Question

Reconsider the determination of the hedge ratio in the two-state model where we showed that one-third share of stock would hedge one option. The possible end-of-year stock prices, uS0 = $135 (up state) and dS0 = $92 (down state).
What would be the hedge ratio for each of the following exercise prices: 135, 122, 112, 92? (Round your answers to 3 decimal places.)

Exercise Price Hedge Ratio
135
122
112
92

Answer 1

Answer:

Upper state  = 135

Down State  = 92

Difference = 135-92= 43

Exercise Price                      Hedge Ratio

135                                       0/43 = 0.0000

122                                        13/43 = 0.302

112                                         23/43 = 0.535

92                                          43/43 = 1.000