A portfolio consists of 800 shares of stock and 100 calls on that stock.If the hedge ratio for the call is 0.5.What would be the dollar change in the value of the portfolio in response to a one dollar decline in the stock price?
A)+$700
B)-$850
C)-$580
D)-$520
E)none of the above

Question

Quizplus · Accepted Answer

The hedge ratio indicates how many calls are needed to hedge against the price change of one share of stock. In this case, the hedge ratio is 0.5, meaning that for every one share of stock, we need 0.5 calls.

Thus, the number of equivalent shares in the call position is 0.5 x 100 = 50 shares.

The total number of equivalent shares in the portfolio is 800 + 50 = 850 shares.

Therefore, if the stock price declines by $1, the total dollar change in value of the portfolio would be:

850 shares x $1 per share = -$850

Note that the negative sign indicates a decrease in the value of the portfolio.

A Portfolio Consists of 800 Shares of Stock and 100