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Why You Need to Learn About the Delta Hedging Strategy

Traders who want to be more professional and make winning moves may need complex strategies such as delta hedging. 

Why You Need to Learn About the Delta Hedging Strategy

Once you have enhanced your experience of stock trading with direct access trading platforms, you may want to look for more advanced trading strategies to better manage risks and maximize earning opportunities. One of these advanced strategies is delta hedging.  It may be complicated to get it right, but if you’re looking for advanced strategies, you need to consider this.     

What Is Delta Hedging?

Delta hedging is a strategy in trading by which you arrange an option play. Which helps in decreasing or eliminating the potential directional risk exposure of an underlying stock, or any option contract you hold. 

Stocks and options generally have directional exposure to price moves. This exposure, called delta, is measured by how much a trading position earns or loses when the stock undergoes a $1 move. For example, if a call option makes a 50-cent movement for every $1 move of the underlying stock, it has a .50 delta. 

Options are used to balance the risk to another option holding or a whole portfolio. The investor aims to attain a state of delta neutrality without any directional bias. A long position without a hedge has a 1.00 delta while a short position without a hedge has a -1.00 delta. 

Pros as Well as Cons in Delta Hedging 

For traders, delta hedging can help isolate any changes in volatility. But a major drawback is that you would need to keep watching the positions involved and adjust them. And since delta hedges get added and removed with the underlying changes in price, the trader incurs further trading costs. 

Delta hedging is complicated, and it’s usually carried out by investment banks and institutional traders. But even individual traders can carry out a simple version of it. This involves buying or selling options before buying; or selling stock or ETF of an equivalent amount. 

But whatever delta hedging practice are used, the hedge needs to be constantly rebalanced since you are looking to neutralize the price of an option in relation to the price of an asset.

A Complex Delta Hedging Strategy

A more complex strategy involves trading volatility with a delta neutral trading strategy. Delta neutrality refers to a portfolio strategy where multiple positions are utilized along with positive and negative deltas to ensure that the overall delta of the concerned assets are zero. 

NewTraderU describes positive and negative delta positions. The positive delta positions are long stock shares, long call options, short put options, buying call spreads and selling put spreads. The negative delta positions are selling stock short shares, long put options, short call options, selling call spreads and buying put spreads.

Why You May Need Delta Hedging

Due to the complexity of the process, Delta hedging is expensive. But, it can be of great benefit for traders anticipating a strong move in the stock they hold, but are worried about the risk of over hedging; if the expected move doesn’t quite turn out that way. 

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Stock Market Seems Bullish but Negative Influences Lurk

While the Covid-19 pandemic battered the American economy, the major indexes, the stock market, the small-caps and midcaps have posted impressive recoveries.

Stock Market Seems Bullish but Negative Influences Lurk

Studying the mood of the market is essential to make informed trading decisions. While
the coronavirus lockdown of the economy plunged stocks and indexes to all-time lows,
the rally from that point for the major indexes has been impressive. The market is
turning bullish, and if you have any doubts about this, analysts are quick to point out
why.

Why the Situation Really Seems Bullish

Bullish investors are getting a lot of ammunition these days, but it seems the market is
even stronger than what was mentioned by MarketWatch’s Mark Hulbert. There seems
to be truth in that statement concerning 94% of stocks making up the S&P 500 trading
higher than their 50-day moving average. With 20% control of the total market cap of
the S&P 500 index, these American stocks (Microsoft ($MSFT), Apple ($AAPL),
Amazon ($AMZN), Alphabet ($GOOGL) and Facebook ($FB)) in terms of market
capitalization, have been firing on all cylinders. This concentration is the highest since 1980. Moreover, before the burst of the internet bubble, these stocks only made up 18%.

The Impressive Performance of Midcaps and Small-caps

The indication of the extent of stocks’ participation in the bull market comes from how
midcap and small-cap stocks perform. These stocks have indeed overtaken the large
caps and risen from there lows of March 23. The Russell 2000 index, which is made up
of small-cap and midcap stocks, has returned 43.8% from March 23. While the S&P 500
only managed 36.1% in that period.

Moreover, MarketWatch quoted FactSet data stating that 94% of the S&P 500 stocks
trade higher than their moving average of 50 days. Market Extremes’ president Hayes

Martin, reported that 90% of stocks that were listed on the NYSE trade higher than their
respective 20-day exponential moving averages.

