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Variance Swap
Variance Swap is a financial derivative whose payout is equal to variance (difference between the square of annualized realized volatility of returns on the underlying price and a fixed quantity over a given period of time).
Effectively, variance swap is a contract in which two parties change their cash flows based on the measured variance of particular underlying asset during specified time period. On date of the trade, parties agree on the contract strike price and number of units in the transaction.
As well as volatility swaps, variance swaps provide exposure to pure volatility of underlying price, with nonlinear payoffs.
As square of standard deviation, variance swaps offer larger payouts than those of volatility swaps. Variance swaps are mostly used to hedge the volatility exposure of other positions, to speculate on future volatility or to trade the spread between implied and realized volatility.
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