Financial Topics Archives

Apr

2025

What Is a Swaption? Understanding Swap Options

What Is a Swaption? Guide to Understanding Swap Options

By Laurel Tincher | Growing Wealth, invest, Investing, Terminology | Comments Off

A swaption, or swap option, is a financial derivative that grants the holder the right — but not the obligation — to enter into an interest rate swap contract with specified terms. Swaptions are primarily used to hedge interest rate risk, but can also serve other strategic financial purposes.

Swaptions are often used to manage interest rate exposure, giving the holder flexibility to secure favorable borrowing or lending terms depending on market conditions. Read on for how they work, the different types, pros and cons, and more.

Key Points

• A swaption is an option giving the buyer the right, though not the obligation, to enter into an interest rate swap at a future date.

• Swaptions offers investors flexibility in managing interest rate risk.

• The upfront premium reflects factors like market volatility, time until expiration, and expected interest rate movements.

• Swaptions can be used to lock in favorable rates or hedge against rate movements.

• Exercising a swaption depends on market conditions and the swap’s terms.

How Swaptions Work

As mentioned above, a swaption is an option on a swap rate. Like other types of options contracts, the buyer pays a premium to enter into the swaption, and beyond that they are not obligated to act on the contract.

Although swaptions are a type of option, they are financial derivatives that provide the right to enter into a swap agreement. Similarities to swaps include:

• They are traded over-the-counter instead of on centralized exchanges.

• They are customizable and offer a lot of flexibility since they are not standardized exchange products.

When two parties enter a swaption agreement, they negotiate the terms of the contract, such as the premium, expiration date, notional amount, the swap’s legs (fixed vs. floating), benchmark rate,and the adjustment frequency of the variable leg.

Recommended: Options Trading 101 Guide

Who Often Uses Swaptions

Swaptions are typically used by institutional investors instead of retail investors, while retail investors rarely trade them. Some private banks offer swaptions to high-net-worth clients. Large corporations, investment banks, commercial banks, and hedge funds use them for various purposes. It takes a lot of work and experience to create a portfolio of swaptions, so they generally aren’t used by individuals or small firms.

They are often used to hedge against macroeconomic risks such as interest rate risk or securities risks. If an institution thinks interest rates might change, they can enter into an agreement to protect against that. Financial institutions can also use them to change their interest payoff terms.

Swap options tend to be used to hedge specific financings, but they can also be used to hedge a broader change in future interest rates. This can be useful if an institution holds a lot of debt maturities for the year and doesn’t want to risk losses.

A swaption’s strike price represents the fixed interest rate at which the swap will execute if the option is exercised. The holder’s risk is limited to the upfront premium, but the potential benefit depends on how market rates compare to the strike price at expiration.

Swaptions can be purchased in most major currencies, such as the U.S. Dollar, Euro, and British Pound.

What Are the Different Types of Swaptions?

Swaptions come in two main types: payer and receiver. Both types give the holder the right to enter an interest rate swap, but the difference comes down to whether the buyer chooses to pay or receive a fixed interest rate if the option is exercised.

Payer Swaption

If a buyer enters into a payer swaption, they are purchasing the right, but not the obligation, to enter into a future swap contract. When exercised, the buyer would become the fixed-rate (non-changing) payer and receive the floating rate (variable) payments.

Fixed interest rates remain constant for the duration of a loan. Floating rates change based on a benchmark interest rate. Historically, the most common reference rate was the London Interbank Offered Rate (LIBOR), but that has been largely phased out in favor of the Secured Overnight Financing Rate (SOFR) in the United States and Euro Interbank Offered Rate (EURIBOR) in Europe. These institutions determine interbank lending interest rates, which then influence commercial and retail loan interest rates.

Receiver Swaption

In a receiver swaption contract, the swap holder has the option to pay the floating rate and receive the fixed rate. These contracts are often used by investors who anticipate falling interest rates and want to lock in a higher fixed return.

When Can a Swaption Be Exercised?

There are also swaptions that have different terms of execution. The three most common are:

American

American swaptions can be exercised on any date prior to and including the expiration date. This flexibility makes them useful for hedging against unpredictable interest rate movements.

European

European options can only be exercised on the expiration date, making them less flexible. They are often easier to price and value since they don’t require continuous monitoring.

Bermudan

Bermudan swaptions have several specific dates when they can be exercised prior to the expiration date. This structure provides a balance between flexibility and cost, often making them cheaper than American swaptions.

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Swaption Example

A borrower wants to purchase rate protection on their current floating rate debt maturities totaling $50 million. They decide that they would like to purchase the right, but not the obligation, to pay a fixed rate on their debts for ten years.

