Answer: Buy short dated options and sell long dated options

## Explanation This question involves hedging an option portfolio that has: - **High unfavorable sensitivity to increases in implied volatility** (negative vega) - **Significant daily losses with the passage of time** (negative theta) ### Key Analysis: **1. Vega Exposure:** - The portfolio has negative vega (unfavorable sensitivity to volatility increases) - To hedge negative vega, we need to **buy volatility** (positive vega) - Buying options gives positive vega **2. Theta Exposure:** - The portfolio has negative theta (time decay losses) - To hedge negative theta, we need to **sell time value** (positive theta) - Selling options gives positive theta **3. Calendar Spread Strategy:** - **Short-dated options** have higher theta decay (more time value erosion) - **Long-dated options** have higher vega sensitivity (more volatility exposure) **4. Correct Hedge:** - **Buy short-dated options**: Provides positive vega to offset negative vega, but has high theta cost - **Sell long-dated options**: Provides positive theta to offset negative theta, but has negative vega - The combination creates a **calendar spread** that balances the vega and theta exposures **Why Option B is correct:** - Buying short-dated options adds positive vega to hedge the negative vega - Selling long-dated options adds positive theta to hedge the negative theta - This creates a net hedge against both risks **Why other options are incorrect:** - **A**: Selling short-dated and buying long-dated would increase negative vega exposure - **C**: Selling both would increase negative vega and negative theta - **D**: Buying both would increase negative theta exposure The calendar spread in Option B effectively hedges both the vega and theta risks simultaneously.

Author: LeetQuiz .