Stock Beta & Using it for Option Trading

STOCK BETA: WHAT IS STOCKS BETA?

The beta factor describes the movement of the stock in relation to that of the nifty or index. It is a numerical indicator. This shows how the stock behaves with the market openness. Rather it says about the stock how much it is affected by the systematic risk of the index.

In other words, it the systematic risk for different industries differs how they react to the market which is depicted in numerical form for easy interpretation. It measures the volatility of the stock with respect to the index. Hence there can be high or low volatility.

Beta can also be defined as its correlation to the Index. Exposure to the systematic risk which effects to the entire market and its impact on the stock such correlation is called Beta.

When the value of the beta is less than 1 it indicates that the stock is less volatile and when the stock beta is more than 1 it indicates that the volatility is more.

For example, a stock beta of 1.4 means that when the Index goes up by 10% the stock is expected to go up by 14%. Same way if the Index goes down by 10% and stock has a beta of 1.4 is expected to go down by -14%.

A Certain stock has a beta of 1 which means their movement is same as the Index. This could be otherwise interpreted by they contribute to a reasonably large extend to the Index.

Positive Beta

  • Beta of 1 The price of the stock will move just like the index and the difference would be very less. If the market is up 2% then the stock would also be up 2%.

The beta of less than 1 but more than zero the market would be less volatile when compared to the index.

The beta of greater than 1 indicates that the stock would be very much volatile compared to the index.

Negative  Beta

When the beta is negative it indicates that the stock is going to move in the opposite direction of the market.

BETA FOR OPTIONS

Higher Beta stocks usually are more volatile than the Index. Hence the stock option premium is much higher when compared to the stock of lower beta stocks. Higher premium gives an opportunity to earn more while at the same time it carries higher risk.

Based on the underlying market conditions one can filter the beta values to understand the opportunities with options trading.

When the market is bullish e.i. the index is expected to be bullish the high beta stock would over-perform compared to the index. At the same time, the lower volatility stock would underperform. For example, the defensive stock would underperform compared to high beta stocks.

Likewise when the market is bearish e.i. the index is expected to be bearish the low beta stock would over-perform compared to the index.

But let us accept that Beta is not full-proof and there are certain factors that are not covered by beta also these would be covered in another post.

Do let us know if you want us to cover any specific topics related to Beta & OptionsTrading Strategies.

 

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