I have been looking at this product recently and there's something I'm not sure I'm interpreting correctly.
I understand a long Varswap can be theoretically replicated with a portfolio of sold options so what I was wondering is whether there's any net Volga risk. The ATM option currently having the largest contribution in terms of Vega hedge won't show any volga (as it's ATM) although the other options (both upside and downside) will indeed show some volga.
So my question is, in a portfolio where a variance swap is hedged with a replicating portfolio of options, does the change in Vega in the Varswap generated by, let's say a rapid increase in vol, get offset by the change in Vega driven by the ITM and OTM options in the portfolio?
Or is it the case that I'll have to be rehedging by longing more options (assuming I'm short the Varswap) as vols go up so the Vega exposure is hedged down to 0 again? Conversely, as vols come back off (if they do) I'd be selling the extra options I bought to reduce my Vega hedge as the Varswap Vega decreases.
Is it like that? Or does the Volga in the options portfolio actually offset the one from the Varswap?