In todays class we learn about what a volatility swap is.
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What is a Volatility Swap?
A volatility swap is a forward contract with a payoff based on the realized volatility of the underlying asset. Volatility swaps settle in cash based on the difference between the realized volatility and the volatility strike.
They are not swaps in the traditional sense, with an exchange of cash flows between counterparties.
At settlement, the payoff is, Notional Amount X (Volatility – Volatility Strike)
They are also similar to variance swaps, where the payoff is based on realized variance. Check out my video on variance swaps here. https://www.youtube.com/watch?v=XO1vKxx4z0M
