Among many available hedging instruments, volatility and variance swaps provide certain unique features when compared to its peers. This article explores the benefits of these products.

Some decades ago, volatility was perceived to be a floating business cycle phenomenon for both secondary and longer-term development objectives. Many theoretical models have since molded short and long-term fluctuations into a single framework, with a growing body of research, they suggest that higher volatility is causally associated with lower growth. And from then onwards volatility has assumed a more central part in the derivative trading community.

The derivative trading community knows that managing volatility is the foremost function to hedge the risk in an option-based portfolio. The Black Scholes option pricing model provides market practitioners a simple and effective framework for hedging volatility risk through delta-neutral long option strategies, but since the underlying stock or index moves, a delta neutral position cannot remain delta neutral any more due to the change in the volatility, which necessitates a rehedging to maintain a delta neutral position. The other traditional option-based volatility strategies such as straddles or hedged put and calls have resulted in spectacular losses in volatility trading making many broker-dealers and hedge funds bankrupt in the past.

Treasury management Magazine, Volatility Risk, Black Scholes Option Pricing Model, Hedge Funds, Chicago Mercantile of Exchange, Equity Index, Stock Markets, Trading Strategies, Hedge Portfolio, Volatility Swap Contract, Hedging Instruments.