The answer here states:

For instance a volatility product that would expire at 10:42 am on a random day would be off term. One that expires at the same time than a major listed contract would be term vol.

Your desk will quote off term products with a higher margin/spread because they are harder to hedge.

Consider say a March COMEX Gold Option (which has an April COMEX Gold Futures underlying), and say we are trying to delta hedge an OTC Gold Option over an April COMEX Gold futures contract expiring at the start of February (so 'off term' using the above terminology).

Why would it be more difficult to hedge the OTC Gold Option compared to the on exchange March COMEX Gold Option (they both have the same underlying). Could you just delta hedge the OTC option as per normal up until its expiry, or is there some assumption in the Black Scholes model that invalidates the price relationship between the underlying and an option that expires earlier?

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    $\begingroup$ Yes you can, but it introduces a hedging error, because you don't know the IV to use for the March (since the March does not trade); you can use the IV for the April which is known, but both conceptually and practically it may not be the right IV to use. You need an IV to compute the Delta to use for Delta Hedging. Perhaps you might use the April IV with some ad-hoc adjustment... $\endgroup$ – noob2 Feb 16 at 14:33
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    $\begingroup$ To get some ideas about something a bit less ad hoc: researchgate.net/publication/… $\endgroup$ – Bram Feb 17 at 13:06
  • $\begingroup$ @noob2 that should probably be the answer! $\endgroup$ – Trent Feb 23 at 10:13
  • $\begingroup$ @Bram looks interesting but I'm a bit lost in the detail. Is this paper just outlining alternative pricing models that don't assume a constant volatility through time, and thus can be used to delta hedge an option that expires earlier? $\endgroup$ – Trent Feb 23 at 10:14

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