You would like to hold a protective put position on the stock of Avalon Corporation to lock in a guaranteed minimum value of $50 at year-end. Avalon currently sells for $50. Over the next year, the stock price will increase by 10% or decrease by 10%. The T-bill rate is 5%. Unfortunately, no put options are traded on Avalon Co.
Suppose the desired put options with X = 50 were traded. What would be the hedge ratio for the option?
A) −1
B) −0.5
C) 0.5
D) 1

Question

Quizplus · Accepted Answer

At t=0, stock price equals $50. At t=1, the price will either increase to $50*(1+0.10) = $55, or decrease to $50*(1- 0.10) = $45, the payoffs for these scenarios are 0 and 5 respectively. The resulting hedge ratio is
H = 11eaaae8_8b44_fc02_a4b8_fb7303776854_TB6474_11 = 11eaaae8_8b44_fc03_a4b8_d34465871279_TB6474_11 = -0.50

You Would Like to Hold a Protective Put Position on the Stock