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.

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 .69. What is the number of call options necessary to create a delta-neutral hedge?

Short answer

75,000 options

Step-by-step solution

Definition of call option

The call option is a financial instrument that provides the buyer the right to attain an asset at a specified price within the specified timeline.

Calculation of number of call options necessary to create a delta neutral hedge

Number of call options for delta hedge = No. of shares / delta

= 51,750 / $0.69

= 75,000 options