Hi,Does anyone have a reference, or suite of references, that comment on the dynamic hedging of an option (written on an underlying S and with maturity T) with some other option (also written on S but this time with maturity T' > T)?Any ideas would be much appreciated.Thank you in advance,trent4213

I dont mean to be rude but your question is like asking : How do you manage a trading book ?Well, if you know your options theory and dont see how people actually use it in real market situation but you are curious enough to ask here, I'd suggest you get some field experience at a trading desk rather than looking for papers.Depending on the business you'll be working on you ll see quite different ways of managing a book while using the same theory (different market - equity / commodities , different business flow trading - structured products ) ...Good luck

QuoteOriginally posted by: trent4213Hi,Does anyone have a reference, or suite of references, that comment on the dynamic hedging of an option (written on an underlying S and with maturity T) with some other option (also written on S but this time with maturity T' > T)?Any ideas would be much appreciated.Thank you in advance,trent4213Carr has written a paper on hedging an option with shorter term options and dynamic hedging with the underlying afterwards.However if you want to dynamically hedge an option with another option without using the underlying you are in fact treating the market as incomplete and you need to price the option accordingly. You can see this artificial incompleteness by setting up a BS PDE using 2 options, a market price of risk will enter the PDE, similar to the situation when deriving the Heston PDE.

As frolloos says (except I'd say more like the one-factor interest rate situation). You get a market price of risk. If the market is really complete (i.e. you can hedge with the underlying, and this is all just a fun exercise) then you can go the extra step of observing that the underlying must be a solution of the PDE and this then gives you the form of the market price of risk, and you are back to the BS equation.P