Business and Personal Finance Dictionary

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• VARIANCE SWAP
  
  Definition: A contract that pays off an amount proportional to the difference between the realized variance over a specific period of time and the contractual variance. Example: If the realized, annualized standard deviation of the rate of return on the S&P 500 is 40% and the contractual variance is 9%, then the net payoff on the side receiving the realized variance on $100 million notional value for half a year is $3,500,000 = $100,000,000 x (0.42-0.09) x 0.5. Application: The variance swap is a potential tool for managing the sensitivity of an option book to volatility risk.
  
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