Question

The current price of a non-dividend-paying stock is $80. Over the next year it is expected to rise to $86 or fall to $76. An investor buys put options with a strike price of $82. Which of the following is necessary to hedge the position?

Select one:

a. Buy 0.6 shares for each option purchased

b. Sell 0.6 shares for each option purchased

c. Buy 0.8 shares for each option purchased

d. Sell 0.8 shares for each option purchased

Answer 1

Put option excercises when the stock price goes below the strike price.

In the given case,

Payoff from put option when the stock price falls to $76 will be

= 82 - 76

= $6

But when the stock rises to $86 nothing receivable.

Therefore,

delta = Change in put payoff / change in stock

= (Pu - Pd) / (Su - Sd)

= (6 - 0) / (86 - 76)

= 6 / 10

= 0.6

We need to buy 0.6 shares in order to hedge against the put option.