options (1) - 88 You are evaluating a stock that is...

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88. You are evaluating a stock that is currently selling for $30 per share. Over the investment period you think that the stock price might get as low as $25 or as high as $40. There is a call option available on the stock with an exercise price of $35. Answer the following questions about hedging your position in the stock. Assume that you will hold one share. What is the hedge ratio? How much would you borrow to purchase the stock? What is the amount of your net investment in the stock? Complete the table below to show the value of your stock portfolio at the end of the holding period. How many call options will you combine with the stock to construct the perfect hedge? Will you buy the calls or sell the calls? Show the option values in the table below. Show the net payoff to your portfolio in the table below.
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What must the price of one call option be?
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The answers are shown below. What is the hedge ratio? The hedge ratio equals the range of the call values divided by the range of the stock values, which equals (5 - 0)/(40 - 25) = 1/3. [If the stock price
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  • Three '10
  • HneryYip
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