Butterfly spread butterfly strikes

Beta Weighting Hedging

Hey everybody its Hari Swaminathan, welcome to the free course library. In this mini course, we are going to look at how you can hedge a per your portfolio with one spider trade. So let’s back up a little and see why we would need to use this in the first place, so let’s say we add a portfolio of which is a combination of stocks as well as options. So as you can see here Apple I have some stock I have 200 shares shows a little bit of profit, I have Amazon which is options we have a call spread here has a bit of loss.

Then same thing on FedEx, Google, we have some options positions so you know a normal portfolio might look like something like this. You have a few stocks, you might have a couple of options positions and now you’re concerned that the overall market might take a downward trend. For whatever reason so you know as of now in the middle of August, we are looking at the russia-ukraine crisis. So you have this portfolio you don’t want to close everything out but you want to position yourself in such a manner that even if the markets take a crash either next week or any time, your portfolio is not going to get affected a whole lot.

The way you do that is you can see now in terms of your Delta, I mean stocks have full hundred Delta so basically if you have 200 shares you have 200 Delta. Because if the stock goes up by one dollar then, you know your Apple shares will be up by $200 because you have 200 shares. But options are different depending on which strike price you have, your deltas are going to be different. If you just looked at the raw deltas you have 200 Delta’s on Apple, you have 154 on Amazon, you have 131 on fedex and 108 on google. But the deltas of all the stocks on not the same, so you know the Apple Delta is not the same as Amazon Delta. So one Delta on Apple is not the same as one Delta on Amazon because both have different correlations to the overall market.

So you would want to better wait this portfolio to the spider which is the overall market, so by when you beta weighed the concept of beta waiting is that each individual stock has its own beta which is the correlation to the overall markets. So when you beta wait it to say the spider then what you’re doing is you’re reducing every stock. It’s beta you mean the platform obviously calculates all of this for you but the platform will calculate the beta of each of the stocks in this portfolio. It will take its beta into account and it will reduce it to a common spider level Delta. So basically, if we do this if I beta weight it now, you can see in terms of the spider we would need eight hundred and sixty-one deltas on the spider.

So which means we can now come to the spider and say if you wanted we know we have positive eight hundred and sixty-one Delta. If you if we wanted to beta weight this and make it delta-neutral on the spider, we would have to buy a certain amount of spider put options. We would buy put options because we have positive Delta here and therefore to neutralise it you would want to buy the spider put options. Let’s go take a look at the spiders and let’s say we wanted to give it protection of let’s say about a month or so. Let’s go into the September series and you want to buy a certain amount of spider put options so that it equals to 861 negative Delta. You know let’s say we wanted to buy the 190 put so the spiders are at 195. So let’s we wanted to buy the 190 put and you can see if you buy 10 contracts of the Spyder puts.

You would get 255 Delta so perhaps we want to buy about 32 maybe so that we get 861, so you know you want to check that and see how you get it 843. I think the right amount would be about 34 spider put contracts of the 190 put option that gives you negative 869 Delta’s just from the spiders. If you look at your position you have 861 positive deltas and this will give you in 869 negative Delta, so you’ll be negative by about 6 or 7 Delta’s which is perfect. So now how much would this cost? this would cost about let’s say with the option is going for 1.4 so $1400, so about $4,500.

If you spend $4,500 on the spider put options, you can completely hedge your entire portfolio, so obviously your entire portfolio is probably worth a lot more you can see it’s worth about $27,000. So spending $4,500 to protect this overall portfolio is not bad and it doesn’t mean that whatever you spend on the spiders is going to go away. It’s not going to go down to 0 first of all, if the markets crashed like you fear that it might then, these put options are actually going to be profitable and not only that if over a period of the next few days say 5 to 7 days, if the risks in the market go away so in which case, you don’t need these options any longer then you can perhaps even sell them maybe for even for a small profit. If the spiders have gone down a little bit you know these put options might increase in value even if it does not increase in value and it goes down a little bit, it has served the purpose of hedging your overall portfolio.

So you can always beta wait your entire portfolio to anything, if you have NASDAQ stocks which is most of these stocks on NASDAQ. So perhaps you want to beta weighted to the Nasdaq ETF and now you can see you need actually 16 24 deltas, when you beta weighted to the Nasdaq. You want to take a look at your portfolio and decide which index it is that you would need to beta weight your portfolio on and because that’s critical. In fact, in this case you would not come to the spider you would come to the QQQ . Because all of the stocks are NASDAQ stocks, except for FedEx. All the others are NASDAQ stocks. So you would want to come and actually have a beta weight your portfolio, hedge it with the QQQ, so here you can see actually you’re going to be spending less contracts.

I mean you’ll need about less contract so let’s put 25 and there we go we have 837 negative actually may not that’s not true, you would need 1600 in this case. If you see 1624 and this gives you 16 74 gives you a little bit more, so perhaps you can just do about 45 contract,s let’s see that’s too less. So maybe about 47 contracts on the QQQ or maybe 48 and this would approximately hedge your portfolio on the Q’s. Because most of these stocks are NASDAQ stocks, so you would want to hedge it against the Q’s. So again you would spend around the same amount , you would spend about forty five hundred, forty six hundred on this and of course, you can close out this hedge at any time. But the important thing is when you want to know how many Q’s you have to buy, how many contracts of the Q’s you have to buy, you have to beta wait it to the Q’s and that will give you the exact deltas, that you on the queues to completely hedge this portfolio. So if you take off the beta waiting you’ll see you have only a raw Delta of 594, but then just having the raw Delta doesn’t make any sense because all of these stocks are going to move differently.

So you want to reduce them all to a common base and you do that by beta weighting it against the q’s. Hope this was helpful if you have any questions please send us an email at info@optionTiger.com. Thank you.

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