For this right, they are willing to take on the risk of 10-year interest rates up to 3.8%, but no higher than that.

The borrower enters into a swaption agreement with a settlement date in the current year, for a notional amount of $50 million, with a 10-year term and a 3.8% strike price. In the context of swaptions, the strike price represents an interest rate rather than a fixed dollar amount. The premium for this contract is $400,000.

Including the premium, the rate is actually hedged higher than 3.8%, but for the sake of this example we will call the strike 3.8%.

If the strike is lower or the settlement date is farther in the future, this increases the value of the swaption and therefore increases the cost of the premium.

The borrower enters into this agreement to hedge against a large increase in swap rates but without choosing a specific rate they want when the contract expires.

It’s important to note that the swaption isn’t tied to the 10-year Treasury, it’s tied to 10-year swap rates, although their movements tend to be related. Also, swaptions are derivatives, so they aren’t the underlying assets themselves, but contracts derived from rates or assets.

When the settlement date occurs, there are two ways the swaption could turn out:

1. If 10-year swap rates fall below 3.8%, the option contract expires worthless, the swaption seller (or counterparty) keeps the premium, and the borrower must enter a new swap at the prevailing market rate.

2. If 10-year swap rates are higher than 3.8%, the borrower exercises the option. In this case the provider of the swaption pays the borrower the difference between the swap rate and 3.8%. The borrower locks in the current swap rate for a swap agreement, and uses the payment they received to buy down the rate on this new swap.

Pros and Cons of Swaptions

There are a few reasons why financial institutions use swaptions, but there can be downsides to them as well. Some of the pros and cons of swap options are:

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Pros:

• Helps hedge against risk when interest rates may rise.

• Swaptions can have longer durations than other types of options.

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Cons:

• If the swaption expires and is not unexercised, the buyer loses the premium amount they put in.

• There is a risk of the other party defaulting on the agreement.

The Takeaway

Entering into swaption agreements is one type of options trading strategy commonly used by institutional investors. They are usually used to help with restructuring a current financial position, alter a portfolio, hedge options positions on bonds, or adjust payoff profiles.

Swaptions are primarily used by institutional investors for hedging and risk management. Retail investors more commonly trade standard stock options — such as calls and puts — on stocks, exchange traded funds (ETFs), and other types of assets to speculate on price movements or manage portfolio risk. There are other types of options on the market that retail investors often trade.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

Explore SoFi’s user-friendly options trading platform.

🛈 While investors are not able to buy or sell swaptions on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q125-073

Apr

2025

What Is a Call Debit Spread?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

A call debit spread — also referred to as a bull call spread or a long call spread — is an options trading strategy that allows traders to try to benefit from a bullish outlook while limiting both risk and reward. It involves purchasing a call option while simultaneously selling another call option with a higher strike price and the same expiration date.

Essentially, the call debit spread consists of a long call combined with a short call as a hedge to reduce risk. The strategy’s level of risk is well defined, but it also has limited profit potential.

This options strategy may allow traders to benefit from increases in underlying asset prices.

Key Points

• A call debit spread involves buying one call option and selling another with a higher strike price, aiming to profit while limiting risk.

• Risk is limited to the premium paid, and profit is capped by the difference between strike prices minus the premium.

• Traders can use the call debit spread strategy to help mitigate the impact of volatility collapse, which can negatively impact long call positions.

• Time decay affects the spread minimally when the asset price is near the middle of the strike prices.

• Early closure of profitable positions may maximize gains and reduce the risk of short call assignment and transaction fees.

Call Debit Spread Definition

Like some other common options strategies, call debit spreads may be traded out-of-the-money (OTM), at-the-money (ATM), or in-the-money (ITM).

To understand this strategy, it helps to review the basics of call and put options. The basic steps of the strategy are:

• Purchase a call option

• Sell a call option with a higher strike price

The reason they are called debit spreads is because the trader incurs a debit (cost) equal to the price of the purchased call option, minus the price of the sold call option when they enter the trade. The closer the strike prices are to the price of the underlying asset, the higher the debit payment is. But a higher debit also means a higher potential profit.

If the underlying stock closes below the strike price of the long call (the lower strike price), the investor’s entire initial cost (debit paid) is lost.

Recommended: Guide to Writing Put Options

Entering and Exiting a Call Debit Spread

To enter a call debit spread, a trader purchases a buy-to-open (BTO) call option and a sell-to-open (STO) call option that has a higher strike price and the same expiration date. The way the trade is structured, the trader is paying a debit. A call debit spread can be entered at any strike price.

If a trader is more bullish, they can choose to purchase a spread that is more out-of-the-money. By selling the call option with the higher strike price, the trader gets into the trade at a lower cost and defines their risk and profit level.

