Quote from tradingjournals:
Do you agree or disagree with the hedged bets comparison to the vanilla option?
It looked correct, at first glance, although I confess to not really spending too much time on it.
jcapital gave an interesting insight, by noting that hedged positions may lower premium compared to what they might request under no hedge.
I don't quite understand what particular insight you might be referring to here. From what I could tell, Ran.Cap's point was simply an illustration of a well-known and well-understood fact that one of the "fudgey" assumptions that are indispensable to option pricing is the so-called completeness of mkts. It's also a well-known and well-understood fact that option sellers are short implicit liquidity risk, i.e. they're the ones that get screwed if the completeness assumption gets violated. Option prices do take this into account, although it's understandably difficult, if not impossible, to decompose option prices into "volatility premium" and "liquidity premium". If this is the insight you're struggling towards, I wish you the best of luck. If/when you manage to quantify liquidity risk, pls let me know and I will personally pay for your ticket to Stockholm, so that you can claim your Nobel Prize.
If the insight you're referring to is something else, I don't know what it is, I am sorry.
Could the hedging process by its nature of moving a bit of risk away to the other guy leads to systematic relative underpricing and overpricing of options?
Firstly, relative to what? Secondly, see above.
If we take the idea a bit further, could an implicitly hedged position (like vanilla call) be affected because of its internal hedge in addition to the hedging external to it?
I have absolutely no idea what makes a vanilla call "an implicitly hedged position". I also don't really understand what an "internal hedge" is. A vanilla option, to me, is the basic irreducible contract that I can price from first principles, if necessary (with some assumptions about the mkt and using a replicating portfolio that consists of basic non-contingent instruments). If I am not mistaken, it seems to me that your notion of "internal hedge" depends on the ability to replicate a vanilla option payoff using digital options. That, to me, is invalid circular reasoning, as I don't know how to price digitals unless I know how to price vanilla options. Again, I apologize if I have misunderstood your point.
If you were someone interested in playing the delta effect, would you use bet1, bet 2, vanilla call, a combination of the three/etc? Explain how and why.
In practice, the answer is obvious. In theory, I believe you will find the passage above relevant to this question as well.
Would it be too much to ask you to just clearly say what you want to say? I am happy to play along, but it would be mighty nice to know where we're all headed with this.
