Reconsider the determination of the hedge ratio in the two-state model (Section

Question

Reconsider the determination of the hedge ratio in the two-state model (Section 16.2), where we showed that one-third share of stock would hedge one option.

Assuming a stock price of $210, what would be the hedge ratio for each of the following exercise prices: $210, $180, $150, $120? (Leave no cells blank - be certain to enter "0" wherever required. Round your answers to 2 decimal places.)

Reconsider the determination of the hedge ratio in the two-state model (Section 16.2), where we showed that one-third share of stock would hedge one option.

Explanation / Answer

a) The hedge ratio will be as follows:

At $210, hedge ratio will be $210 / $210 = 1.00

At $180, hedge ratio will be $180 / $210 = 0.86

At $150, hedge ratio will be $150 / $210 = 0.71

At $120, hedge ratio will be $120 / $210 = 0.57

b) As the option becomes progressively more in the money, its hedge ratio increases to a maximum of 1.0.

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