopy dude blocked me because (thankfully) I don't see anything you guys are typing about.
First off, its going to take some time to really understand your post, but i'm very glad you took some time to break this down. Now, my knowledge is very limited, but I am learning. You said "how var-swaps effects the cash close in the SPX". So now, I didn't know this. I still don't know what it really means, but lets walk through this. Are you saying that the variance swaps on the SPX effect the cash close, thus effecting the realized SPX volatility? Thus var-swaps effect how realized vol will actualize? Are variance swaps like options? I know they are OTC and not available to retail, but can you trade var swaps on any underlying that's liquid? Like AAPL, AMZN var swaps?
A market-maker who is long the variance swap can offset the risk by shorting the replicating portfolio of options, and delta-hedging. They will therefore be short gamma in the options market (Fig. 108). As described, a delta-hedger who is short options will act to increase volatility in the underlying – buying as it rallies, and selling as it sells-off. However, the action of these market makers hedging their short options will not necessarily act to increase volatility in the underlying, as the counterparties they have sold options to may be counteracting this effect by themselves hedging their long volatility positions. However, the important difference between these two groups of hedgers is that the variance swap market-makers who are short options, must hedge only on the close to capture the close-close realised variance specified in the variance swap contract. In contrast, the hedgers who are long the options, will generally be free to choose when to delta-hedge, as they attempt to capture the true volatility of the underlying process. Therefore, the overall effect of hedging these variance swaps need not have the effect of increasing overall market volatility, although it may if the long options positions are not being hedged (e.g. they are sold on to end-investors). However, the important point is that the hedging of long variance swap positions may act to increase close-to-close volatility, with option hedges on the close having the potential effect of magnifying daily moves. http://sp-finance.e-monsite.com/pag...hedging/effects-of-variance-swap-hedging.html
Exactly. If there is a large outstanding variance swap position in the market, dealer hedging could impact the behavior of SPX around the close. The interesting bit for a retail trader is the short-term trade opportunities that creates around the close - the actual change to daily volatility will be relatively small. It's nearly impossible to get dealers to quote single name variance swaps, instead dealers are quoting single name volatility swaps. This is because most funds what to buy single name variance and sell S&P variance. Dealers do not like being short single name variance swaps because single names are much more prone to gaps and gaps can be very painful when holding a variance position (you don't have time to rebalance delta and get disconnected from the option strip hedge).
Can you kindly explain in layperson's language what is variance swap? What is one selling if he sells variance swap? I only sell/buy single name options.
Not really. It's over my head. AFAIK it's a tool for omm to manage their book. Also, for really big traders in vol, it's a risk management tool. From http://quantlabs.net/academy/download/free_quant_instituitional_books_/%5BJP%20Morgan%5D%20Variance%20Swaps.pdf From quant.stackexchange.com "A variance swap has a cleaner exposure to volatility then the straddle. But you have to take a bit of care if you use it for hedging how you define your variance swap vega, and how you define your options book vega. I presume your question is about hedging the vega risk of an options book with varswaps." "A variance swap can be replicated by delta-hedging a strip of options."