Assume that the current price of an XYZ share is $4 00 and that the price of a call option on these shares is $0 80 If we know that a 10 c movement in share price will be accompanied in the same direction by a 5c movement in the call price,then an appropriate risk-free hedge will be:

Question

Quizplus · Accepted Answer

To create a risk-free hedge, we need to determine the number of calls we need to write for each share held. From the information given, we know that for every 10c the share price moves, the call price moves 5c in the same direction.

Therefore, to offset a potential loss in the share price, we need to write calls in a ratio of 2:1 (i.e., for every one share held, we need to write two call options).

Since the price of a call option is $0.80, we can collect a premium of $1.60 ($0.80 x 2) for every share held.

Therefore, the appropriate risk-free hedge would be writing two calls for every share held, which would generate sufficient premium income to offset any potential loss in the share price.

The correct choice is D.

Assume That the Current Price of an XYZ Share Is