To exit a call debit spread, the trader sells-to-close (STC) the long call option and buys-to-close (BTC) the short call option.

Traders can adjust their trade before the option’s expiration date, but will pay an additional amount to do so, potentially increasing their risk and lowering their profit potential due to added costs.

Additional flexibility exists in the ability to roll out spreads to a later expiration date. A trader might choose to do this if the option’s underlying asset price hasn’t moved enough to make the trade profitable.

In order to do this, the trader can sell the bull call spread they own and buy a new spread that has an expiration date further in the future. This may increase the potential for profit, but the trader will incur additional costs, which can also add risk to the trade.

This is just one of many strategies traders can consider when thinking about how to trade options today.

Call Debit Spread Examples

Let’s look at two examples.

Example 1

A stock is currently trading at $100 per share. A trader initiates a call debit spread by purchasing a $103 call for $1.00 and simultaneously selling a $105 call for $0.40. This creates a net debit.

The maximum loss and net debit for this call debit spread is the premium paid, which is:

Net premium paid = Cost of Long call – Cost of Short Call

Premium paid = $1.00 – $0.40 = $0.60 net debit

Note: The $0.60 net debit is per share. Since an option contract is for 100 shares, the debit will be $60 per option contract.

The maximum profit for this call debit spread is:

Maximum profit = Width of strike prices – Premium paid

Maximum profit = ($105 – $103) – $0.60 = $1.40 per share, or $140 per option contract

The breakeven point for this trade is when the stock price reaches:

Breakeven = Strike price of long call + Premium paid

Breakeven = $103 + $0.60 = $103.60

Finally, user-friendly options trading is here.^*

Trade options with SoFi Invest on an easy-to-use, intuitively designed online platform.

*Check out the OCC Options Disclosure Document.

Example 2

A trader buys a $50 call option for $3.50 and sells a $55 call option for $1.50, resulting in a net debit of $2.00 Their maximum loss is $200, which will occur if the stock closes below $50 at expiration. If the stock option closes above $55, the trader will profit $300. The trader will break even at a closing price of $52.

The maximum loss and net debit for this call debit spread is:

Premium paid = $2.00 ($3.50 for the long vall minus $1.50 for the short call)

The maximum profit for this call debit spread is:

Maximum profit = Width of strikes – Premium paid

Maximum profit = $55 – $50 – $2 = $3 per share or $300 per option contract

The breakeven point for this trade is when the stock price reaches:

Breakeven = Strike price of long call + Premium paid

Breakeven = $50 + $2 = $52

Maximum Gain, Loss, and Break-Even for Call Debit Spread

The maximum profit for a call debit spread is:

Width of Strikes – Premium (Debit) paid

The maximum profit for a call debit spread is:

Premium paid

The break-even point for a call debit spread is:

Premium paid + Strike price of the long call

Recommended: How to Trade a Bull Put Spread

Why Trade Call Debit Spreads?

Traders use the call debit spreads option strategy when they expect a moderate rise in the price of an asset.

Traders may use the call debit spread to gain exposure to an asset’s potential price increase without having to purchase it outright. This strategy provides defined risk and requires lower capital than buying the asset itself.

Traders also use the strategy as a way to hedge against the risk of volatility collapse. If volatility collapses in a long call position, this can go poorly for an investor. But with the structure of a call debit spread, changes in volatility don’t have much effect.

Call Debit Spread Tips

Here are some tips for trading call debit spreads and some additional factors to be aware of before opening your first call debit spread.

Sensitivity to Theta (Time) Decay

One factor that impacts call debit spreads is time decay, or theta decay. Theta is one of the Greeks in options trading and refers to the gradual loss of an option’s value as it approaches expiration.

If the underlying asset price is near to or below the long call (lower strike price) the trade will decrease in value as the expiration date nears. However, if the asset price is near to or above the short call (higher strike price) the trade will increase in value as the expiration date nears.

If the asset price is near the middle of the strike prices, time decay of the long and short call is offset and time erosion will have little impact on the price of the call debit spread.

Closing Call Debit Spreads

Closing a call debit spread before expiration may help lock in profits, especially if the trade has reached its maximum potential gain.

Another reason to close a call debit spread position as soon as the maximum profit is reached is due to the risk of your short call being assigned and exercised. To avoid this situation, you may close the entire call debit spread position or keep the long call open and buy to close the short call.

If the short call is exercised, a short stock position is created. You can close out the position with stock in your account, buy back stock in the market to close out your short position, or exercise the long call. Each of these options will incur additional transaction fees that may affect the profitability of your trade, hence the need to close out a maximum profit position as soon as possible.

