482 Part IV: Additional Considerations 
follow-up monitoring technique, using the deltas of the options involved, is present­
ed later in this chapter, and has been described several times previously. 
FACILITATION OR INSTITUTIONAL BLOCK POSITIONING 
In this and the following section, the advantages of using the hedge ratio are outlined. 
These strategies are primarily member firm, not public customer, strategies, since 
they are best applied in the absence of commission costs. An institutional block trad­
er may be able to use options to help him in his positioning, particularly when he is 
trying to help a client in a stock transaction. 
Suppose that a block trader wants to make a bid for stock to facilitate a cus­
tomer's sell order. If he wants some sort of a hedge until he can sell the stock that he 
buys, and the stock has listed options, he can sell some options to hedge his stock 
position. To determine the quantity of options to sell, he can use the hedge ratio. The 
exact formula for the hedge ratio was given earlier in this chapter, in the section on 
the Black-Scholes pricing model. It is one of the components of the formula. Simply 
stated, the hedge ratio is merely the delta of the option - that is, the amount by which 
the option will change in price for small changes in the stock price. By selling the cor­
rect number of calls against his stock purchase, the block trader will have a neutral 
position. This position would, in theory, neither gain nor lose for small changes in the 
stock price. He is therefore buying himself time until he can unwind the position in 
the open market. 
Example: A trader buys 10,000 shares of XYZ, and a January 30 call is trading with 
a hedge ratio of .50. To have a neutral position, the trader should sell options against 
20,000 shares of stock (10,000 divided by .50 equals 20,000). Thus, he should sell 200 
of the January 30's. If the hedge ratio is correct - largely a function of the volatility 
estimate of the underlying stock - the trader will have greatly eliminated risk or 
reward on the position for small stock movements. Of course, if the block trader 
wants to assume some risk, that is a different matter. However, for the purposes of 
this discussion, the assumption is made that the block trader merely wants to facili­
tate the trade in the most risk-free manner possible. In this sample position, if the 
stock moves up by 1 point, the option should move up by ½ point. The trader would 
make $10,000 on his stock position and would lose $10,000 on his 200 short options 
- he has no gain or loss. Once the trader has the neutral position established, he can 
then begin to concentrate on unwinding the position. 
In actual practice, this hedge ratio may not work exactly, because it tends to 
change constantly as the stock price changes. If the trader finds the stock moving