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welcome back everyone to Mike and his white board my name is Mike this is my white board and today we're going to be talking about hedging so we talked a little bit about this when I cover Delta and we talked about Delta hedging which is what we're going to talk about today but we're also going to talk about some other aspects of hedging that aren't so Orthodox we're going to look at some unorthodox ways of hedging our portfolio and I think it's going to be very revelatory in that sense so let's get right into it and we'll talk about the difference between just buying stock and using a covered call instead to hedge because at the end of the day a covered call is a form of hedging stock so when we look at hedging we're basically looking at minimizing risk so when we're looking at minimizing risk when we're talking about long stock I've got this full circle here and it's signifying directional risk so if I'm just buying long stock and I'm fully exposed with long stock I'm also fully exposed to that directional risk however if I use a covered call instead which is buying stock and selling a call against it which have differing assumptions in terms of direction what I do is I take a chunk of that directional risk out of the equation and it reduces that directional risk for me so this is great for a few reasons and we're going to talk about that on the next slide here so when we go to the next slide we're going to be talking about how we can use long stock and selling a call against it and what that means directionally so we know that if I'm buying 100 shares of stock let's say at $50 which would be an investment of $5,000 in a cash or IRA account that's going to be a bullish assumption so again a bullish assumption just means that I want the stock or underlying to go up so if I buy shares of stock for me to profit I would sell those shares for a higher amount so obviously I would want that underlying to go up in price for me to do that what I can do instead of just buying the long shares is also sell a call against it so we have to remember that a call contract or any option contract for that matter unless you're trading a mini is going to represent 100 shares of long or short stock so in this case if I'm selling a call contract at expiration it's going to represent 100 short shares of stock so if I'm buying 100 shares at 50 and I'm selling a short call at 55 which still gives me some room to the upside to be profitable and I'm also collecting a credit of a dollar 50 cents which is really a hundred and fifty dollars and it also has a bearish assumption what this does is it gives me two positions that battle against each other but my long shares will eventually outweigh that short share loss so let's say if the stock goes from 50 to 60 I would see the profit all the way up to my short call at 55 but once that stock price reaches that 55 strike that's when the profits would be offset because if I've got long shares and short shares so 100 long shares and 100 short shares of 55 any movement above 55 is going to be a wash so this would still be a profitable situation but I'm hedging my risk to the downside as well so it's something we covered in Delta and if you missed that segment you can go to fine shows at the top of tastytrade and just go down to Mike and his white board and it'll be there but we covered how basically selling a call against shares and we also have a segment on covered call which went into this pretty in-depth which it basically reduces our directional risk to the downside and also when we're selling a call against it we're increasing our probability of profit which is really what we're trying to do here as well so if we go on to the next slide we're going to be talking about another way we can hedge so so doing covered calls is not the only way to hedge our portfolio we can actually get pretty creative with it so I think it really comes down to correlation and understanding correlation so if I have a covered call in Apple for example and let's say I want to hedge some of those deltas maybe I'm not comfortable with having long deltas and Apple maybe I want to look to neutralize those a bit instead of doing another trade and Apple I could look at other correlated underlyings so for example the queues which has a very high correlation with Apple I could do a negative or bearish assumption in that underlying so let's say I've got a high IV environment maybe I would look to sell a call spread in the queues which would effectively hedge my position in Apple so if my if for whatever reason my main portfolio is based on Apple stock and I'm looking to hedge it I could use the queues as a way to hedge it because at the end of the day a covered call is a bullish assumption where a short call spread would be a bearish assumption also what I could do if I didn't want to look at that is I could look at maybe s py so s py and Apple have a very high correlation Apple actually makes up a good a good sector of the s py stocks that are considered in that bucket and maybe instead of a call spread if I'm not very risk-averse I could maybe just short a call outright so there's different ways we can do that and even in low Ivy environments maybe if I'm not happy with the implied volatility in the market but I still want to hedge my position in Apple some way maybe I'd look at a long put spread which would pretty much be unaffected or maybe benefit from an increase in implied volatility or if I just want to avoid the options in general maybe I could short stock in s py so I don't have to short 100 shares of stock maybe I could short 15 or 20 shares which would give me a small notional value and a small hedge against my long stock and Apple so these are different ways that we can hedge our positions and really it all boils down to understanding what underlyings are correlated and what we can do to be creative to hedge against our position and really once we understand how everything works together that gives us a better understanding of what we're doing in our portfolio as a whole so another way we can measure hedging is going to be on the next slide and that's what we're talking about when we talk about Delta hedging so again if you miss the Delta segment it was a previous whiteboard segment you can definitely check it out but really what Delta hedging is is just measuring your deltas and then using the option Delta Delta is to offset that so when we're talking about shares of stock if I'm buying 100 share of stock I would have a positive 100 Delta in that underlying so each share of stock