A Variance Swap is a type of financial derivative that allows investors to trade the volatility of an underlying asset, rather than the asset itself. A variance swap is a bet on the expected volatility of an underlying asset, such as a stock or stock index, over a specified period of time.The variance swap is similar to a volatility swap, but there is a key difference: while a volatility swap allows an investor to trade the volatility of an underlying asset over a specified period of time, a variance swap allows an investor to trade the expected variance of an underlying asset.To understand how a variance swap works, let's say an investor enters into a variance swap with a notional amount of $100,000. The investor agrees to pay the counterparty a fixed rate of return on the notional amount, based on the realized variance of the underlying asset over a specified period of time. If the realized variance is higher than the expected variance, the investor receives a payment from the counterparty, and if the realized variance is lower than expected, the investor pays the counterparty.In summary, a variance swap is a tool used to trade the volatility of an underlying asset and is used by investors to express a view on the expected volatility of an underlying asset over a specified period of time.
