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Variance & Volatility Swaps (VVS) Best Practices

Variance & Volatility Swaps (VVS) Best Practices

Overview

This document applies to all releases of Eagle software. Version-dependent functionality is noted with the initial release(s) it became available.

Variance and Volatility Swaps (VVS) allow investors to speculate on the volatility, or magnitude of movement, of a given underlying reference against a volatility strike. This can be the price of an index, FX rate, interest rate, or just about any other reference that has a measurable level. They function almost identically to Swaptions, except there are no calls/puts or exercise/assign process. Cash is settled based on the difference between the actual volatility vs. the established strike level. Another flavor, called a Dispersion Swap, allows investors to go long (buy) or short (sell) the volatility associated with an index and take the opposite position on particular components of that index. This document covers the full lifecycle including Accounting, Data Management, and Performance.

There are two models available for VVS depending on your current Eagle release.

  • V17 R2.27 & Above: use Swaption functionality (OPOPSW)

    • This supports positive/negative pricing and holding the position long/short

    • The Credit Default Swap model can also be used if preferred

  • Prior to V17 R2.27: use Credit Default Swap functionality (SWCDCO)

    • This allows you to price positive and negative, but the position is always held long

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Entity Setup

Before any trades can be booked, the target entity must be set up appropriately.

OPOPSW Entity Setup

Refer to Options Entity Setup Processing Notes for details.

SWCDCO Entity Setup

Refer to Swaps Entity Setup Processing Notes for details.

Reference Data

Storage & Configuration

Both OPOPSW/SWCDCO security master files (SMFs) have single rows in Data Management. Security Type (82) and Sub Security Type (1464) can be used to distinguish VVS from regular OPOPSW/SWCDCO. In V17 R2.28, a dedicated security field named Variance/Volatility Swap (18275) was added to further identify VVS.

Market Data

Both models provide familiar processing workflows that also aligns with VVS pricing in the market. Both models use par-zero pricing, which allows positive and negative prices to be entered directly. Par-zero pricing also allows for extreme price fluctuations, which would be capped if using par-based/percentage pricing.

There should be no price manipulation required for the OPOPSW model. When using the SWCDCO model for Dispersion Swaps, you may need to flip the price from positive to negative, or vice versa, because SWCDCO are always held long in Eagle.

Security Data

VVS can be setup and maintained using Reference Data Center (RDC) or Issue Viewer. The list below contains all fields required to configure a VVS SMF.

OPOPSW Security Data

  • Issue Name (961)

  • Primary Asset ID (14) & Type (1432)

  • Processing Security Type (3931) = OPOPSW (Swaptions)

  • Price Multiplier (18): 1.00 is most common for VVS, but 0.01 may be correct depending on your price source

  • Contract Size (19): typically 1.00 for VVS

  • Issue Country (1418)

  • Asset Currency (85)

  • Expiration Date (38): date when Eagle Accounting will automatically mature the VVS, unless the entity-level Options and Futures Expiration Delay Days field has been populated

  • Strike Price (67): used for reference/reporting purposes, not required for processing

  • Option Type (1142): any value can be selected because the exercise/assignment process is not used for VVS

  • Underlying Security (1347): if you set up the index SMF ahead of time, you can add it here for reference purposes

SWCDCO Security Data

  • Issue Name (961)

  • Primary Asset ID (14) & Type (1432)

  • Unique Product (1955) & Swap Identifier (1958, V12.1.2 and above)

  • Processing Security Type (3931) = SWCDCO (Credit Default Swaps)

  • Security (82) & Sub Security Type (1464): can be used to distinguish VVS from regular SWCDCO

  • Price Multiplier (18): 1.00 is most common for VVS, but 0.01 may be correct depending on your price source

  • Issue Country (1418)

  • Asset Currency (85)

  • Buy/Sell Indicator (1364): required for securities using the SWCDCO model, but has no impact on Accounting for VVS; can be used to denote buying or selling the variance/volatility

    • Buy: long exposure to variance/volatility

    • Sell: short exposure to variance/volatility (typically the broker side or party writing the contract)

  • Coupon (70) = 0.00

    • This suppresses income accruals

  • Coupon Type (97) = F (Fixed Rate)

  • Day Count Basis (471) = ACT/360

  • Payment Frequency (472) = MAT (At Maturity)

  • Business Day Convention (1536) = NONE

  • Issue Date (68): first trade date of the swap

  • Dated Date (1183):  "Effective Date" in ISDA contracts; typically same as Issue Date for VVS

  • First Coupon Date (473) = Maturity Date

  • Last Coupon Date (474) = Maturity Date

  • Maturity Date (38): "Final Observation Date," "Expiration Date," or "Termination Date" in ISDA contracts

  • Cleared Security (5027) = No

Trade Processing

OPOPSW Open & Close

The fields below are used for both opens and closes.

  • Contracts (40): notional amount of the VVS

  • Price Per Contract (45): multiplied by Contracts, Contract Size, and Price Multiplier (18) to calculate the premium

    • Can be positive, negative, or zero

  • Commission Per Contract (971): multiplied by Contracts to calculate Commission Amount Local (47), which is factored into the Net Amount fields

  • Tax Amount (46), SEC Fee (48), Stamp Duty Tax (51), & Other Fee (3752): added to the premium and commission to generate the total net amount

  • Broker (88)