Comparing Variance Swaps, Futures, and Puts for Equity Portfolio Hedges
Summary
The discussion compares long variance swaps with two familiar ways to hedge an equity portfolio against a decline: short futures and long puts. A short futures position has roughly constant delta, so its protection per unit of further price decline stays constant. A put gains delta as the underlying falls toward its strike, increasing protection; at the strike, its payoff provides a defined floor-like hedge for the option position.
The answer argues that a variance swap lacks this put-like convexity, so its protection is more appropriately compared with futures than with puts. The respondent adds a qualification: variance can rise faster after a large market decline, but a variance swap still does not guarantee a full floor. The passage offers a conceptual comparison rather than payoff calculations or empirical evidence; actual hedge behavior depends on the instrument terms and market conditions.
Key ideas
- Short futures provide approximately constant delta exposure as the underlying falls.
- A long put becomes more protective as the underlying approaches its strike.
- The answer characterizes a long variance swap as lacking the guaranteed floor associated with a put.
- The author therefore considers futures a fairer comparison for variance swap hedges than puts.
- Variance may rise more sharply during a large decline, which qualifies the simple comparison.
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Full text
# Hedging equities portfolios with vol products # Hedging equities portfolios with vol products Quote > Hedging with variance is not comparable to puts Due to the lack of convexity of a variance swap hedge, we believe it is best to compare long variance hedges to hedging with futures rather than hedging with puts. Although variance hedges might be cheaper than put hedges, the lack of convexity for long volatility makes this an unfair comparison, in our view. End Quote Source: Santander Volatility Trading Primer, Page 92 http://www.globalvolatilitysummit.com/wp-content/uploads/2015/10/Santander-Volatility-Trading-Primer-Part-I.pdf Why does a var swap hedge have a lack of convexity? (I guess for long vol). Also I do not understand why they are comparing this to futures and puts hedges. ## Answer by Alex C (score 2, accepted) https://quant.stackexchange.com/a/32533 Short Futures and Long Puts are the main hedging strategies for hedging an equity p'folio against a drop, so it is natural that a proposed new technique, going Long a VarSwap, is being compared to the 2 traditional techniques. How do the 2 traditional techniques differ ? When you hedge an equity p'folio with short futures, you have a constant delta. As S goes down, the amount of protection per drop in S stays constant. When you hedge with a put, the delta increases as S goes down, affording you more protection for the next drop; after S reaches K the protection is 100%. "Convexity" is being used synonimously with Gamma and refers to this "curvature" or second order change in delta. The question then is does Long VarSwap resemble the Short Futures case or the Long Put case, for the purpose of comparison. The author argues that the "additional protection kicking in as S goes down" (the convexity) is absent in the case of VarSwap. In my experience when the market is already down a lot the increases in Var become somewhat larger, so I am not sure I completely agree with the author. But it is true that the protection never becomes total, there is no guaranteed floor like with a Put. So the VarSwap is more comparable to the Future, it is an incomplete hedge.
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