Risk Management: Introduction To (Beta-Weighted) Delta

Introduction

The beauty of options is that they have a particular delta attached to them, creating opportunities for both conservative and aggressive risk-taking. Delta reflects the change in the options price per $1 increase/decrease. In the portfolio manager Excel sheet, we make adjustments based on the price of the stock to come up with a %-delta. To what extent will our portfolio value be affected by a 1% increase in the share price of our holdings?


In this short piece, we're going to assess the basic concept around of delta. It's the prelude of an in-depth article regarding strategy allocation.


Varying versus Static Delta: Impact of Corrections on Our Current Strategies

Depending on the strategy you're implementing (depending on the stock, time frame...), delta will be either static/stable or varying. Long-term positions will exhibit rather static deltas, whereas short-term trade setups introduce more volatility.


#1: Monthly Covered-Call Writing (Portfolio Overwriting)

As of July 31, 2020 - based on the monthly Fact Sheet - our net long delta contribution of portfolio overwriting to the entire portfolio amounted to +0.23%. If our monthly covered-call writing positions were to go up 1%, the positive effect on the entire portfolio would be +0.23%. However, in case we see a correction of 10%, that net long delta would immediately increase to +0.45%. That's an increase of +0.22%.


#2: In-The-Money Covered Call Writing

Looking at in-the-money covered call writing portion of the portfolio, our net long delta was +0.11%. A 10% correction would push that rate to +0.19%.


#3: Long call LEAPs

The positive contribution of long call LEAPs stood at +0.08%. That long delta would decrease to +0.06%.


Adding it all up, a conservative portfolio w/o long call LEAPs would see its delta increase from +0.33% to +0.64% during a 10% correction. This, in turn, means that - assuming no changes in implied volatility - the loss of our portfolio would be about 64% that of a passive investor.


Beta-Weighted Delta

Beta-weighting delta is a number that tells us as to how much our portfolio would move up if the index moved up 1 point -- or how much our portfolio would move down if the index lost 1 point. Picking stocks that have a beta of <1 are considered less risky than owning the market. Along with selecting non-correlated assets and strategies, this helps reduce volatility in our P&L.


Conclusion

In the next segment, we're going to take a look at the impact of changes in implied volatility, share price, time decay and strategy allocation.

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