From this link: http://gcc.gnu.org/onlinedocs/gcc/Directory-Options.html
If a standard system include directory, or a directory specified with -is
The documentation says:
-isystem dir
Search dir for header files, after all directories specified by -I but before the standard system directories. Mark it as a system directory, so that it gets the same special treatment as is applied to the standard system directories. If dir begins with =, then the = will be replaced by the sysroot prefix; see --sysroot and -isysroot.
So you're using it wrong. You need to specify a directory for the -isystem option itself, it doesn't work like a "modifier" of the -I option like you seem to be trying.
I believe your command should be:
$ gcc -isystem ../include hello.c
System headers get special treatment w.r.t. warnings (since they are read only, and some cannot be written in strictly conforming code)