What are the pros and cons of delta re-hedging an option combination (straddle, strangle etc...) with options of the same underlying rather than with the underlying itself? I am having a hard time finding litterature on the subject.
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$\begingroup$ If you can hedge your position with an option cheaper than the underlying it feels more like arbitrage. $\endgroup$– berkorbayDec 5, 2016 at 22:04
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$\begingroup$ google 'static hedging of options' $\endgroup$– Alex CDec 5, 2016 at 23:17
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$\begingroup$ @ Alex C. Thanks for the info. There are quite some papers on the subject, mainly dedicated to exotic (barrier) options. $\endgroup$– NicolasDec 7, 2016 at 9:15
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2 Answers
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Delta hedging with other options would give you exposure to the implied vol dynamics of those options. Delta hedging with the underlying gives you exposure to the realized volatility of the underlying.
It will also change the gamma/vega of your position which can be a significant improvement over just hedging with the underlying.
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On top of my head, there are two reasons. One is that the underlying may not be accessible, while you can buy/sell options on exchange or OTC. The other (more important) reason is your position on other greeks (gamma, vega, etc). With appropriate options you can adjust both your delta and other greeks.
