Option hedging for EES

Eugene,

Bob and I had a discussion about your question you raised yesterday.

For an option writer, he has the obligation to deliver, so he hedges it with
the underlying by adjesting delta positions. The hedging cost, theoretically,
should be equal to the fair value of the option premium.

On the other hand, for the option holder, he has no obligation, by delta
heging,
he would pay double for the option, with no upside. So he should not hedge
it at all.

If the option holder wants to protect the time value of the option, he should
sell
the option to the market or some equivalent options to create a theta-neutral
portfolio.
This may require trading in both the orginal and the equivalent option
underlyings.

Our question to you, if the call options you mentioned are embedded in the
EES
contracts, say fixed price sale contracts, What makes it possible to just
separate those options
and sell them to the market to retain the full values of the options ? We
conjecture that these
options are meant to hedge the original contract. By selling those options
you eliminate the upside of the
original contract.

Give one of us a call if you want to discuss this further.

Zimin