Question

a) You have written a call option on 1 share of A Street stock that is worth $15. You expect the price of the stock to either move to $20 or $10 over the next year. How many shares of A Street stock should you own to perfectly hedge your position on the call option? The strike price on the option is $15.

b) If the one-year risk-free interest rate is 10% and the strike price on the option is $15, what should have been the proceeds of the call option you wrote for A Street stock?

c) If you sell one call option for A Street stock with a strike price of $15 and you own one share A Street stock as well. Assuming no option premium from selling the option or fees from buying the stock, draw the payoff diagram for this portfolio.

Answer 1

a). Number of shares to own for perfect hedge = (20 - 10) / (20 - 15)

= 10 / 5

= 2.

Conclusion :- Number of shares = 2.

b). Call option proceeds = 15 * 10 %

= $ 1.50