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Answer: The interest cost of carrying the delta hedge will be highest when the options are deep in-the-money.
The correct answer is B. The interest cost of carrying the delta hedge will be highest when the options are deep in-the-money. This is because the deeper the options are in-the-money, the larger their deltas, which means that more capital is required to maintain the delta hedge. As a result, the cost of borrowing this capital, which is reflected in the interest cost, will be higher. This concept is discussed in the context of dynamic delta hedging, which involves adjusting the hedge as the underlying asset's price changes to maintain a neutral position with respect to small price movements. The explanation is based on the principles outlined in the book "Valuation and Risk Models" by the Global Association of Risk Professionals, specifically in Chapter 16 on Option Sensitivity Measures: The "Greeks".
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When evaluating the implementation of dynamic delta hedging for a portfolio composed of short option positions, which of the following statements is correct?
A
The interest cost of carrying the delta hedge will be highest when the options are deep out-of-the-money.
B
The interest cost of carrying the delta hedge will be highest when the options are deep in-the-money.
C
The interest cost of carrying the delta hedge will be highest when the options are at-the-money.
D
The interest cost of carrying the delta hedge will be lowest when the options are at-the-money.