Looking at FX in particular, but I think it`s a general question. any good reference would be appreciated. VAFs are not mentioned in Derman`s paper (“More than you ever wanted to know more about volatility swewings”) Trading volatility gives investors the opportunity to hedge the volatility risk of a devalued position against adverse market movements of the underlying/underlying. It also allows investors to speculate or express views on the level of volatility in the future. In fact, trade volatility is higher than Delta hedging, which uses options to get views on the future direction of volatility. I think the underlying idea is that the future ATM IV is a proxy for expected future volatility. However, ATM IV, Spot or Future, is not a good proxy for expected volatility when there is a significant correlation between the underlying and volatility. From what I understand, an FVA is a swap on the future implied volatility of at-the-money, which is guaranteed by a front/straddle start option. A startup volatility swap is actually a swap on realized future volatility.
In another thread, I wrote that Rolloos & Arslan wrote an interesting paper on price reconciliation without a Model spot Starting Volswap. This option is used to commit to implied volatility in advance and usually resembles trading a longer option and cutting your gamma exposure with another option, whose expiration date matches the departure date in advance, constantly rebalancing yourself, so that you are gamma-flat. An agreement between a seller and a buyer to exchange a Straddle option on a given expiration date. On the trading day, counterparties determine both the expiration date and volatility. On the expiry date, the exercise price is set on the Straddle`s at the cash futures value on that date. In other words, the forward volatility agreement is a futures contract on the realized volatility (implied volatility) of a given underlying, whether it is a stock, a stock market index, a currency, an interest rate or a commodity index. etc. In a very recent (quite compressed) working paper, I saw that Rolloos also deduced a model-free pricing approach for Forward Starting Volswaps: in terms of sensitivity, it is similar to Forward Starting Vol/Var swaps, since you currently have no gamma and are exposed to Forward Vol. However, it is different from the fact that you are exposed to Standard Vega distortions of vanilla options and MTMs due to distortions, given that the spot moves away from the initial trading date.
FVA has nothing to do with Volswaps. This is a volatility agreement and you agree to a contract to buy/sell a vanilla forward starting option with black Scholes parameters (except for the spot price) that have been set today. Experts, analytics and intelligent data will help you break through the noise to identify trends, risks and opportunities. Join more than 300,000 financial experts who are already subscribers to FT. Home > Financial Encyclopedia > Derivatives > F > Forward Volatility Agreement The mathematics in this last article looks correct – but I haven`t yet seen any numerical tests of the result without a model. Someone tested the latest result of Rolloos, any comment/ideas about it?. . .