Question

Use the following case in answering Problems 10 – 15 :

Mark Washington, CFA, is ananalyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market wouldmost 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 approximately4% 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 optionsstrategy to determine why the hedged portfolio did not perform as expected.

Return to the previous problem. Will the number of call options written for a delta-neutralhedge increase or decrease if the stock price falls?

Short answer

increase

Step-by-step solution

Definition of call option

A buyer gets the right to obtain the investment at a particular amount within the timeline through the financial instrument called call option.

Calculation of number of call options written for delta neutral hedge

Since the number of calls needed for delta hedge is inversely proportional to the delta, the price decrease leads to decrease in delta. This implies that the fall in stock price would lead to the increase in the number of necessary calls.

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