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Suppose that ABC Finance sells call options on $ 1.25 million worth of a stock portfolio with

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Suppose that ABC Finance sells call options on $ 1.25 million worth of a stock portfolio with beta 5 1.5. The option delta is .8. It wishes to hedge out its resultant exposure to a market advance by buying a market index portfolio.
a. How many dollars’ worth of the market index portfolio should it buy?
b. What if ABC instead uses market index puts to hedge its exposure? Should it buy or sell puts? Each put option is on 100 units of the index, and the index at current prices represents $ 1,000 worth of stock.
Portfolio
A portfolio is a grouping of financial assets such as stocks, bonds, commodities, currencies and cash equivalents, as well as their fund counterparts, including mutual, exchange-traded and closed funds. A portfolio can also consist of non-publicly...
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a To calculate the hedge ratio suppose that the market index increases by 1 percent Then ...View the full answer


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A put option is a financial contract that gives the owner the right, but not the obligation, to sell an underlying asset, such as a stock or a commodity, at a predetermined price, known as the strike price, on or before a specific date, known as the expiration date. Put options are used by investors as a form of insurance against a decline in the value of the underlying asset. If an investor expects the value of an asset to fall in the future, they can purchase a put option on that asset. If the value of the asset does fall, the put option will increase in value, allowing the investor to sell the asset at the higher strike price. For example, if an investor owns 100 shares of a stock that is currently trading at $50 per share, they may purchase a put option with a strike price of $45 and an expiration date three months in the future. If the stock price falls to $40 before the expiration date, the investor can exercise the put option and sell their shares for $45 each, even though the market price is only $40. This would allow the investor to limit their losses. It\'s important to note that purchasing a put option involves paying a premium to the seller of the option, and the investor can lose the entire premium if the price of the underlying asset does not decline as expected. Put options are just one type of financial derivative and should only be used by experienced investors who understand the risks involved.

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