The “Option Greeks” are an obscure group of letters and symbols that most traders tend to ignore.But those of us who understand how they work? We can make the money that others lose. You’ve probably heard of some of them. Delta, theta, gamma, and the lesser used: rho and vega. Most of these terms apply to the options contract itself. However, there is another Greek that’s just as important to be aware of that I don’t see many educators talking about. And that is Beta.
A stock’s beta measures how the price of the individual stock moves compared to the price of the S&P 500.In short, it’s a volatility score. Beta is expressed as a decimal ratio, such as a beta of 1.5 versus a beta of 0.8. The stock with a beta of 1.5 will, on average, move 1.5% for each single percent the S&P 500 moves. Meanwhile, the stock with a beta of 0.8 will move 0.8%. This tells us something critically important when setting up an option trade: How volatile the price action is of the stock we’re buying an option on. A higher beta corresponds to more drastic price movement up and down, while a lower beta corresponds to less drastic price movement as the market ebbs and flows. Now, the simplest and most effective way to use this in our option trading is a strategy like this… Using higher beta stocks for day trades — in order to get bigger relative moves on the stock itself, and using the lower beta stock for longer term swing trades or position trades — where we have more time to expiry and less drastic volatility, meaning we are more likely to avoid being stopped out of the trade. Here’s an example of my ThinkOrSwim setup where I have beta at the bottom of all my stock charts:
Now, beta itself can move up and down, so to find the beta on an average-basis, I simply look down the visible middle line of the chart plot to get the average value. You can also add a moving average to the study to get the moving average of the beta.click here to learn more, and become a smarter trader tomorrow.There are many ways to use this value to fine-tune option trading, and I hope you’ve found this article a good place to start incorporating this often-overlooked bit of data into your trading. Ultimately, it helps with predicting and anticipating the move of the profit and loss of a given option trade, and the ability to anticipate profit and loss effects is, in my opinion, the most essential skill a good trader possesses. For more in depth training on options trading, be sure to join me live in the Trade Room every single week day at noon and 3pm ET. I cover concepts like this and much more in greater detail during my daily coaching sessions. If you’re not already a member,
Until Next Time,
Bryan Klindworth Senior Analyst, Kings Corner