What is “Notional Protection”?

by | Apr 6, 2022 | Market Updates

Last month we focused on the Delta of an option and how that relates to our portfolios and strategies. It was a simplified explanation of answering the questions around how and when of the effectiveness of the hedges we deploy. This month, we add to the answer by tackling the meaning of ‘notional’.

A real feel for the effectiveness, and timing of that effectiveness, requires an understanding of both delta and notional.

Why The Focus on Options Recently?

Our focus on the basics of options recently is driven by the world we live in. We are entering a period of decision making by the Fed that could materially alter the way markets are priced, and Fed decisions are just one item on a long list where each item is a potential catalyst of volatility.

In other words, we think there will be a heightened desire for hedges. Hedges can be viewed as a form of insurance premiums paid, in deploying options to reduce and manage risk.

Our focus is paying the smallest premium possible for the largest payoff. As with any insurance, sometimes it never pays off, and that’s not a bad thing – that typically means the sun has been shining and things are good. 2021 was a perfect example of that environment.

We pay premiums for potential protection, not because we fear the future, but because of the freedom it provides. We can seek out greater returns in growth assets knowing we have protection in place.

The Aptus portfolio construction philosophy is the definition of the strong engine/strong brake analogy that we’ve been using (credit to David Dredge of Convex Strategies). Stocks are a stronger engine relative to bonds, in our opinion.

We do not see value in the traditional approach of risk management through bonds, and won’t handcuff our portfolios with allocations to negative expected returns via bonds. We want a stronger engine (more stocks) equipped with better brakes (our hedges). Competitive in a straightaway, quick in and out of the turns…that’s how you win the long-term race of compounding capital.

With all that said, our ability to add value to you and your clients is a combination of our portfolios and effective communication. We need to message clearly and these last couple of notes are (hopefully) aiding our ability to do that. A shared understanding of our hedges can only help towards in end goal of generating sufficient returns that can be digested by your clients.

Notional Value 

We throw phrases like this around often:

“Currently, we have 100% of the notional value of a strategy protected.”

Here’s what that means:

Notional value refers to the amount of value an option controls. For example, let’s assume stock ABC is trading for $100 and we own 1000 shares, which would mean we owned $100,000 of ABC.

With each option carrying a multiplier of 100 shares, buying 10 put contracts gives us the right to sell 1000 shares. If those puts carry a 90 strike price (right to sell at $90), we have 90% notional protection. It’s that simple – the notional protection amount is simply the number of contracts we have multiplied by the strike price.

Blend of Delta and Notional 

The notional value tells you one thing, but it’s the blend of notional and the deltas of the options that give you a greater understanding of what to expect from your hedges.

Let’s assume the same information but let’s add the delta of the put options we bought is currently 40. Technically it’s negative 40 but we are keeping this as simple as possible.

As a refresher, two things to keep in mind:

  1. Deltas are dynamic, so that 40 delta option will not remain a 40 delta as our stock position moves
  2. Delta tells us how much the option moves relative to the underlying. So, for a 1 dollar move in our stock, this put option should move 40 cents.

Now we are getting to the things that matter…

As a holder of the combination of this stock and your put protection, here’s what you can expect to feel of an immediate move lower:

Your notional protection covers 90% and the delta of the option is currently 40. You simply multiply your % Notional by the Delta to get 36% as the amount you’d protect.

Let’s say you had a 5% drop in the stock. Right now, you’d feel 64% of that drop while protecting 36% of your position from it. Remember, as the stocks continues to drop your puts will be realizing more and more delta as their deltas increase closer and closer to one. The effectiveness (and size) of the hedges will grow if your position keeps falling.

Hopefully, you can see clearly how the notional value and deltas dictate the effectiveness, but also how the effectiveness is dynamic. 

Our Portfolios 

Our portfolios are holding elevated notional protection now. With the market’s recent rise, our deltas are not as elevated as they once were.

We continue to like our positioning at the allocation level (more stocks and less bonds), as well as the positioning of our hedges. We believe Q2 could get interesting and have no issue holding higher notional protection.

As always, please don’t hesitate to reach out and thank you for your trust.





Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward-looking statements cannot be guaranteed. 

This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible. 

Advisory services are offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2204-4. 

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