Comprehensive Guide to Beta Hedging: Put, Call, and Multi-Leg Strategies

In portfolio management, beta hedging is an essential risk management technique that allows investors to mitigate their exposure to market volatility. It’s done by offsetting a portfolio’s market exposure through the use of financial derivatives, such as put options, call options, or multi-leg strategies. In this article, we will explore in depth how to calculate portfolio beta, how to hedge with put options on an index ETF like SPY, and various advanced strategies like call options and multi-leg combinations for a more efficient hedge.‍

What is Beta Hedging?

Beta measures the sensitivity of a portfolio to the overall market, often using a benchmark like the S&P 500. A portfolio beta of 1.0 indicates that the portfolio moves in line with the market. A beta greater than 1.0 means the portfolio is more volatile, while a beta below 1.0 indicates less volatility than the market.

For instance, if your portfolio has a beta of 1.2, it is expected to move 20% more than the market—if the market rises by 10%, the portfolio would rise by 12%. Similarly, a market drop of 10% would result in a 12% loss in the portfolio. This is where beta hedging becomes useful to protect against significant downside risks.

Step-by-Step: How to Calculate Your Portfolio Beta

Before you can hedge, you need to determine your portfolio’s beta. Here’s how to do it:

Find the Beta of Each Asset: Look up the beta of each asset in your portfolio (using a platform like Yahoo Finance or AlphaHarmonic.io).
Calculate the Weighted Beta for Each Asset: Multiply the beta of each asset by its percentage weight in your portfolio. For example, if a stock makes up 40% of your portfolio and has a beta of 1.3, the weighted beta contribution from that stock is 1.3×0.4=0.521.3 \times 0.4 = 0.521.3×0.4=0.52.
Sum the Weighted Betas: Add up the weighted betas of all the assets in your portfolio to get the total portfolio beta. For example:
- Stock A: Beta = 1.2, Weight = 50% → 1.2×0.5=0.61.2 \times 0.5 = 0.61.2×0.5=0.6
- Stock B: Beta = 0.9, Weight = 30% → 0.9×0.3=0.270.9 \times 0.3 = 0.270.9×0.3=0.27
- Stock C: Beta = 1.5, Weight = 20% → 1.5×0.2=0.31.5 \times 0.2 = 0.31.5×0.2=0.3
- Total Portfolio Beta = 0.6 + 0.27 + 0.3 = 1.17
Alternatively, you can use our portfolio beta checker tool.

This portfolio has a beta of 1.17, meaning it’s 17% more volatile than the market.

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Using Put Options to Hedge Your Portfolio Beta

Once you have your portfolio beta, the next step is to hedge using put options on an index ETF like SPY.

Calculating the Number of SPY Puts to Buy

Let’s say your portfolio is worth $100,000 and has a beta of 1.2, meaning it has $120,000 worth of market exposure. The SPY ETF, which tracks the S&P 500, is typically used to hedge U.S. equity portfolios. If SPY is trading at $400 per share, each SPY option contract controls 100 shares (since each option contract represents 100 shares of the underlying asset).

Step 1: Calculate the total exposure to hedge. Multiply your portfolio value by its beta. In this case, $100,000 x 1.2 = $120,000.
Step 2: Calculate the number of SPY shares needed to hedge this exposure. Divide your exposure ($120,000) by the current SPY price ($400):
120,000400=300 shares of SPY\frac{120,000}{400} = 300 \text{ shares of SPY}400120,000=300 shares of SPY
Step 3: Determine the number of option contracts. Since each SPY option contract represents 100 shares of SPY, you need to hedge 300 shares. Therefore, you would need to buy 3 SPY put option contracts.

Partial Hedge with Puts

You don’t always need to hedge the full beta exposure of your portfolio. If you’re aiming for a partial hedge, you can adjust by buying fewer put contracts. For example, if you want to hedge only 50% of your exposure, you would only need 1.5 SPY puts (rounded to 2 contracts).

Hedging with Call Options

While put options are the most common tool for beta hedging, call options can also play a role:

Covered Calls: If you own stocks or ETFs, you can sell covered calls to generate premium income. This helps offset the cost of buying puts. By selling calls at a higher strike price, you cap your potential upside but generate income to reduce the net cost of the hedge.
Protective Call Options: Less common, but if you hedge your portfolio with puts and the market rallies, protective call options can recoup some of the missed upside. For example, you could buy call options on a lower-beta stock that would benefit from the rising market.

Multi-Leg Hedging Strategies

For more advanced risk management, you can employ multi-leg strategies that combine puts, calls, and spreads to fine-tune your hedging:

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1. Put Credit Spread

A put credit spread involves selling a put option at a higher strike price and buying a put option at a lower strike price. This reduces the cost of the hedge but also limits your downside protection.

For example, if SPY is trading at $400, you could sell a put at $390 and buy a put at $380. You collect a premium from the put sale to offset the cost of the protective put, while still maintaining some downside protection.

2. Collar Strategy (Covered Call + Put)

A collar strategy combines the sale of a covered call and the purchase of a protective put, effectively creating a band around your portfolio:

Sell a covered call at a higher strike price to generate income.
Buy a protective put at a lower strike price to hedge against downside risk.

This strategy limits both the upside and the downside, but it’s often used when investors want to protect against market drops while reducing the net cost of hedging.

3. Iron Condor

An iron condor involves selling a call spread and a put spread simultaneously, allowing you to profit in a low-volatility market:

Sell a call and a put at strikes closer to the current SPY price and buy a call and a put at further strike prices to create a range of risk exposure.

The iron condor generates premium income but limits both your upside and downside, making it a good strategy for markets with low volatility.

Best Practices for Beta Hedging

Expiration Dates: Choose option expiration dates that align with your time horizon. For short-term hedges, near-term options are sufficient, but for longer-term protection, use LEAPS (long-term equity anticipation securities).
Regular Review: Continuously monitor your portfolio’s beta and market conditions. Adjust your hedge as necessary based on changing risk levels and market volatility.
Cost vs. Protection: Options come with premiums, so balance the cost of hedging against the level of protection you need. Multi-leg strategies like collars and spreads can reduce costs but may limit flexibility.

Conclusion

Beta hedging using options—whether through basic puts, calls, or advanced multi-leg strategies—offers a range of tools to manage portfolio risk. By calculating your portfolio’s beta and using appropriate option contracts, you can tailor a hedge that aligns with your risk tolerance and market outlook.

For a full hedge, SPY put options offer protection against market downturns, while combining calls and multi-leg strategies like collars and iron condors allows you to hedge while generating income and minimizing costs. Regularly reassessing your beta and hedging strategy will keep you prepared for market volatility and ensure long-term portfolio success.