Question
Suppose Ford stock is at $7.76. The 8.0 options for Ford are $.13 for a call (with N(d1) = .3565. By now, you know that
Suppose Ford stock is at $7.76. The 8.0 options for Ford are $.13 for a call (with N(d1) = .3565. By now, you know that the hedge ratio tells you how to use a call (or a put) to hedge your stock position. If a call's N(d1) = .3565, then you'd sell 1/.3565, or 3 calls (rounding up from 2.8) per share you own. Then, if the stock falls by $1, each call would theoretically fall by $.3565, but you'd be short 3 of them, and your short position would gain 3x$.3565, or about a dollar. This would offset the dollar loss in the stock, keeping your portfolio position basically even.
The N(d1) for the 8.0 PUTS is -.6312. Describe the PUT position you would use to hedge one share of stock (assuming that each option is for ONE share, not for 100). What would THEORETICALLY happen to the resulting portfolio if the stock fell $1? What factors might make the theoretical prediction not come exactly true?
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