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FX Derivatives Trader School by Giles Jewitt

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Chapter 31Miscellaneous Options

Exotic FX derivative option types not yet examined include “volatility” products like volatility swaps, variance swaps, and forward volatility agreements, plus forward start options, and compound options.

Volatility and Variance Swaps

In FX derivatives:

  • A volatility (vol) swap is a forward contract on the realized volatility of spot over an agreed period.
  • A variance (var) swap is a forward contract on the realized variance of spot over an agreed period.

Most commonly, daily spot fixings are used to determine realized volatility and variance. Mathematically, for daily spot fixings, realized variance c31-math-0001 is calculated using this formula:

equation

where c31-math-0003 are spot log returns, that is, c31-math-0004, c31-math-0005 is spot fixing number c31-math-0006, and in total there are N log returns.

The mean return is usually not included in the realized variance formula and usually this will not significantly impact ...

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