Watching out for Divergences

These indications are considered bullish because the major turning points in the market
came with major market divergences. The high of the market in late September 2018
happened when the S&P 500 was heading for a nearly 20% drop. Though the market
was approaching a new high, less than 10% of the S&P 500 stocks traded higher than
their respective 50-day moving averages. These factors caused Martin to predict a
correction of 8% to 13%.

So, Martin reckons bulls should watch out for any divergences materializing pretty soon.
Things could deteriorate if they materialize. For the moment though, and for the near-
term, the prospects are promising and the strength of the market is pretty impressive.

Consumer Sentiment Recovering

One factor that has been depressing is the drop-in consumer sentiment. But even that
experienced a growth in May, according to a University of Michigan study. May saw
consumer sentiment rise from 71.8 in April to 72.3. In February, the consumer
sentiment reading was 101; which was around the time that the Covid-19 pandemic
started spreading.

Worsening US – China Tensions

Meanwhile, the escalating US – China tensions are casting a shadow on the market.
Trump escalated the tensions after he announced his intention to terminate the
country’s relationship with the WHO (World Health Organization), an organization he
accuses of subjecting itself to China. Donald also mentioned increasing his scrutiny on
Chinese companies on the US stock exchanges.

So, there are disturbances that could negatively impact the stock market. But judging by
the impressive rally of the major indexes and the small-cap and midcap stocks, the
situation seems to be bullish for the near future. But it is important to watch out for the
unfolding international political situation; and also, how the economy fares following
the reopening of business operations in the states.

While Covid-19, the major indexes, small-caps and the midcaps continue to affect the
American economy, get started in stock trading. Use zero commission trading offered
by reputable online broker dealers.

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Chinese Stocks

How the New Delisting Bill Could Impact Chinese Stocks

The new delisting bill could be critical for many high profile and popular Chinese stocks.
Investors need to watch out for their moves.

The US Senate passed a crucial bill on Wednesday, May 20, that could have implications for the
relationship between the US and China. This bill will also have an impact on the stock market;
here’s how. Fox Business reports that the new bill, called the Holding Foreign Companies
Accountable Act (HFCAA), removes “rogue” Chinese companies from the US exchanges.

The Reason Behind the Legislation

The main reason behind the legislation is the concern that Chinese companies listed on the US stock exchanges are not subject to those standards of accounting and investor protection rules that US companies have to follow.

As a result, retail investors are faced with a greater risk of fraud. According to the bill, if the Public Accounting Oversight Board isn’t provided access to the books of any foreign issuer of stocks for 3 years, the Securities and Exchange Commission will prohibit the trading of those shares on the US exchanges. All that’s needed now is the approval by the House of Representatives after which the President will sign the bill.

Now what do investors need to keep in mind? Well, there are some stocks that would be directly affected by this. In fact, 165 Chinese companies (of which are quite popular with investors) have their stocks listed on the American stock exchanges, and all these could be adversely affected by this legislation.

High Profile Chinese Stocks that Could Be Affected

Among these are search engine giant Baidu ($BIDU), cloud computing giant Alibaba ($BABA), e-commerce platform provider JD.com ($JD), and social media and video game company Tencent ($TCEHY).

One Chinese company that already has its stock hit is Luckin Coffee ($LK). NASDAQ already sent the beverage chain a delisting notice after its COO was found to have fabricated sales worth $310 million in 2019. Debuting at $17 per share on NASDAQ in May 2019, the stock soared to $50.02 in January. The company was valued at $12.02 billion. On Wednesday, its value dropped to less than $700 million.

Delisting from NASDAQ

Baidu is already thinking of delisting from NASDAQ. It plans to list on some stock exchange located closer to China since it believes its stock isn’t given the deserved value in US markets.
Will other Chinese companies follow suit? That could happen, or a situation could arise when these companies could be blocked from trading in the US. Or only be allowed to trade on the OTC markets instead of the top exchanges. New Chinese companies could also be prevented from listing on the US stock markets.

If you are using an online stock broker or one of the commission-free trading brokers you need to be vigilant when dealing Chinese stocks and how the Holding Foreign Companies Accountable Act (HFCAA) will effect their listing in the US stock exchange.

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Stock Market Rally

Can You Count on the Stock Market Keeping Its Rally Going? 

