In Chapter 8, we showed that it is possible, at least in theory, to capture an option’s mispricing in the marketplace by employing a dynamic hedging strategy. The first step in this process involves hedging the option position, delta neutral, by taking an opposing market position in the underlying contract. But the underlying contract is not the only way in which we can hedge an option position. We might instead take our opposing delta position with other options.
Consider a call with a delta of 50 that appears to be underpriced in the marketplace. If we buy 10 calls, resulting in a delta position of +500, we might hedge the position in any of the following ways:
Sell five underlying contracts.
Buy puts with ...