2. The following reading deals with another example of how spread positions on volatility can be taken. Yet, of interest here are further aspects of volatility positions. In fact, the episode is an example of the use of knock-in and knock-out options in volatility positions.

a. Suppose the investor sells short-dated (1-month) volatility and buys 6-month volatility. In what sense is this a naked volatility position? What are the risks? Explain using volatility swaps as an underlying instrument.

b. Explain how a 1-month break-out clause can hedge this situation.

c. How would the straddles gain value when the additional premium is triggered?

d. What are the risks, if any, of the position with break-out clauses?

e. Is this a pure volatility position?