represents one Delta also if I've got 200 shares of stock then I would see a positive 200 Delta if I had short shares it would be just the opposite so if I short of these shares outright I would see negative 200 Delta and if I shorted these 100 shares I would see negative 100 Delta so what I can do to utilize that in my portfolio as a hedge is look at the option Delta if I'm going to for example create a covered call position so there's three terms here that are great to understand and we have under hedging which is basically hedging under 100 percent of that Delta value so let's say I've got 100 shares of stock at 100 Delta an example of an under hedge which would be just a standard covered call so if I sell an a call option with a 30 Delta it would actually be a negative 30 Delta since it's bearish and I'm selling a call so now instead of having 100 shares or 100 Delta's of exposure I would have 70 Delta's of exposure because I've got 100 shares of long stock but negative 30 Delta on my short call another thing I can do is a perfect hedge so a perfect hedge would be using multiple call contracts for example to perfectly hedge my scenario so let's jump down to 200 shares so let's say I've got 200 shares of long stock and I know that selling and at the money call would give me roughly negative 50 Delta so what I'd have to do to perfectly hedge that is sell for calls against it so if I've got 200 positive deltas with my 200 shares and I sell for calls that have negative 50 Delta each then my Delta should be pretty neutral it should be pretty close to zero and lastly what we can do is over hedge so let's say we're holding onto stock but we're really not comfortable with what might be happening but for whatever reason we still want to hold the stock instead of getting out of it maybe we see some downside potential in the future we could over hedge the position it's pretty rare that we would do this normally we would just get out but we can always overhead position so let's say I've got 100 shares of stock and I've got 100 Delta so one thing I could do is look to sell maybe three at the money calls so if I sold three at the money calls that had negative 50 Delta that would give me negative 150 Delta against my 100 Delta here so I would actually have a net negative 50 Delta position in this scenario so what's really important to know is that when we're dealing with covered calls for example which is what we've been using in this example if I've got 100 shares of stock I can sell one option against it and I won't have any additional risk if I sell more than one option so if I sell two options for example my risk is defined on my 100 shares in my short call that's together the the risk can be associated with one another but since I don't have another 100 shares that represents my short call my additional short call I'm actually exposed to one naked short call so it's really important to know and remember that each option contract that we're selling must be associated with 100 shares of stock for it to be correctly correlated in terms of risk so if we don't want any additional upside risk then we need to be mindful of the fact that 100 shares of stock is associated with one short call and that risk will outweigh itself another thing to consider when we're talking about Delta hedging is that it's not static so this is considered a form of dynamic hedging so if I for example have 100 long shares and I sell a call against it let's say it's an out of the money call with a 30 Delta like we talked about first so now I've got a positive 70 Delta so everything's fine but if the stock price starts to move down since I sold the the call out of the money it's now going to be farther out of the money which means my Delta's going to be lower so let's say my Delta is now a 15 Delta negative so if I have 100 shares of stock which is going to be a static Delta but now I'm selling a call that's only a 15 Delta now I've got an 85 Delta so it's important to understand the relationship and basically the further out of the money an option goes or is the smaller the Dell it will be so the relationship here even if I create a perfect touch when the stock price moves that hedge is going to change so that's another thing to be mindful of when we're Delta hedging dynamically so that's been a lot but we'll wrap it all together with some tape takeaways here so hedging can reduce our risk so instead of just buying 100 shares of long stock something we can do is create a covered call so it not only helps us on the downside if the stock price moves down it increases our probability of profit as well so the only thing we're really reducing is our max profit so we don't have that unlimited profitability but we're having that increased probability of profit which is going to help us in the long run another takeaway is that deploying opposite strategies is our go-to so whether that be deploying an opposite strategy in a positive correlated underlying or if you want to get creative we can create a bullish strategy in both like if I've got an underlying that is completely negatively correlated with another so if an underlying goes up and it has a negative correlation with an under another underlying the other underlying should go down so if I've got two situations where I know that's true if I create a bullish scenario in both of those that's a technically a way of hedging one of those positions so we can get creative with it and that's one of the beauties of options trading another takeaway is that understanding correlation is key so if I've got position an Apple like we talked about in the previous example and I want to hedge that position elsewhere maybe I would look to use the Q's q QQ or s py which is an ETF of the S&P 500 so there's many ways we can hedge and lastly we use Delta to measure our hedges and this is really key especially when we're getting really down into it and understanding where we want our portfolio Delta to be it's really important to understand how we can use Delta to hedge that position but it's even more important to understand that that number is not static so it will change as the underlyings move so this has been hedging hopefully you've enjoyed it thanks so much for tuning in my name is Mike if you've got any questions or feedback at all shoot over to support at doe comm or support at tastytrade.com or you can shoot me a tweet at doe trader Mike we're going to be off tomorrow but we'll see you on 2 des what's up everyone thanks for watching our video click below to watch more videos subscribe to our channel and visit our website at tastytrade calm