Gap-Risk Swaps for Targeted Jump Exposure

Summary

The document asks whether investors can isolate jump risk premia in a way that variance swaps isolate variance risk premia. It describes gap-risk contracts as a practical analogue: an over-the-counter swap or exposure embedded in a structured note, based on daily close-to-close moves and a put spread. In the example, the equity payer receives a premium for taking the risk of a sufficiently large downside move; the put spread sets a loss threshold and caps the loss relative to a single put. The structure is presented as allowing leveraged exposure while targeting gap risk.

The example illustrates that a move just inside the put-spread threshold causes no payment, while a larger decline creates a payment tied to the amount beyond the threshold. The cited discussion gives a typical premium range for major equity indices, but says pricing is volatile. This is a brief description rather than a full contract specification: it does not detail valuation, counterparty risk, settlement terms, or how the structure performs across different jump sizes or markets.

Key ideas

• Gap-risk swaps can provide targeted exposure to large price gaps, akin to how variance swaps target variance risk.
• A put spread can define the move threshold at which the contract begins to pay.
• The example uses daily close-to-close observations and cancels the contract upon payment.
• The premium compensates the equity payer for taking downside gap risk and varies over time.

Tags

# What is the purest way to get exposure to Jump risk premia, is there a jump swap


# What is the purest way to get exposure to Jump risk premia, is there a jump swap












So to get exposure to Variance risk premia one could use variance swaps, is there a equivalent security for jumps. Hedging against jump but not diffusion risk could allow one to take targeted exposure which could be good for leveraged investor for example. Now I know we could buy Out of the money puts, but that for a fixed known jump size. With unknown jump size, we need to buy a lot of OTM puts which is not really practical? so?

## Answer by James Spencer-Lavan (score 1)

https://quant.stackexchange.com/a/44681

The closest contract to this is gap risk which does trade, either as OTC swap (client looking for a hedge) or embedded inside a structured note (bank looking to recycle risk).

Basic starting point is daily close-to- close observations against a 80-90% putspread, cancel upon payment, equity payer receives a spread for being short the risk (major equity indices this is normally circa 30-40bps p.a., but is quite volatile price)

In the above setting, if asset moves -9.99% in a day, you are fine. If it moves -15%, you will pay 5% etc. Idea of putspread is to allow leverage of up to 10x.

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.