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Answer: The cost will be highest when the options are deep in-the-money.
The correct answer is B. The cost 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 represent the rate of change of the option's price with respect to the underlying asset's price. A larger delta means that the option's price is more sensitive to changes in the underlying asset's price. As a result, the trader needs to adjust the delta hedge more frequently and with larger quantities of the underlying asset to maintain the hedge, which incurs higher transaction costs. Therefore, the cost of carrying the delta hedge is highest when the options are deep in-the-money.
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An investment bank operates a derivatives trading desk where a trader manages a portfolio that consists primarily of short option positions. In order to mitigate the risk associated with these short positions, the trader employs a delta hedging strategy. Considering the dynamic nature of this strategy and its implications, which of the following statements correctly describes the interest expense involved in maintaining the delta hedge?
A
1 The cost will be highest when the options are deep out-of-the-money.
B
The cost will be highest when the options are deep in-the-money.
C
The cost will be highest when the options are at-the-money.
D
The cost will be lowest when the options are at-the-money.