# Options Theory: What is Beta Weighting? | Tackle Trading

Today we’re tackling a few key questions surrounding portfolio management & beta weighting.

What is Beta Weighting?

Beta weighting allows you to modify the delta of all your positions to a single underlying. I think of it as the common denominator. It is necessary to do this if you want to measure the overall risk or directional exposure of your portfolio BECAUSE you can’t add the deltas of different stocks. For example, if you have +25 delta on AAPL and +30 delta on MSFT, then ThinkorSwim will say your total delta is +55 for the portfolio.

This is nonsense because 1 AAPL delta is not the same as 1 MSFT delta. For starters, they both have different stock prices, so a $1 move in one is not identical to a $1 move in the other. Furthermore, even if they were the same price, they will likely have different volatilities. Maybe one of them typically moves $3 a day, and the other only moves $1 a day.

So, it becomes necessary to translate the +25 AAPL delta and the +30 MSFT delta to whatever the equivalent would be in terms of SPY deltas. Essentially we can use the historical relationship of AAPL vs. SPY and MSFT vs. SPY to get a sense of how much either position would increase if SPY rises $1 dollar.

When you click the beta weighting button and input SPY as the underlying, it will modify the +25 AAPL delta to, say +30 SPY deltas. And it will change the +30 MSFT to deltas to maybe +20 SPY deltas. With both positions stated in like terms, you can now add them to identify that your net exposure is +50 SPY deltas.

That means your portfolio is the equivalent of 50 shares of SPY. For every $1 increase in the SPY your portfolio will rise $50, and for every $1 decrease in SPY your portfolio will fall $50.

Here’s a screenshot of a sample portfolio that contains seven different options positions. Note the Beta Weighted SPY deltas is 179.

The next question is to figure out what is an appropriate delta given your portfolio size. Before I dive-in let me preface by saying I’m assuming we’re talking about an active trading account that uses options strategies. If you’re buying shares of stock over time as a passive investor, then your delta will undoubtedly be much higher than what the active trader would be comfortable with. Here’s the thought process I use in figuring out what is an appropriate delta.

First, what is your account size? Suppose it’s $30K

Second, how much would you be okay with the account fluctuating on a typical day? Suppose it’s 2% or $600.

Third, what is the current Average True Range (ATR) of SPY? Right now it’s $3.50. That means the market is moving $3.50 a day on average.

Fourth, divide the ATR into the dollar amount you’re okay with your account fluctuating on a daily basis. ($600/$3.50).

The answer to that formula, 171 in this case, is what I would consider an appropriate delta for the account. So, if I didn’t want to see my $30K account fluctuate much more than $600 on a typical day, then I would keep the delta between +171 (when max bullish) and -171 (when max bearish).

If my delta grew larger than 171, then that would mean adjustments were in order. I would either exit bullish trades or add bearish.

If my delta grew larger than -171, then my portfolio would be too bearish. I would either exit bear trades or add bullish ones.

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*Originally published at **https://tackletrading.com** on October 18, 2018.*