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The Why and How of Beta-Weighted Deltas

From Theory To Practice

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Delta itself is a fairly straightforward concept to understand – it represents the move in an option’s price given a $1 move in the underlying. From this, we are able to deduce our directional risk and even an approximation of the pertinent probabilities. However, all deltas are not created equally. The delta in a growth company like AMZN or NFLX is not the same as the delta in a value company like PEP or CLX. This is why we like to beta-weight our deltas.

To beta-weight our deltas, we convert all of our raw deltas into some standardized measure using a broad based index, like the S&P 500. Remember that beta effectively takes each stock’s risk relative to the overall market, so by translating an individual stock’s delta to a SPY-weighted delta that factors in its beta, we are able to compare one underlying to another more easily and effectively. Raw deltas, however, are still extremely useful when it comes to trade management.

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