ST1 Delta hedging with fed prices

A stock and two options are hedged against a Treasury strip. The case feeds the bid and ask of the stock and the options.

Objective

Hedge the short option so final wealth does not depend on where the stock goes. Graded on final wealth.

What it shows

• Delta hedging with prices that are given, not made.
• Why the call and the put need opposite hedges.
• A short option as a position that has to be managed, not just held.

Watch out for

• Hedging with the wrong sign for a put.
• A fed quote that moves faster than the hedge.
• Orders of up to 10,000, so a hedge can be placed in one trade and cannot be undone for free.

Who takes part

• Desk A — half the class. Starts short 2,000 calls, C320.
• Desk B — the other half. Starts short 2,000 puts, P360.
• Both trade IMB, the stock, and STRIP, a Treasury strip that pays 900; bid and ask for IMB and the options are fed.

Class size

Any size. Quotes are fed, so each student hedges alone; the strip is the only security the class prices.