Question

Use the following case in answering Problems 10 – 15 : Mark Washington, CFA, is an analyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market would most likely experience a slight downturn and suggested delta-hedging the BIC portfolio.

As predicted, the U.S. equity markets did indeed experience a downturn of approximately 4% over a 12-month period. However, portfolio performance for BIC was disappointing, lagging its peer group by nearly 10%. Washington has been told to review the options strategy to determine why the hedged portfolio did not perform as expected.

Washington considers a put option that has a delta of .65. If the price of the underlying asset decreases by $6, then what is the best estimate of the change in option price?

Short answer

$3.90

Step-by-step solution

Definition of put option

The put option is a financial instrument that gives the owner the right to sell an asset at a particular price within the specified timeline.

Calculation of the estimated change in price of the option

Change in estimated price = Change in asset price x delta

= (-$6) x (-.65)

= $3.90

This implies that the option price is estimated to increase by $3.90.