Question

A stock is selling at $90. A 3-month call with a strike price of $100 is selling for $3.105 with a delta of 0.329. How many call contracts are required to perform a hedge on 1,000 shares of this stock? Would they be bought or sold? What happens if the price of the stock falls to $50?

Answer 1

To perform a hedge on 1,000 shares of the stock, 10 call contracts would be required. They would be sold. If the stock price falls to $50, the value of the call options would decrease.

Step-by-step explanation:

To perform a hedge on 1,000 shares of the stock, we need to calculate the number of call contracts required. One call contract typically covers 100 shares. To find the number of call contracts, we divide the number of shares (1,000) by the number of shares covered by one contract (100). So, 1,000 shares / 100 = 10 call contracts are required.

Since the call options have a delta of 0.329, they provide a hedge for only 32.9% of the stock's value. Therefore, to fully hedge the 1,000 shares, 10 call contracts (covering 100 shares each) would be sold.

If the price of the stock falls to $50, the value of the call options would decrease. However, the investor would still have the premium received from selling the call contracts to offset some of the losses.