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Professional · Lesson 5 of 8Total return swaps, equity swaps and variance swaps
A total return swap (TRS) pays one party the full return of an asset (price change plus income) in exchange for a funding rate. It gives exposure without owning the asset. In 2021 Archegos Capital built huge hidden positions through TRS with several banks; its collapse cost banks over US$10 billion, with Credit Suisse the largest loser.
Equity swaps exchange the return on a share or index for a fixed or floating rate. Contracts for difference (CFDs) are retail versions of the same idea.
A variance swap pays the difference between realised variance and a fixed strike. It is a pure bet on volatility, used by hedge funds and banks. Dispersion trades and VIX futures are related volatility instruments.
Key takeaways
- TRS gives full asset exposure without ownership.
- Archegos shows hidden leverage risk in swaps.
- Variance swaps are pure volatility trades.
Check your understanding
1. What did Archegos Capital use to build hidden leveraged positions?
- ETFs
- Total return swaps
- Term deposits
- Covered calls
Show the answer
Total return swaps. Swaps hid the true size of its exposure.
2. A variance swap pays off based on...
- Dividends
- Realised volatility versus a strike
- Interest rates
- Credit events
Show the answer
Realised volatility versus a strike. It isolates volatility exposure.
Go deeper
- Wikipedia: Total return swap
- YouTube videos: total return swap archegos explained
- Investopedia: total return swap
- Wikipedia: Variance swap
- Wikipedia: Archegos Capital Management
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