Explanation:
The static replication method involves searching for a portfolio of plain vanilla options with similar attributes that approximately replicate the exotic option and then taking a short position in this portfolio in order to hedge the exotic options. This method is used to create a portfolio that mimics the payoff of the exotic option. By taking a short position in this replicating portfolio, the risk associated with the exotic options can be offset. This is because the gains from the short position in the replicating portfolio will offset the losses from the exotic options and vice versa. Therefore, this method effectively hedges the risk associated with the exotic options.
A, B and D are incorrect following the above explanation.
Q.801 Katja Firos is an investment analyst at Frankfurt Securities, a brokerage and investment company. She was instructed by the head of the investments unit to hedge the portfolio of exotic options through static options replication. Which of the following steps should she take to implement the static replication method?
A
The static replication method involves searching for a portfolio of the same exotic options which other market participants are using for hedging.
B
The static replication method involves searching for a portfolio of plain vanilla options with opposite attributes that inversely replicates the exotic options and then taking a short position in this portfolio in order to hedge the exotic options.
C
The static replication method involves searching for a portfolio of plain vanilla options with similar attributes that approximately replicates the exotic option and then taking a short position in this portfolio in order to hedge the exotic options.
D
The static replication method involves searching for a portfolio of similar exotic options with similar attributes and then taking a long position in this portfolio in order to hedge the exotic options.
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