Question

You would like to hold a protective put position on the stock of Ximera Corp to lock in a guaranteed minimum value of $50 at year-end. Ximera currently sells for $50. Over the next year. Ximera's stock price will increase by 10% or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are traded on Ximera Corp. Suppose the desired put options with X = 50 were traded. What would be the hedge ratio for the option?
Multiple Choice
A. 1
B. -1
C. -0.5
D. 0.5

Answer 1

Answer: C)  -0.5

Explanation:

So first we take down the information we where given;

lets say

x = 50

SO = 50

therefore

uSO = ( 50 * ( 1 + 0.1) = (50 * 1) = 55

dSO = ( 50 * ( 1 - 0.1) = (50 * 0.9)  = 45

SO

Pd = (x - dS0) = 50 - 45 = 5

Pu = (x - uSO) = 50 - 55 = (-5) because its negative, its = 0

now to get the HEDGE RATIO

we say HEDGE RATIO = (Pu - Pd) / ( uSO - dSO)

HEDGE RATIO = ( 0 - 5) / ( 55 - 45)

HEDGE RATIO = -5 / 10

HEDGE RATIO = -0.5