Investors always look for the light at the end of the tunnel. It’s no different this time, with the lull the months of March and early April have witnessed as a result of Covid-19 coronavirus. While it is essential to look for the next big investing opportunity, even when there seems to be none around, you also need to be careful you don’t jump the gun. 

Since March, the Market Is on a Roll

After the coronavirus pandemic, the market did experience flashes of growth despite the overall bearish volatility. But since March 23, the S&P 500 has grown around 25%. There has been a continuous debate about how sustainable these gains can be, as a result of the Covid-19 fallout. Even the Nasdaq Composite is in the year-to-date (YTD) lead. Is this an indication that the bad times are past?

Not to Get Drawn Away by the Rebound 

According to prominent strategist Sophie Huynh, as quoted by MarketWatch, investors really shouldn’t be drawing too much from this since the rebound has been mainly surrounding the healthcare, staples and technology sectors. What’s characteristic about these sectors is that they benefit from an environment of low interest rates and kind monetary policies. The current work-from-home situation has also contributed to their growth. These influences aren’t exactly sustainable. 

The upside is limited now, Huynh reckons. She is waiting for a rebound concerning industrial, energy and discretionary stocks. These are stocks that really reflect economic growth recovery more than the other stocks. A total “risk off” is still some way off, she reckons. Currently she doesn’t see any sign of capitulation when compared to 2008 levels, but some of the risk-off has settled in.  

Unemployment Figures Keep Rising

As per reliable data, the total number of individuals who have filed for unemployment in the US is 25 million, when including the 4.4 million who have recently filed for unemployment. The Markit PMI services and manufacturing indexes have dropped, while sales of new homes have also sunk 15%.

Domino’s Pizza, Target and Eli Lilly 

As for the current situation, Domino’s Pizza ($DPZ) missed its same-store sales estimates. The company’s shares slumped 2% in premarket trading on last Thursday after the pizza chain reported first-quarter profit and revenue that rose above expectations but saw reduced U.S same-store sales. However, Target ($TGT) experienced an increase in online sales while pharmaceutical company Eli Lilly ($LLY) also reported earnings growth.  The shares of Eli Lilly rallied 1.5% during premarket trading Thursday – the drug maker had reported better-than-expected first-quarter profit and revenue and also provided an outlook for the full year, which was consistent with the forecasts. They witnessed revenue boost by an estimated $250 million due to increased customer buying patterns related to the COVID–19 pandemic.

Uncertainty for Target?

But there is still uncertainty for Target as it experienced big sales swings. The shift in shopping trends during the pandemic is the primary reason. In fact, the shopping trend shift has been from physical and online stores to only online. That has affected Target’s earnings, making it less profitable. So, the uncertainty continues for the period past the first quarter. 

On April 23, Target released a business update containing valuable information for investors as well as those following the broader retail sector. 

  • Their quarter-to-date comparable sales are up 7% though comps have reduced slightly in stores and digital sales have more than doubled. 
  • For the first few weeks of April, digital sales surged 275% whereas social distancing measures resulted in in-store comparable sales to fall by the mid-teens. 

The company noted that it has increased market share across all of its core merchandise categories. Nevertheless, changes in supply chain to cope with the rise in digital sales and higher wages and bonuses for staff have added up to incremental costs. Investments and expenses and the shift to lower-margin products like food and beverage as well as inventory write-downs for unsold apparel and accessories may lead to the company’s operating margin for the first quarter to fall by more than 5% points from the previous year. This is a threat to its quarterly profit caused by an operating margin of less than 1.4% compared to 6.4% the previous year. However, the company’s CEO reassures that even though the present crisis will put near-term pressure on their profitability, that pressure is far outweighed by doing right by their team and their guests. He said they were confident the actions they were taking at present will drive growth and greater guest affinity over the long term.

The market may give weight to factors such as reduced in-store sales for Target, uncertainty regarding the return of customers in full numbers to their stores, and the shift to lower margin online shopping. This could keep Target’s stock value uncertain, at least for now.

As a stock trader, you can find growth opportunities in the current situation. But it’s still too early to make any investment plan under the notion that we’re out of the woods. We still need more time to find that out for sure. Keep your eyes on the industrial and energy sectors. But with advanced direct access trading platforms offered by online broker dealers, you can easily get started in stock trading.        

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