Question

If the hedge ratio is -.5, according to the Black-Scholes model:

a.) you should buy 100 shares of stock for each call option you write

b.) you should buy 50 shares of stock for each call option you buy

c.) you should buy 50 shares of stock for each call option you write

d.) you should buy 100 shares of stock for each call option you buy

Answer 1

The correct answer is c.)you should buy 50 shares of stock for each call option you write

The delta is -0.5, which means if the stock price goes up by 1, the value of the option goes down by 0.5 and vice versa.

If you write a call option, if the stock price goes down by 1 you get 0.5

Contract size is 100

If you buy 50 shares, and if the stock price goes down by 0.5, you lose $50

But, the option gains $50

So, you are hedged.

Can you please upvote? Thank You :-)