Variance Swaps, within the crypto derivatives landscape, are financial contracts that allow participants to trade the future realized variance of an underlying cryptocurrency’s price, rather than its directional movement. These instruments provide direct exposure to volatility as an asset class, separating it from price risk.
Mechanism
The contract specifies a variance strike price and a notional amount. At expiration, the realized variance of the cryptocurrency’s price over the contract period is calculated. Payments are exchanged based on the difference between this realized variance and the agreed variance strike, multiplied by the notional. This settlement is typically conducted in stablecoins or a pre-agreed fiat equivalent.
Methodology
The strategic methodology behind variance swaps focuses on hedging volatility exposure or speculating on future market turbulence in digital assets. It enables sophisticated investors to take a pure view on volatility, independent of their directional market bias. This instrument facilitates more granular risk management and sophisticated portfolio construction in volatile crypto markets.
Binary options are avoided for volatility trading due to their unhedgeable, discontinuous risk profiles and structural incompatibility with institutional risk systems.
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