Question #104

Reading: Reading 31 Valuation of Contingent Claims

PDF File: Reading 31 Valuation of Contingent Claims.pdf

Page: 49

Status: Unattempted

Part of Context Group: Q103-104
Shared Context
- After discussing the concept of a delta-neutral portfolio, Washington determines that he needs to further explain the concept of delta. Washington draws the payoff diagram for an option as a function of the underlying stock price. Using this diagram, how is delta interpreted? Delta is the: A) slope in the option price diagram. B) level in the option price diagram. C) curvature of the option price graph.
Question
BIC owns 51,750 shares of Smith & Oates. The shares are currently priced at $69. A call option on Smith & Oates with a strike price of $70 is selling at $3.50, and has a delta of 0.69 What is the number of call options necessary to create a delta-neutral hedge?
Answer Choices:
A. 0
B. 75,000
C. 14,785
Explanation
The number of call options necessary to delta hedge is = 51,750 / 0.69 = 75,000 options or 750 option contracts, each covering 100 shares. Since these are call options, the options should be sold short.
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