Today, on this segment of "The Skinny On Options Modeling", Tom Sosnoff, Tony Battista and Tom Preston discuss beta weighting a portfolio.
Beta weighting is a method to adjust deltas in order to normalize them for different stocks. For example, 100 deltas in MSFT doesn't have the same P/L or risk as 100 deltas in GOOGL. A one dollar in GOOGL is more likely than a one dollar move in MSFT because of both price and volatility so a trader cant simply sum the deltas to see the delta of a portfolio comprised of GOOGL and MSFT.
A trader can use beta weighting to adjust each stock's position delta by the stock price, the stock's beta to the index (we default to SPY) and the price of the index to transform the delta in terms of the stock into deltas in terms of the index. The delta of a stock estimates the P/L if the stock moves one dollar while beta weighted deltas estimate the P/L if the SPY moves by one dollar.
The beta weighted delta of a portfolio is the number of deltas of the beta symbol (eg. SPY) that would hedge the portfolio. If a trader uses SPY to beta weight the deltas and the result shows the portfolio is long 500 SPY then 500 short SPY deltas would result in a zero delta for the portfolio. The short SPY deltas would be accomplished by shorting the SPY, selling SPY calls or buying SPY puts (or even shorting E-mini futures).
Beta weighted deltas are just a snapshot of risk which is why the hedge was imperfect and there was a loss. Time, price changes and a change in volatility all can change a stock's beta. That is why frequent monitoring of your numbers is necessary to make sure your hedge is maintained.
Watch this episode of "The Skinny On Option Modeling" with Tom Sosnoff, Tony Battista and Tom Preston for an explanation of beta weighting deltas and how it may help your P/L.
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