Variance swaps strike again!
Did anyone notice that the curious timings in Wednesday yen currency-cross slumps? Societe Generale’s head of currency research, Kit Juckes, certainly did:
Overnight, the news flow out of Japan continued to deteriorate in a high stress environment defined by the 27-40 regime in the VIX. JPY crosses suffered heavily at 3PM EDT fixing when AUDJPY var swaps were hedged, as they are a squared exposure to the drop in spot. This likely increased selling pressing on the 27bn usd in AUD/JPY uridashi position, as of March ex redemptions. With retail’s confidence deteriorating in Japan, we are yet to see the main moves. This can be detected in ZAR/JPY with its 5bn USD in uridashis but 100 million a day market or AUDJPY 1M ATM vol given the underlying 25bn USD in uridashis issued.
For those not gifted in currency code, an explainer might be helpful here.
Options traders sell leveraged positions like variance swaps to investors as a bet on volatility — be that volatility in interest rates, equity indices or even … FX.
The variance swap is basically the difference between volatility and variance. If something like the JPY/USD rate moves then the variance swap makes it square.
It’s the volatility of volatility, if you will.
And in the meantime the options traders (i.e. banks) that actually sold the positions need to start hedging since they’re effectively short all that (increased) volatility.
Crucially though, we hear they are hedging not only the yen moves which have already happened but also for what might happen if the retail money really starts pulling back. “The market is so incredibly nervous,” one currency-type told us.
In the meantime though — those variance swaps will be getting fixed at multiple times throughout the day. Though if you know a particular important fixing time (like 3pm on Wednesday) we hear you also know when the yen is about to surge …
Related links:
Volatility as the new Black-Scholes - FT Alphaville
Goldman’s Q2 really was ‘exciting with risks’ - FT Alphaville
Vim and vigour in variance swaps – FT Mandate