Question

Describe what a hedge ration of .3 on a option describes about the relative price adjustment between the option and the underlying.

Answer 1

Hedge ratio is basically the delta of an option;

Hedge ratio=[change in price of option/change in price of underlying stock]

An hedge ratio of .3 implies that if the underlying stock price increases by 1 unit, the price of the option will increase by .3 unit.

This ratio is used to hedge the stocks; Suppose an investor has 100 shares of a stock where delta of stocks =1 ;

for hedging he needs to have a short position of 100/.3 options= 333 (appx) no of options shorted to be delta neutral. Here the options are shorted so that the hedge ratio of both cancels each other and combined delta will become 0