Call Debit Spread Summary

Below is a summary of the key factors involved in a call debit spread:

Maximum Profit	Limited
Maximum Loss	Defined
Risk Level	Low
Best For	Prediction of a moderate upward movement in stock price
When to Trade	When bullish on a stock
Legs	Two legs
Construction	Short call (with a higher strike price) + Long call (with a lower strike price)
Opposite Position	Call credit spread

The Takeaway

A call debit spread allows traders to define both risk and profit potential while taking a bullish position on the underlying asset.

If a trader wants to take a long position on an asset, but not have to buy the asset itself, they can use the call debit strategy — which gives them exposure to the asset with less risk and lower capital requirements.

It’s also possible to use this strategy in options trading as a way to hedge against the risk of volatility collapse.

Explore SoFi’s user-friendly options trading platform.

🛈 While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

Photo credit: iStock/SDI Productions

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q125-064

Apr

2025

Guide to Synthetic Longs

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

A synthetic long is an options strategy that replicates a long position in an underlying asset. The strategy is used by bullish investors who wish to use the leverage of options to benefit from a potential rise in a stock’s price with less capital than would be needed to buy the shares outright.

Similar to holding the underlying stock, the synthetic long position offers unlimited profit potential if the stock’s price rises. Conversely, it also entails the risk of substantial losses if the stock’s price declines precipitously or goes to zero.

Key Points

• A synthetic long is an options strategy that combines a long call and a short put at the same strike price and expiration to replicate a long stock position.

• Leverage allows for exposure to price movements with less capital, but the strategy carries significant downside risk if the asset’s value declines.

• Maximum profit is theoretically unlimited, while the maximum loss is limited to the strike price minus the premium received since an asset cannot drop below zero.

• Exiting a synthetic long involves closing both the long call and short put before expiration to avoid assignment and capital outlay.

• Alternative strategies include risk reversals, synthetic long calls, and synthetic long puts, each offering different risk-reward profiles based on market outlook.

What Is a Synthetic Long?

First, a refresher on the two basic types of options: puts and calls. Options are a type of derivative that may allow investors to gain — not by owning the underlying asset and waiting for it to go up, but by strategically using options contracts to profit from the asset’s price movements.

Establishing a synthetic long involves purchasing at-the-money call options and selling put options with the same strike price and expiration. This strategy typically aligns with a bullish outlook, since potential gains are unlimited, the downside risk could be substantial if the asset price declines significantly.

An investor puts on a synthetic long options position when they’re bullish on the underlying asset, but want a lower cost alternative to owning the asset. A synthetic long options position has the same risk and reward profile as a long equity position. The setup can be beneficial to traders since a lower amount of capital is needed to establish the position. The options exposure offers leverage, whereas owning the asset outright does not.

Unlike owning the stock directly, a synthetic long position is subject to the expiration dates of the options involved. Additionally, if the stock’s price falls below the put’s strike price, the investor may be obligated to purchase the stock at that price, which could potentially lead to a significant financial commitment. Additionally, the options trader also does not have shareholder voting rights and will not receive dividends.

How Do Synthetic Longs Work?

Synthetic longs work by offering traders the potential for unlimited upside via the long call position. If a trader was very bullish, they might buy only the long call.

However, the short put helps finance the synthetic long trade by offsetting the expense of buying the long call. In some cases, the trade can even be executed at a credit (profit) depending on the premiums of the two options.

By including the short put, the investor can be exposed to losses, should the asset price drop below the strike price of the short put, but no more than would be expected if the trader went long the underlying asset.

Setup

A synthetic long options play is one of many popular options strategies, and it can be constructed simply: You buy close-to-the money (preferably at-the-money) calls and sell puts at the same strike price and expiration date.

Your expectation is that the underlying asset price will rise, just as you would hope it to do if you were holding the asset outright. If you’d rather own the asset outright, you could purchase the stock directly through a brokerage as an alternative.

Maximum Profit

There is unlimited profit potential with a synthetic long, just as there is with a long position. If the underlying share price rises, the value of the call will increase, allowing the position to be closed at a profit while covering (buying back) the short put.

Breakeven Point

The breakeven point for a synthetic long position is determined by adding the net debit paid to the strike price, or subtracting the net credit received from the strike price at the onset of the trade

Maximum Loss

The maximum loss is limited, but only because an asset’s price cannot fall below zero. However, the synthetic long position can incur substantial losses if the underlying stock’s price decreases significantly. The potential loss mirrors that of owning the stock outright and can be seen if the underlying share price drops below the breakeven point. Losses are maximized if the asset price drops to zero.

