What’s Your Portfolio’s Risk Level? Beta Weighting on thinkorswim® May Offer Clues

If someone asked you how risky your portfolio is, you’re probably not going to come up with a quick and accurate answer. You may know how much each of your positions is making or losing, but that’s only a piece of the risk puzzle.

Most traders have a bunch of stocks or options positions in their portfolios. Each position is like a bowl of different pieces of fruit. If you were to compare the different pieces of fruit, you’d be weighing apples against oranges or oranges against bananas. Each fruit has different characteristics, very much like each position in your portfolio. One stock position might have a different price than another. One options position might have a different price, volatility, or delta than another. These differences make it difficult to figure out the risk of your entire portfolio. 

This is where beta weighting your portfolio comes in. It’s a great way to place all your positions into a single, standard unit. So, instead of looking at a medley of fruit, suddenly you have a bowl of apples you can more easily assess against each other.

“When you have a lot of options positions, it’s a good idea to assess them and make adjustments to keep things under control,” said Michael Follett, education coach at TD Ameritrade. “With beta weighting, a trader can measure the risk levels of a portfolio and have the opportunity to assess and make potential adjustments to each position’s risk levels.”

Beta Weighting: What It Means

Before getting into the nuts and bolts of beta weighting, it’s important to understand how delta works. Delta gives you an idea of how much the price of an option could change relative to a change in the price of the underlying, with all other factors held constant. So, a delta of 0.70 means that if the underlying goes up by $1, the price of the option will move up by $0.70. Each underlying is likely to have a different delta, and that makes it difficult to assess how much your overall portfolio could move in relation to the broader market.  

You’ve likely heard the term beta before. It’s often used to measure the volatility of a given stock against the volatility of an index. If, say, a stock tends to move a similar percentage to an index’s percent move, then that stock will have a beta of one when compared to the index. But if a stock moves a higher percentage than the index’s percent move, that stock’s beta will be higher than one in comparison to the index. You can also use a similar comparison between the volatility of two stocks.

So, when you beta weight your portfolio, it standardizes the risk levels of individual positions by converting the delta of each position relative to a comparable index or benchmark. This makes it possible to do an “apples-to-apples” comparison of all your positions. Beta weighting could help traders assess the various positions in terms of a portfolio’s systemic risk, which is the risk borne by the market as a whole.

How to Beta Weight Your Portfolio

Here’s a quick breakdown on how you can use the beta-weighting tool on the thinkorswim® platform (desktop and mobile). Fortunately, you don’t need to know any portfolio beta formulas or anything about beta coefficient multiple regressions. 

Under the Monitor tab, select Activity and Positions. You’ll see that each of your positions has a different delta. 

To beta weight the portfolio, select the Beta Weighting checkbox at the top of your Position Statement (see figure 1). Then select the symbol of the index or other benchmark you want to beta weight to (or compare all positions relative to that symbol) from the menu. Say you want to beta weight the portfolio relative to the S&P 500® index (SPX). Select Indices from the symbol menu, then SPX. The beta-weighted delta of your portfolio will be represented as equivalent to the SPX.

Sometimes if you apply beta weighting, a symbol in your account may display NA. This could mean the position is a mutual fund or newly issued stock. You can request an NA be converted to a beta-weighted number by selecting the Help tab at the top of the screen and contacting the thinkorswim support team.

The Common Denominator

Converting deltas of individual positions into stock or index equivalent deltas could give you a better understanding of how much risk exposure you really have. You may find that an individual position had a low delta prior to beta weighting, but in relation to your entire portfolio, it may be higher than you thought.

If you have multiple stock and options positions, it might be difficult to conceptualize portfolio risk levels. “The beta-weighting tool could help investors understand their market exposure even if they have complex portfolios,” concluded Follett. Having this additional insight can help make portfolio hedging decisions.