but this won't solve your problem since you don't understand gamma ...
Continous hedging as a rachet device to lock-in profits
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But you made it wrong twice in different postings... I don't think it was just a typo...
So, you are no wiser than me, man! Welcome on board! Learn something
I'll answer because you seem genuinely interested in this stuff.
For the purposes of deriving any pricing methodology for options, only delta hedging is required. That is what every pricing model does out there (BSM, binary, etc).
Now because in the real world it is impossible to continuously delta hedge, anyone that needs to hedge their deltas (option dealers, big volatility guys, so forth) tend to also hedge gamma one way or the other. But it is question of practicality.
This is not a correct answer to his question imho ... for derving options delta is necessary ... but due to gamma, delta changes continuesly and you need to adjust your delta, gamma measure how much the delta changes as the price of the underlying moves so you can't delta-hedge without it ...
gamma-hedging is however something else, that is used in a portfolio of options ... no market maker wants to be either totally short options or totally long ... they like to balance all their greeks ... but it's get way too complicated ... walk before you can run ...
gamma-hedging is however something else, that is used in a portfolio of options ... no market maker wants to be either totally short options or totally long ... they like to balance all their greeks ... but it's get way too complicated ... walk before you can run ...
From the famous article that was recently posted here or in an other of the options threads:
http://www.riskencyclopedia.com/articles/dynamic_hedging/
"To recap, dynamic hedging of a negative gamma position loses money. Dynamic hedging of a positive gamma position makes money. To make sense of this observation, note that negative gamma positions arise when you sell options. You receive a premium for selling the options but lose money dynamically hedging the negative gamma position. Positive gamma positions arise when you buy options. You pay a premium for the options but make money dynamically hedging the long options position."
Ok, but in my testing it works even without considering Gamma. But as said I used a different algo than the classic textbook algo...
http://www.riskencyclopedia.com/articles/dynamic_hedging/
"To recap, dynamic hedging of a negative gamma position loses money. Dynamic hedging of a positive gamma position makes money. To make sense of this observation, note that negative gamma positions arise when you sell options. You receive a premium for selling the options but lose money dynamically hedging the negative gamma position. Positive gamma positions arise when you buy options. You pay a premium for the options but make money dynamically hedging the long options position."
Ok, but in my testing it works even without considering Gamma. But as said I used a different algo than the classic textbook algo...