Editing Variance swap (section)

{{Short description|Over-the-counter financial derivative}}
A '''variance swap''' is an [[over-the-counter (finance)|over-the-counter]] [[financial derivative]] that allows one to [[Speculation|speculate]] on or [[hedge (finance)|hedge]] [[risk]]s associated with the magnitude of movement, i.e. [[volatility (finance)|volatility]], of some [[underlying]] product, like an [[exchange rate]], [[interest rate]], or [[stock index]].

One leg of the swap will pay an amount based upon the realized [[variance]] of the price changes of the underlying product.  Conventionally, these price changes will be daily [[logarithm|log]] [[return (finance)|returns]], based upon the most commonly used closing price.  The other leg of the swap will pay a fixed amount, which is the [[strike (finance)|strike]], quoted at the deal's inception.  Thus the net payoff to the [[counterparty|counterparties]] will be the difference between these two and will be settled in [[cash]] at the expiration of the deal, though some cash payments will likely be made along the way by one or the other counterparty to maintain agreed upon [[margin (finance)|margin]].