In the event that the asset price drops below the strike price of the short put, the trader can be assigned shares and would be obligated to buy the asset at the strike price. The risk of assignment increases as the asset price declines and the option nears expiration, but assignment can happen at any time once the asset trades below the strike price.

The loss would be slightly higher or lower based on the credit or debit of the initial trade.

Exit Strategy

Most traders do not hold a synthetic long through expiry. Rather, they use options to employ leverage with a directional bet on the underlying asset price, then exit the trade before expiration.

To exit the trade, the investor sells the long call and buys back the short put. This tactic avoids them having to buy the underlying asset and the increased capital outlay that would require.

Synthetic Long Example

Let’s say an investor is bullish on shares of a stock currently trading at $100, and wants to use leverage via options rather than purchasing the stock outright.

The investor constructs a synthetic long options trade by purchasing a $100 call option contract expiring in one month for $5 and simultaneously selling a $100 put option contract at the same expiration date for $4. The net debit (premium paid) is $1 per share.

Net debit = Call Option Price – Put Option Price = $5 – $4 = $1 per share
Note: The $1 net debit is per share. Since an option contract is for 100 shares,
the debit will be $100 per option contract.

This price reflects the total cost of entering the synthetic long position, factoring in both legs of the trade.

If the asset price declines, the position incurs losses. If the stock price drops to $90 after one week, the put premium rises to $12 while the call option price falls to $4. The unrealized loss is $9 (the long call price minus the short put price minus the net debit paid at initiation).

Unrealized loss = Long Call Price – Short Put Price – Net Debit at Initiation
Unrealized loss = $4 – $12 – $1 = Loss of $9 per share or $900 per option contract

The investor chooses to hold the position with the hope that the stock price climbs back. Because the stock price has dropped below the $100 strike price, the investor is at risk of the short put being exercised and assigned.

A week before expiration, the stock price has risen sharply to $110. The investor manages the trade by selling the calls and covering the short put. At this time, the call is worth $12 while the put is worth $3. The net proceeds from the exit is $9. This results in a profit of $8 ($9 of premium from the exit minus the $1 net debit).

Profit = Long Call Price – Short Put Price – Net Debit at Initiation
Profit = $12 – $3 – $1 = Profit of $8 per share or $800 per option contract

The investor could hold the trade through expiration but would then be exposed to having to own the stock.

Calculating Returns

A synthetic long replicates a long position in the underlying asset but at a lower cost.

In the example above, an investor might have purchased 100 shares at $100 each for a capital outlay of $10,000. If the shares closed at $110, the long position would be worth $11,000.

$ Gain = Selling Price – Purchase Price

$ Gain = $11,000 – $10,000 = $1,000

% Gain = $ Gain / Purchase Price

% Gain = $1,000 / $10,000 = 10% Gain

The synthetic long in the example above is substantially cheaper at a cost (debit) of $100 per contract, representing 100 shares. When sold, the options were worth $900.

$ Gain = Selling Price – Purchase Price

$ Gain = $900 – $100 = $800

Note this gain is similar to what would be realized in a long stock position, though transaction costs and execution factors can affect actual returns.

% Gain = $ Gain / Purchase Price

% Gain = $800 / $100 = 800% Gain

Although dollar gains are very similar, the percentage gains are larger due to the power of leverage using options. But leverage works both ways.

If we take a loss on a synthetic long, dollar losses will also be in line with losses on a long position, but percentage losses can be as outsized as the gains.

Pros and Cons of Synthetic Longs

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Pros:

• Potential for significant upside

• Uses a smaller capital outlay to have long exposure

• Clearly established cost basis

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Cons:

• Substantial loss potential if the stock falls to zero

• Does not provide voting rights nor dividends as a shareholder would

• The trade’s timeframe is confined to the options’ expiration date

Alternatives to Synthetic Longs

To have long exposure to a stock, an investor can choose to own the stock outright. Stock ownership carries with it the benefits of voting rights and dividends but at a much higher capital outlay.

Another alternative to holding the stock is a risk reversal, which involves selling an out-of-the-money put and buying an out-of-the-money call, both with the same expiration date. This approach differs from a synthetic long stock position, which typically uses at-the-money options. A risk reversal is sometimes referred to as a collar.

A synthetic long call can also be created by holding a long stock position and purchasing a long put option at the same strike price and expiration to hedge downside risk.

A bearish alternative is a synthetic long put strategy, which replicates the payoff of a long put option. This strategy is created by shorting the underlying stock and purchasing a call option at the same strike price and expiration to define risk while maintaining downside exposure.

The Takeaway

Options synthetic long strategies combine a short put and a long call at the same strike and expiration date. This options trading strategy mimics the exposure of being long the underlying asset while requiring less capital than outright ownership. It’s one of many options strategies that allow traders to help define their risk and reward objectives while employing leverage.

