XYZ stock is currently at 100. A 3-month 100 strike call is at 8.00. The delta is 0.55. You buy 100 calls and delta hedge by trading 55 shares of stock.
Answer the following:
a) Do you buy the stock or sell short the stock to set up the hedge?
b) Tomorrow, the stock opens at 95. You need to rebalance your position. Will this require buying stock or selling stock?
c) The next day, the stock opens up back at 100. You rebalance again. At this point, after rebalancing twice, are you holding a substantially bigger stock position than you did at first, a substantially smaller stock position, or about the same?
d) Over the two days, did you make a significant profit, a significant loss, or hardly any profit or loss on your trading?