Question

Hedge Ratio

1. If an investor sells 152 calls and the hedge ratio is 0.42. How many shares does he buy to reduce the risk of loss?

2. An investor owns 1000 shares of stock. He thinks the price will fall in the near future. To reduce the risk of loss, how many call options must be sold if the hedge ratio is 0.7?

Answer 1

Ratio = Value of Hedging Instrument/Value of Hedged Asset

1.

If investor sells 152 calls,

Number of shares to buy,

Hedge ratio = 0.42 = 152/Number of Shares to buy

Number of Shares to Buy = 152/0.42 = 361.90~362

So, investor needs to purchase 362 shares to hedge the risk.

2.

Is investor owns 1000 shares,

Number of calls to sell,

Hedge ratio = 0.7 = Number of call to sell/1000

Number of calls to be sold = 0.7 * 1000 = 700

So investor needs to sell 700 calls to hedge the risk.