How Does a “Variance Swap” Allow Traders to Bet Directly on Future Realized Volatility?

A variance swap is a forward contract where one party agrees to exchange a fixed rate (the strike price) for the actual, or realized, variance of the underlying asset over a specified period. It allows traders to directly speculate or hedge against the future level of realized volatility without the complexity of managing a portfolio of options.

The payoff is linear to the variance, making it a pure play on volatility.