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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.
## Explanation **Option B** correctly describes how to create a zero-cost derivative from a long option position. ### Analysis of Each Option: **A. Deferred payment**: This doesn't create a zero-cost product - it just delays the payment. The present value of the cost remains the same. **B. Correct**: This describes creating a **forward start option** or similar structure where: - You pay the future value of the premium at maturity - The net cost becomes zero in present value terms - This effectively transforms the option into a zero-cost derivative **C. Option combination**: While this can create zero net premium, it typically changes the payoff profile (e.g., creating a spread or collar), not preserving the original option's payoff. **D. Stock hedge**: This creates a synthetic position but doesn't make it zero-cost. The stock sale generates cash, but the position's risk profile changes. ### Key Insight: The transformation to zero-cost while maintaining the original option's payoff requires structuring the payment to occur at maturity rather than upfront, effectively creating a forward-style contract on the option payoff. **Correct Answer: B**
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An option trader at an equity hedge fund is assessing the cost structure of the fund's portfolio of options. The trader examines the types of positions the fund trades with its prime brokers and investigates whether the fund can reduce the upfront costs of its option positions. How can the trader transform a long option into a zero-cost derivative product?
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.
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