We hold these truths to be self evident, that all stocks are not created equal, that they are endowed with various betas and cannot all be treated the same if traders want to achieve portfolio growth and profits, especially those with smaller sized accounts and that the thinkorswim platform can solve this problem. All traders need to know the concept discussed here.
The option greek that quantifies the directional risk of a position is known as delta. A position with +50 deltas means that we can expect $50 of profit for a 1-point increase in the underlying or a $50 loss if the underlying decreases by 1 point. It’s a simple calculation if we are only trading one underlying.
The problem is that a big part of the tastylive philosophy is to be diversified in positions. How do we measure our overall risk when our portfolio consists of numerous underlyings? Adding them together doesn’t work as Tom and Tony explained. A visual aid was used.
A table of the stock price of a $50 and $500 stock was displayed. The table included the position delta and theoretical P/L after a 1% move on both. The table showed that using the raw deltas gave us an inaccurate gauge of directional risk. The answer is beta weighted deltas. A formula of how we beta-weight the deltas to a certain underlying was displayed. We normally use the SPY (S&P 500 ETF) for beta-weighting portfolios. The formula for the calculations was displayed. The thinkorswim platform can do this for you.
An example using long 25 shares of JNJ (Johnson & Johnson) to find the SPY-weighted JNJ delta was displayed. The example showed that if SPY increased by one point, the theoretical profit on our JNJ shares would be plus $9.
A graphic using NFLX which has a beta of 1.3 to the SPY was displayed. The graphic using a NFLX call was both unweighted and beta-weighted to the SPY. The graphic showed that the NFLX call had a larger delta exposure by beta-weighting to the SPY than the unweighted. The graphic helped to show what your real risk is.
As mentioned above, we normally use the SPY as the object of our beta weighting. We can use any underlying and sometimes, if we are very concentrated in one area, a different underlying may be a better choice (such as the QQQ if we were heavily into tech stocks.
Watch this segment of “tasty BITES” with Tom Sosnoff and Tony Battista for the takeaways and other information to help you understand beta-weighting to get a more accurate representation of your directional risk.
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