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The Cost of Delta

Market Measures

The major stock indices have all made new all time highs since Donald Trump became President Elect. As contrarians, at market extremes, we like to fade them and play the Pot Odds to the down side. We have several choices for getting short. What’s the most efficient way to take a directional shot? How can we get the most bang for our buck?

The first step is to know how we should judge each strategy. We need to determine what its Delta is so we know how much we will make should it move in our direction. We need to calculate the Buying Power Reduction (BPR) to make sure we are getting a good “bang” for our “buck”. We must measure the risk and the reward. Finally, we need to know the probability of profit (POP). A P/L graph was displayed for 4 different ways of getting short (short 100 Shares, short at-the-money (ATM) Call, short Call Spread and long a Put Spread).

Higher Delta options are more efficient than further out ones so, we compared a SPY (S&P 500 ETF) short at-the-money (ATM) Call to a short 16 Delta Call. We saw that to achieve a higher Delta, barely any more capital (BPR) is required.

We then compared the short Calls to an ATM Call & Put spread. A table included the Delta, BPR and Delta per Dollar BPR. We saw that defined risk spreads have the most Delta bang for the BPR buck. We also compared the POP, potential profit and loss potential of each strategy based on a 2 Standard Deviation (SD) move in 57 days. This enables us to judge our risk versus our reward.

Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and an examination of the most efficient way to take directional risk using the least amount of BPR.

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