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April 2011 Q8iib)

S

sma09gc

Member
Hi,

I understand how the delta is calculated and the amount of stock, but don't understand how the cash is calculated. Where does the £10000 come from in the solutions? Why do we then take away the number of sharesxshare price from this £10000?

Thanks!
 
£10,000 is the cost of 1,000 options, since we're told each option is worth £10.

The calculation of the cash amount is based on working out the cost of the delta-hedged portfolio. In general, we know that a short holding in a derivative (ie -1 derivative) plus a holding of delta shares is risk-free/cash. Reversing the signs of all this, we have +1 derivative and a holding of -delta shares is equivalent to negative cash. The solutions then use this equation multiplied up by 1,000 as we're told to consider 1,000 options.
 
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