CFA Level I · CFA Level I Exam · Valuing a Derivative Using a One-Period Binomial Model
A stock trades at 50. After one period it will be either 60 or 40. A call option has an exercise price of 50. The hedge ratio (number of shares per short call) that creates a risk-free portfolio is closest to:
The hedge ratio is 0.50 shares per call. It equals the call payoff spread (10 minus 0) divided by the stock price spread (60 minus 40), which gives the same portfolio value in both states.
- A0.25
- B0.50Correct
- C1.00
Explanation
Call payoffs: 10 in the up state and 0 in the down state. Hedge ratio = (10 - 0)/(60 - 40) = 0.50. Using 0.25 or 1.00 would leave payoffs differing across states.
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