Differences between Stop-loss strategy and dynamic hedging

[Liming]

Dear David,
I’ve had some confusion, misunderstanding and doubts when doing 09 Level I Annotated Boot Camp. Appreciate your kind help on this!

What are the differences between Stop-loss strategy and dynamic hedging? Aren’t they both referring to a situation in which a trader is shorting an option and is constantly hedging this short option positions with constantly adjusted amount of underlying stocks?

Thank you for your enlightenment and correction!
Cheers
Liming
16/11/09

 

[David Harper CFA FRM]

Hi Liming,

The stop loss is inferior: it naively buys a stock (when price rises) to "cover" the ITM written option and sells (when price drops) to be "naked" with option is OTM.
The dynamic hedge is constantly rebalancing to maintain a delta-neutral position,
as illustrated in: http://www.bionicturtle.com/premium/spreadsheet/4.b.5_dynamic_delta_hedge/

some helpful (I hope) recent discussion here: http://forum.bionicturtle.com/viewthread/2047/P15/

David