Putting on a synthetic long position means buying at-the-money call options and selling put options at the same strike price and expiration. This strategy has a bullish outlook because the maximum profit is unlimited, while downside risk can be substantial.

Explore SoFi’s user-friendly options trading platform.

🛈 While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

FAQ

What is a long combination in options trading?

A combination is a general options trading term for any trade that uses multiple option types, strikes, or expirations on the same underlying asset. A long combination is when an investor benefits as the underlying share price rises.

How do you set up a synthetic long?

A synthetic long is established by buying an at-the-money call and selling a put at the same strike price. The options have the same expiration date. The resulting exposure mimics that of a long stock position.

What is the maximum payoff on a synthetic long put?

The maximum payoff on a synthetic long put occurs if the stock price goes to zero. Maximum profit in this scenario is the short sale price minus the premium paid to establish the trade.

Photo credit: iStock/FG Trade

SoFi Invest®

INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SOIN-Q125-071

Apr

2025

Guide to Understanding and Tracking Robo-Advisor Returns

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

Robo-advisors are not advisors, but rather automated investment platforms that provide algorithm-generated portfolios to help individuals manage their money over time. As such, robo portfolios deliver a range of returns for investors, like any investment.

Robo-advisors are only automated in the sense that they use sophisticated technology to manage basic portfolios, typically composed of exchange-traded funds (ETFs) or other low-cost investments. Returns are not automated or guaranteed.

The underlying funds in a robo portfolio are the same or similar to those that regular investors can purchase on their own. Thus investors still need to consider the impact of gains and losses, taxes, and fees when thinking about robo-advisor returns.

Key Points

• Robo-advisors are automated portfolios, generated and managed by sophisticated algorithms.

• Investors supply some basic personal information and receive portfolio recommendations.

• The returns, positive or negative, from a robo-advisor platform are not automated or guaranteed, although the portfolios are designed to help manage risk.

• Automated portfolios are generally considered lower cost and consist of a basic assortment of exchange-traded funds.

• When choosing to invest in a robo-advisor portfolio, investors still need to consider the impact of taxes and fees over time, as these can impact returns.

How Robo-Advisors Help Investors

A robo-advisor is an automated, algorithm-based service that typically offers investors a questionnaire to assess their risk tolerance, time horizon, and investment goals. Based on these inputs, the robo-advisor platform suggests a portfolio that, ideally, will match the investor’s goals and preferences.

Robo-advisor algorithms typically employ some of the principles of modern portfolio theory (MPT), and other quantitative techniques, to establish and manage a range of pre-set portfolio options. Investors generally have a choice between more aggressive or more conservative investing allocations, but they typically cannot alter the makeup of an automated portfolio (unless that’s a feature specifically offered by a certain platform).

The algorithms used by robo-advisors are often updated to reflect changes in the market, and most rebalance on a regular cadence (e.g. annually) to maintain the portfolio’s asset allocation.

Robo Advisor Tools

Robo-advisors may also offer tools to help investors make decisions about their finances. These can include portfolio analysis tools, risk tolerance assessment tools, and educational resources. Investors can use these tools to monitor their portfolios and make informed decisions.

Robo-advisors typically charge a fee for their services, usually a percentage of the total portfolio value. However, the fees are generally lower than those traditional financial advisors charge.

The goal of robo-advisors is to provide a low-cost and convenient investing option to a wide range of customers, including those who may not have the resources or desire to work with a human, financial advisor — and those who prefer a more hands-off approach to their investments, whether they’re investing online or through a brokerage.

Recommended: What Is Automated Investing?

Evaluating Robo-Advisor Performance

Evaluating the performance of a robo-advisor is critical for investors interested in using them to build wealth. Although some robo services claim to have proprietary algorithms based on investment theories developed by Nobel Prize-winning economists, these formulas simply inform the technology on the backend; they don’t guarantee a certain return or performance.

An investor should evaluate robo-advisor performance by considering its historic returns, cost, and other key metrics. By assessing the following metrics, investors can better understand the robo-advisor’s performance and how it aligns with their investment goals:

• Cost: The annual cost to invest with a certain robo advisor is one of the most important factors influencing returns that investors can control.

Robo advisors are generally lower cost than, say, working with a live financial advisor. But automated services charge annual fees, in addition to the expense ratios of the investments in the portfolio. Because fees eat into returns over time, it’s always important to know what the total costs are up front.

