CFA Level I · CFA Level I Exam · Valuing a Derivative Using a One-Period Binomial Model
A trader holds a long position in a call option and wants to hedge the position over one period using the underlying stock. The hedge most likely requires:
The trader should sell shares equal to the hedge ratio per call held. A long call gains when the stock rises, so a short stock position of that size offsets the risk, making the combined position riskless over the period.
- Abuying shares equal to the hedge ratio
- Bselling shares equal to the hedge ratioCorrect
- Cselling shares equal to the reciprocal of the hedge ratio multiplied by the premium
Explanation
A call gains when the stock rises, so its delta is positive. To neutralize this exposure, the trader shorts the hedge-ratio number of shares. Buying shares would double the exposure rather than offset it.
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