Why delta hedge when one can gamma hedge?

[baraider]

If you work at a bank, you need to hedge unless you want to lose your shirt and you want the control office, compliance folks eat you alive.

If it's your money then you can do whatever you want: all in or nothing.

[Baltazar]

dongta

option price do depend on the stock/index/whateverunderlying level but also on dividend/volatility/time/interset and so on.



If you want to trade dividend through option, you'd rather by neutral with the underlying and volatility moves, hence you will hedge stock moves with delta/gamma and volatility by other options/var swaps,



if your play on dividend was rigth you will gain money.

[jaiman]

This is an even more silly question: why do you delta-hedge if you want to make some money? What do you gain in this game?



It depends, a prop trader looking to take a directional view wouldn't hedge delta and then has to deal with the consequences of his view being wrong.



A market maker, though, is basically in the business of manufacturing and selling options. The input costs on an option would be your hedging costs (delta, gamma, vega, etc) so as long as you are selling the option for more than it cost to manufacture you're making money.

[kr]

to that end, any trader worth his salt will bet on outcomes where signal-to-noise is at least semi-decent - and in most cases, the place where that's worst is in the outright market direction, so in that case being delta flat is a good start. To some extent that is because either liquidity or being a price-maker means that it is easier to take money out of something other than market direction outright. I.e. if I am in the business of replication then I will just overcharge for gamma to the best of my abilities, since I will never be able to undercut the index trader.

[Jurassic]

>A market maker, though, is basically in the business of manufacturing and selling options.



Does this argument that market makers are manufacturers work outside options?

[day1pnl]

yes, it does work outside options. more crudely you could say a derivative is manufactured simply by holding a collection of proxy-hedges. But there are some caveats to any choice of the collection of proxy-hedges as hinted above

[katastrofa]

A more "social" explanation of the term "manufacturing" is that people working on those desks like the idea that they're actually producing something.

[ronin]

> more crudely you could say a derivative is manufactured simply by holding a collection of proxy-hedges



You could say it, but it wouldn't be correct. A derivative is a contract for some exchange of payments. It is created when the contract is executed. Either side can hedge it, not hedge it or mishedge it - doesn't affect the derivative contract in the slightest.



It doesn't really work outside derivatives. You can't just create another share of IBM or a UST. And you definitely can't create oil or gold. On the other hand, you can create shares in ETFs. So there.

[day1pnl]

Sure, but then an options isn’t “manufactured” by the buying or selling of delta either... but that is to my understanding what is meant by the term, no? Or perhaps i simply (incorrectly) do not distinguish between the terms “manufacturing” and “replication”... ive always heard the terms used interchabgeably

[ronin]

Options can be created, extinguished and replicated.



If you and I trade an option between us, we "created" it. One or both of us may be hedging it, so the payoff is "replicated" on that side - but it doesn't have to be. At some point in the future, one party can ask the other to get out of the option in exchange for some cash changing hands. If the other party accepts, the option is duly "extinguished".



The expression "manufacturing" is a bit strange. I would understand it to mean "creating" an option. I can see how in a certain context it could mean "replicating" an option as well.



That's the problem with language. Words can mean different things to different people in different contexts.