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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
**B is correct.** This describes the process that transforms a regular upfront premium option into a zero-cost derivative product. The option purchaser essentially agrees to buy the option payoff for a premium equal to the future value of the upfront option premium. **A is incorrect.** The option buyer would not be able to pay the same premium at maturity as they would at option initiation. The premium would be increased by an interest charge. **C is incorrect.** A single option can be packaged with other options to make the net premium zero but the payoff will not remain identical. Generally, there is a trade-off involving the cost of the position and the payoff of the position. For example, if the payoff of a call could be structured with a package of options resulting in no cost, there would be no need for outright calls. This is not the process described to make any derivative a zero-cost product. **D is incorrect.** It is not going to have the same payoff.
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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 the sale of an option on another underlying, such that the net premium is zero and the payoff and risk profiles are identical to the original
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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