• Returns: It may be useful to compare the rate of return of a robo-advisor’s portfolios to relevant benchmarks. For instance, investors can look at the returns of their robo-advisor portfolio versus the S&P 500 Index. If the robo-advisor performs better than the S&P 500, it may indicate a well-run robo-advisor.

However, past performance is not predictive of future results, but it can provide a general idea of how the robo-advisor’s investments have performed over time.

• Diversification: Evaluate the diversification of the robo-advisor’s portfolios within and across different asset classes. Portfolio diversification can help manage risk by spreading investments across different types of securities.

• Rebalancing: Inquire how often and how the robo-advisor’s portfolios are rebalanced and how frequently the underlying investments are reviewed. Some robo-advisors offer automated tax-loss harvesting, which can be advantageous.

• Customer Service: Check if the robo-advisor provides access to a live advisor or customer support, as this can be an important factor if you need help or have questions.

What Is the Average Robo-Advisor Return?

The average return for a robo-advisor portfolio can vary depending on several factors, such as the portfolio’s specific investments (i.e., its allocation), the robo-advisor’s investment strategy, and overall market conditions.

In general, robo-advisors tend to invest in low-cost index funds and ETFs, which often track the broader market. Therefore, a robo-advisor portfolio’s returns may be similar to a mix of comparable index funds minus any advisory fees charged by the robo-advisor, plus the fees of the underlying funds.

Nonetheless, returns can vary widely depending on the robo-advisor and the portfolio. For example, as of November 30, 2024, the 3-year annualized trailing return for robo-advisors with portfolios with a 60/40 allocation ranged from 3.98% to 5.96%, net of fees.

Robo-Advisor Returns

Below are the returns of the top 10 largest robo-advisors by AUM, according to the Motley Fool. The returns shown in the table are from portfolios with a 60% stock and 40% bond asset allocation, net of fees, as of November 30, 2024.

Robo-Advisor	Assets Under Management (AUM)	5-Year trailing returns
Vanguard Digital Advisor	333,066,527,268	4.01%
Betterment	$45,932,816,617	4.30%
Wealthfront Risk 4.0	$35,915,923,641	5.96%
US Bancorp Automated Investor	$15,874,717,608	4.11%
Acorns	$8,210,969,354	5.38%
Stash	$3,343,843,237	5.51%
SigFig	$2,797,084,452	3.98%
Ellevest	$2,112,640,438	4.28%
Ally Invest	$1,127,619,162	4.17%
SoFi	$943,520,661	5.00%
Source: The Motley Fool, as of November 30, 2024.

Understanding Robo-Advisor Fees

Understanding the different kinds of investment fees associated with robo-advisors, and how they compare to other investment options is critical for investors.

Investment fees are often expressed as a tiny percentage, e.g. 0.25% or 0.50%. But over time fees eat into a portfolio’s returns, making it harder for investors to build wealth. Analyzing robo-advisor expenses will help investors to determine if the robo-advisor is a cost-effective solution for their investment needs.

Note that all investment costs should be spelled out clearly for the investor (be sure to call customer service and ask, if they aren’t).

• Advisory Fees: This is the fee charged by the robo-advisor for managing the investor’s portfolio. It is typically a percentage of a portfolio’s assets under management and many robo-advisors charge less than 0.50%. Some robo-advisors offer fee-free options to their clients.

• Expense Ratios: An expense ratio is the fee charged by the underlying funds in the portfolio, such as ETFs. Expense ratios vary widely — a common range is 0.05% to 1.50%. Given the long-term impact of these fees, be sure to know what you’re paying up front.

• Account Minimums: Some robo-advisors may have minimum account balance requirements. A minimum account balance means investors must deposit a certain amount to open an account, which can be a headwind to opening an account if the investor starts with a small amount of capital.

• Other Fees: Some robo-advisors may charge additional fees for services such as tax-loss harvesting or closing an account.

Pros and Cons of Robo-Advisors

Robo-advisors are often appealing to many investors because of their hands-off nature. However, as with any financial product or service, there are pros and cons to using a robo-advisor.

Pros and Cons of Robo-Advisors
Pros	Cons
Relatively low cost vs. live advisors	Platforms charge a fee in addition to expense ratios
Convenient, and easy to use	Limited personalization
Provide basic diversification	Portfolio options are not flexible
Automatic rebalancing	Minimum balance requirements can limit access to certain features

The pros of using robo-advisors include the following:

• Low cost: Robo-advisors typically have lower fees than traditional financial advisors, making them an attractive option for people who want to invest but avoid paying high fees. Some robo-advisors charge as little as 0.25% of assets under management, while traditional financial advisors may charge 1% or more. This can make a significant difference over time, especially for people with smaller portfolios.

• Convenience: Robo-advisors are available 24/7 and can be accessed from anywhere with an internet connection, which makes it easy for people to check their investments.

