You own 2,500 shares of Jordan Co. stock, which is currently, valued at $38 a share. The $40 put has a premium of $2.25 and a put delta of −.25. What position should you take in $40 put contracts to hedge your stock against a $1 decrease in price?
A)buy 100 contracts
B)buy 1,000 contracts
C)buy 10,000 contracts
D)write 100 contracts
E)write 1,000 contracts

Question

Quizplus · Accepted Answer

To hedge against a $1 decrease in price for 2,500 shares, you need a delta-neutral position. The put delta of -0.25 means for every $1 decrease in the stock price, the value of the put option increases by $0.25 per share. To fully hedge 2,500 shares, you need a total delta of -2,500 (since you're hedging against a decrease, hence the negative sign). Each put contract covers 100 shares, so the delta per contract is -0.25 * 100 = -25. To find the number of contracts needed to achieve a delta of -2,500, divide -2,500 by -25, which equals 100 contracts.

You Own 2,500 Shares of Jordan Co