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Home» CIPM Exam Tips & Tricks » Option Hedge Ratio

Option Hedge Ratio

Posted by John D. Simpson, CIPM - April 7, 2015 - CIPM Exam Tips & Tricks

options - doors

Continuing on the theme of errata, the CIPM Program recently made a change to one of the Learning Outcome Statements in the Return Measurement study session at the Expert Level.  I am happy to see this change made, as I made this suggestion several years ago.

One of the Learning Outcome Statements that has been in the curriculum since it’s introduction has read as follows:

calculate the hedge ratio (delta) of an option and determine whether the option is in-the-money, at-the-money, or out-of-the-money

The portion in bold italics font has been a concern to me for several years, because the formula/mathematics and logic behind option valuations is not covered in the curriculum materials.

The Expert Level errata now contains a revised Learning Outcome Statement:

determine whether an option is in the money, at the  money, or out of the money, given the hedge ratio (delta) of the option
The new LOS is really quite simple; the key points to know are as follows:
  • Hedge ratio is a function of stock price, term of option contract, expected variance of stock price and the risk-free rate
  • If stock price is considerably below strike price (deeply out-of-the-money), hedge ratio approaches zero
  • If option is at-the-money (stock price and strike are roughly equal), hedge ratio is .5
  • If option is deep in-the-money, hedge ratio approaches 1

Happy studying!

call options, CIPM, CIPM Expert, derivatives, John D. Simpson, option contracts, performance measurement, return calculation, The Spaulding Group

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