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Forward Volatility Agreements Versus Forward-Starting Volatility Swaps

Article Quant Q&A · Author: gregV
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Summary

The document distinguishes a Forward Volatility Agreement (FVA) from a forward-starting volatility swap. An FVA provides exposure to future implied volatility through a forward-starting vanilla option, with its Black–Scholes parameters set at trade inception except for the spot price. Its payoff is therefore tied to option-implied volatility rather than directly to volatility realized over a future period.

The discussion compares the FVA’s exposure with a longer-dated option hedged using an option expiring at the forward start, with rebalancing to manage gamma. Although an FVA can resemble a forward volatility or variance swap in having forward volatility exposure without current gamma, it also retains ordinary option vega effects and mark-to-market sensitivity to skew as spot moves. A forward-starting volatility swap instead targets future realized volatility. The document offers conceptual descriptions rather than pricing formulas or a full treatment of hedging; it also cautions that future at-the-money implied volatility may be a poor proxy for expected realized volatility when the underlying and volatility are correlated.

Key ideas

  • An FVA gives exposure to future implied volatility through a forward-starting vanilla option.
  • A forward-starting volatility swap targets volatility realized during a future period.
  • FVA exposure includes vanilla option vega and mark-to-market effects from skew as spot changes.
  • A longer-dated option hedged with an option expiring at the forward start can approximate FVA exposure.
  • Future at-the-money implied volatility may not represent expected realized volatility when spot and volatility are correlated.

Tags

OptionsForexVolatilityDerivatives pricing
Full text
# What is the difference between forward volatility swap and FVA?


# What is the difference between forward volatility swap and FVA?












Specifically looking at FX but i guess it's a general question. any good reference would be appreciated. FVAs are not mentioned in Derman's paper ("More than you ever wanted to Know about volatility swaps")

## Answer by hjw (score 5)

https://quant.stackexchange.com/a/40797

FVA is unrelated to Volswaps. Its stands for Forward Volatility Agreement and you are entering into a contract to buy/sell a forward starting vanilla option with black scholes parameters (with the exception of spot price) determined today.

This is used to gain exposure to forward implied volatility and is generally similar to trading a longer dated option and cutting your gamma exposure using another option with expiry equal to the forward start date, constantly re-balancing so that you are gamma flat.

In terms of sensitivity, it is similar to forward starting vol/var swaps in that you have no gamma currently and have exposure to forward vol. It is different however in that you are exposed to standard vega deformations of vanilla options as well as MTM due to skew as spot moves away from initial trade date.

## Answer by user34971 (score 2)

https://quant.stackexchange.com/a/40773

As I understand it, a FVA is a swap on future implied at-the-money volatility, which is hedged by a forward starting ATM option / straddle.

I believe the idea behind this is that the future ATM IV is a proxy for expected future realised volatility. But the ATM IV, spot or future, is not a good proxy for expected realised volatility if there is substantial correlation between the underlying and the volatility.

A forward start volatility swap is really a swap on future realized volatility. See for example:

Rolloos - model free forward start volswap

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.