Greetings Fellow Optionistas— As an investor approaching retirement, I try to balance investment return and capital preservation, with my target allocation being about 65% in equities.
With options being part of the equation — mostly short puts and short calls — I look at the delta for each option to determine a delta-adjusted equity portfolio %.
If the market crashes and I am assigned all my puts, I’d be about 75% equities. But when I apply my delta adjustment, I am below my target. So I’m feeling good…. But should I feel good?
Delta-adjusted portfolio allocation
byu/resipsa701 inoptions
Posted by resipsa701
2 Comments
Getting assigned at your strikes might set you at 75%, but what about the 20% SPY drop and your beta weighted names? Will they drop 30% for e.g.? And what happens to your allocation then? Are you still good?
I’m not sure I’m following you. So your portfolio is 65% equities plus some amount of written calls and written puts. Given you say if the market drops significantly you will be 75% equities we can infer that you have a 10% gross (not delta adjusted) exposure to equities through written puts. What we don’t know is how much of your 65% equities you’ve over written. You don’t say what the other 25% is. Cash? fixed income?
Remember delta is a point-in-time value and it changes as the stock price changes. So let’s assume you have 10% gross exposure to puts at a current average of 50 delta and you have a 35% exposure to written calls at a 30 delta. If the market drops enough through your put strikes you will be put into the full 10% allocation of puts and your put delta will go to one. You call delta will likely go to zero or near there and not offer any cushion again the draw down save a bit of cushion from the premia you collected up front. So let’s say the market draws down 20%. Your:
puts become delta 1 and you have an additional ~10% exposure to equities. It wont be fully 10% because once you’re below the strikes you start losing money on those.
65% equity exposure will decline by 20% because equities are delta 1, so your equity exposure becomes 52% (assuming that the 10% cash underlying your puts and the other 25% you didn’t mention are delta 0 products or unaffected by the market drawdown). If the other 35% is impacted then your relative equity exposure will be greater than 52% but it’s hard to determine where without knowing.
calls will be all well OTM and likely delta 0. They wont offset your position from a delta perspective any longer.
So your overall portfolio equity exposure likely drops to 61% or thereabouts; 52% from the delta 1 equities and say 9% from your puts after assignment and draw down relative to the strikes.