This complimentary article from Options Profits was originally published on January 24 at 7:27am EST. Don't risk missing over 40 options trade ideas every week and exclusive commentary from over 10 experts. Click here for more information and a 14-Day Free Trial.

In "Putting Greeks to Good Use" and "Managing Greeks, Not Trades," I discussed the idea of using greek exposures to get a bird's eye view your total portfolio, allowing you to manage your total risk instead of only focusing on specific trades. Naturally, you want the individual trades to be as successful as possible, but what matters most of all is that, when everything gets mixed together in your portfolio, you're happy with the result and with the total amount of risk.

One of the biggest challenges when managing a portfolio that contains options on multiple underlying assets is to account for the qualities of those underlying assets. If you're trading positions on 10, 20 or 50 stocks, they won't all move together up and down in unison, and when they do move it won't be at the same rate. On a given day, your positions in General Electric (GE), Exxon Mobil(XOM), Amgen(AMGN), Research in Motion(RIMM) and so on may be a mix of green and red, and may be up or down to greater or lesser extents.

The standard advice you'll hear at this point is that you should beta-weight the individual positions against some relevant index and then use index products to hedge your total beta-weighted delta risk. Beta measures two things: how correlated an asset is to the market, and the magnitude of the asset's movement relative to the market. A stock with a beta of 1.5 will tend to rise when the market rises and fall when the market falls, but it will do so at a faster rate, e.g. rising 15% when the index is up 10%. Multiplying the deltas of your option positions by the beta of the underlying ensures that you manage the delta risk of higher-beta stocks more carefully, and give lower-beta stocks slightly less attention. If you hold positions in a lot of technology stocks, NDX or NASDAQ 100 Trust(QQQ) options might be a good fit as an index to weight against, or RUT or iShares Russell 2000 Index ETF(IWM) if your focus is on small caps.

But this conventional advice doesn't go far enough. For one thing, beta is usually estimated using a large time series of returns, which improves accuracy but hurts responsiveness. If something fundamental changes in a company that causes it to begin to behave very differently, that change won't be reflected in the beta for some time. Think of how unresponsive a long-term moving average on a chart can be when large, short-term price swings occur.

Secondly, many option trades are short-term in nature, while beta estimates rely on long-term tendencies. Assume that nothing has changed about a given stock such that the first objection is not relevant; for any given trade, the presence of randomness and noise in the markets over the course of a few days or weeks can still make a weighted delta exposure estimate unhelpful.

Finally, beta is not your friend in a panic. For the sake of argument, let's just assume that we can get perfectly accurate estimates of beta on all our stocks. If some market-wide crisis or even moderate-impact event occurs, all of our assets are more likely to move in sync. The slogan for this is: in a crisis, correlations go to one. That means that the returns of all assets are likely to become more similar to one another, which makes carefully beta-weighted deltas less meaningful. My articles on correlation here at OP over the last several months have explained why rising correlations matter so much.

How should you deal with these limitations of beta-weighted deltas? One solution is to hedge more aggressively overall. Over-estimating your exposure in the direction of your current deltas (e.g. if you're long 400 beta-weighted SPY deltas, imagine that it's 425) can ensure that unexpectedly high correlation or market noise don't introduce unwanted risk. Another idea is to group assets into buckets and hedge with sector-, country-, or capitalization-specific indexes or ETFs. Finally, rebalancing your delta hedges more frequently or in smaller intervals can ensure less hedging error. Of course, as is always the case with any kind of hedging, a tighter grip on risk usually entails higher costs, so it is good to try several methods to determine the best fit.

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At the time of publication, Jared Woodard held positions in RIMM, SPX, QQQ, SPY.