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Capital Markets

Variance swaps: Volatility wobbles towards asset status

And variance swap strategies remain popular.

May’s unexpected increase in equity market volatility, which led to big mark-to-market losses for some hedge funds, has not dented the variance swaps market, according to dealers. No volume figures on the products are available but, according to Gerry Fowler, equity derivatives strategist with Citigroup in London, it remains a burgeoning market, with investors even starting to enhance their volatility strategies by trading new variations of volatility contracts called conditional variance swaps.

“Most people weren’t discouraged by the volatility in May, and even though a lot of them lost a decent amount of money on their mark-to-market positions during that period, it gave them an opportunity to be selling at much higher levels, which means they recouped most if not all of those losses,” says Fowler.

Variance swaps enable traders to take pure positions on equity market volatility. The number of volatility products that have hit the market in the past few years together with increased use by investors mean volatility is now often referred to as an asset class in its own right.

Short volatility

At the time of writing, realized volatility levels remain lower than implied volatility, which means selling volatility is still profitable, as it has generally been over the past three years.

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