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Answer: Entering into an agreement to purchase the payoff of the option at maturity for an amount equal to the future value of the current option premium
The correct answer is B. The option trader can transform a long option into a zero-cost derivative product by entering into an agreement to purchase the payoff of the option at maturity for an amount equal to the future value of the current option premium. This process effectively converts the upfront premium option into a zero-cost derivative by agreeing to pay a premium at maturity that is equivalent to the future value of the initial premium, taking into account the time value of money. The other options (A, C, and D) are incorrect because they do not result in a zero-cost derivative with the same payoff as the original option. Option A suggests a payment at maturity which would include an interest charge, making it not zero-cost. Option C implies a combination of options that would not maintain the original option's identical payoff. Option D involves selling the underlying stock along with purchasing the option, which does not preserve the original option's payoff. The reference material from the Global Association of Risk Professionals' "Financial Markets and Products" provides further insight into exotic options and the concept of zero-cost derivatives.
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A trader working for an equity hedge fund is scrutinizing the fund's options portfolio, particularly focusing on the expense structure associated with it. The trader aims to understand the nature of the positions that the fund takes with its prime brokers and is interested in exploring strategies to lower the initial costs tied to the fund's options positions. What approach can the trader utilize to transform a long option into a derivative instrument that incurs no initial cost?
A
Arranging with the option seller to pay an amount equal to the upfront option premium at maturity rather than at option initiation
B
Entering into an agreement to purchase the payoff of the option at maturity for an amount equal to the future value of the current option premium
C
Combining the purchase of the option with a sale of other options such that the net premium is zero and the combined payoff is identical to the payoff of the original option
D
Purchasing the option and selling the underlying stock such that the net upfront cash flow is zero and the payoff is identical to the payoff of the original option