Suppose that you have written a call option on €10,000 with a strike price in dollars. Suppose further that the hedge ratio is ½. Which of the following would be an appropriate hedge for a short position in this call option?
A)Buy €10,000 today at today's spot exchange rate.
B)Buy €5,000 today at today's spot exchange rate.
C)Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today .
D)Buy the present value of €5,000 discounted at i€ for the maturity of the option.
E)Both c and d would work.
F) None of the above

Question

Quizplus · Accepted Answer

The hedge ratio of 1/2 means that for every euro paid out on the option, 50 cents of it should be hedged. Option C involves agreeing to buy €5,000 at the forward exchange rate for the maturity of the option, which would hedge 50% of the potential payout. Option D involves buying the present value of €5,000 discounted at i€ for the maturity of the option, which would also hedge 50% of the potential payout. Therefore, both option C and D would be appropriate hedges for a short position in this call option.

Suppose That You Have Written a Call Option on €10,000