A share sells for $40, and its call option sells for $4. The hedge ratio is .8 and the share price rises by 10%. The call option price should
A) fall by 20%.
B) rise by 80%.
C) rise to $4.80.
D) fall by $3.20.

Question

Quizplus · Accepted Answer

CThe hedge ratio, also known as the delta, indicates how much the price of an option is expected to move based on a $1 change in the underlying asset price. With a hedge ratio of .8, if the share price rises by 10% (from $40 to $44, a $4 increase), the call option's price should increase by 0.8 * $4 = $3.20. Therefore, the new call option price would be $4 + $3.20 = $7.20. This is an 80% increase from the original price of $4 ($3.20 increase on a base of $4), and the call option price rises to $7.20, which is equivalent to stating it rises by $3.20 from the original $4, making both B and C correct in the context of the question's details.

A Share Sells for $40, and Its Call Option Sells