Reconsider the determination of the hedge ratio in the two-state model (Section
ID: 2767234 • Letter: R
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 $336, what would be the hedge ratio for each of the following exercise prices: $336, $273, $210, $147? (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
Hedge Ratio = Size of Exposure / Size of position in futures
Exercise price of $336:
Size of Exposure = Quantity of Asset x Spot Price of Asset
=> 1 x $336 = $336
Size of position in futures = Contract Size x Number of contracts
=> $336 x 1 = $336
Hedge Ratio = $336/$336 = 1
Exercise price of $273:
Size of Exposure = Quantity of Asset x Spot Price of Asset
=> 1 x $336 = $336
Size of position in futures = Contract Size x Number of contracts
=> $273 x 1 = $273
Hedge Ratio = $336/$273 = 1.2307
Exercise price of $210:
Size of Exposure = Quantity of Asset x Spot Price of Asset
=> 1 x $336 = $336
Size of position in futures = Contract Size x Number of contracts
=> $210 x 1 = $210
Hedge Ratio = $336/$210 = 1.6
Exercise price of $147:
Size of Exposure = Quantity of Asset x Spot Price of Asset
=> 1 x $336 = $336
Size of position in futures = Contract Size x Number of contracts
=> $147 x 1 = $147
Hedge Ratio = $336/$147 = 2.2857
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.