• Diversification: Robo-advisors use algorithms to create diversified portfolios with a mix of different index funds and ETFs in various asset classes, which can help investors reduce risk and improve returns.

The cons of using robo-advisors include the following:

• Limited personalization: Robo-advisors use algorithms to create portfolios, which may not take into account an individual’s unique financial situation or goals. A lack of personalization can be a problem for people with complex financial situations or who have specific investment goals that a robo-advisor may be unable to accommodate.

• Limited or no access to human advice: While some robo-advisors provide access to a financial advisor to help investors, these services can be limited or dependent on a minimum balance. As such they may not meet the needs of some users.

• Fewer investment options: Some robo-advisors may have limited investment options compared to traditional financial advisors or a self-directed brokerage account. For instance, robo-advisors tend to invest in ETFs rather than individual stocks. If an investor wants to put money into a specific stock or asset, they may want to open a self-directed brokerage account in addition to a robo-advisor portfolio.

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Can Investors Lose Money With Robo-Advisors?

As with any investment, investors can lose money with robo-advisors.

The underlying investments in an automated portfolio are generally ETFs that an investor can buy anywhere. In other words, these are ordinary investments that may gain or lose value.

That said, a robo portfolio is designed to provide a well-balanced allocation, based on the investor’s goal and time horizon, with the aim of mitigating the risk of losses. That said, there are no guarantees. And the term “automated” refers to the use of technology; it doesn’t mean returns are somehow automated.

Why Do People Use Robo-Advisors?

People use robo-advisors because they can be cheaper than traditional financial advisors, and because the investment choices are decided by an algorithm, some investors find it reassuring to know that there may be less risk of human error. Other investors may find that a robo-advisor offers greater convenience when managing investments.

Investors who are comfortable with the underlying technology that these services use may appreciate having certain investment chores automated for them.

For example, some robo-advisors will automatically rebalance the portfolio according to the investors’ risk tolerance, and investment goals. This ease of rebalancing can help investors maintain their desired risk level and ensure that their portfolio stays aligned with their investment goals.

Additionally, as noted above, some robo-advisors use automated tax-loss harvesting to help investors minimize their tax liability. Tax-loss harvesting is a technique that involves selling investments that have lost value to offset capital gains from other investments, which can help reduce the amount of taxes you owe. SoFi does not offer automated tax-loss harvesting.

The Takeaway

Robo-advisors use algorithms and technology to create and manage portfolios for investors. In recent years, robo-advisors have become increasingly popular as more and more people look for low-cost, convenient ways to invest their money. This has lowered the barrier to entry for many individuals, including younger people, to start investing.

Ready to start investing for your goals, but want some help? You might want to consider opening an automated investing account with SoFi. With SoFi Invest® automated investing, we provide a short questionnaire to learn about your goals and risk tolerance. Based on your replies, we then suggest a couple of portfolio options with a different mix of ETFs that might suit you.

See why SoFi is this year’s top-ranked robo advisor.

FAQ

Do robo-advisors work?

Robo-advisors can be effective tools to help people invest their money and achieve their financial goals. Robo-advisors are generally cheaper and more convenient than traditional human financial advisors. However, it is important to research each robo-advisor to ensure it is the best fit for your needs, and that you’re comfortable with what a robo platform can and cannot do.

What are the differences between a robo-advisor and a financial advisor?

Robo-advisors typically have lower advisory fees and minimum deposit requirements, while financial advisors often require a minimum deposit and charge a percentage of the assets they manage. Another difference is that robo-advisors provide automated and algorithm-based guidance, while financial advisors provide personalized advice tailored to individual needs and goals.

Are robo-advisors good for retirees?

Robo-advisors can be a good option for some retirees because they can provide a low-cost, automated way to manage investments. However, if a retiree wants more personalized advice or help with tax and estate planning, a live advisor may be preferable.

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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOIN-Q125-050

Apr

2025

Understanding the Life Insurance Application Process

By Kelly Boyer Sagert | Life & Career, Terminology | Comments Off

The first step is to fill out an application with your carrier of choice. You’ll want to be well versed in whole and term, whether a medical exam is required, contestability, and the right amount of insurance needed.

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The pros of using robo-advisors include the following:

The cons of using robo-advisors include the following:

Want to start investing?

Our robo-advisor service can offer a portfolio to suityour needs and risk level.

Can Investors Lose Money With Robo-Advisors?

Why Do People Use Robo-Advisors?

The Takeaway

FAQ

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What are the differences between a robo-advisor and a financial advisor?

Are robo-advisors good for retirees?

Understanding the Life Insurance Application Process

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