Investing Archives | Page 5 of 194

Mar

2025

What Is a Bond Option? Definition & Examples

By Brian O'Connell | Growing Wealth, invest, Investing, Terminology | 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 bond option, like any option contract, gives the contract holder the right to buy or sell an underlying asset (in this case, a bond) at a specific price and time.

Although bond options are generally considered less risky than stock options, they still typically carry higher risk than more traditional investments.

Like all options, bond options are derivative securities, used by investors to bet on the direction of an underlying security. Understanding what bond options are and how they work can help you understand these risks and determine whether bond options make sense for your portfolio.

Key Points

• The put-call ratio measures market sentiment through the volume of put and call options.

• A ratio above 1 indicates bearish sentiment, while a ratio below 1 indicates bullish sentiment.

• Traders use the PCR for trend confirmation and contrarian strategies, often alongside other indicators.

• Extreme PCR values, such as above 1.5 or below 0.5, can signal potential market reversals.

• Interpreting PCR within historical benchmarks and current market conditions enhances trading decisions.

What Are Bond Options?

A bond option is a legal contract to buy and sell underlying bond assets, usually through a call option (the option to buy an underlying bond) or a put option(the option to sell a bond) at a specific price (known as the strike price), at or before a specific expiration date.

For example, an investor might purchase a bond call option with a strike price of $900. The level value (also known as “par value”) of the underlying U.S. government bond is $1,000. Let’s say market conditions push the value of that bond up to $1,100. In that scenario, the option holder has the right to buy the government bond at $900 — even as the value of that underlying bond now stands at $1,100.

Investors typically trade bond options on over-the-counter exchanges. Bond options on U.S. Treasury bonds can sometimes be found through specialized brokers or financial institutions that offer derivative products.

Pros and Cons of Bond Options

There are benefits and drawbacks to incorporating bond options in your portfolio.

Pros of Bond Options

Higher return potential. A well-executed options strategy can potentially increase a trader’s gains on a particular investment. Bond options can also be used to protect against downside risk. Investors often use bond options as a hedge against higher-risk investment strategies.

Risk hedging. Bond options investors can leverage derivative contracts to take advantage of interest rates and other short-term drivers of investment performance in the market. Investors can also lean on bond options to take advantage of pricing variations in options pricing, or to position their portfolios ahead of major geopolitical events (e.g., presidential elections, potentially big Federal Reserve policy decisions, or major recessions and other powerful economic forces).

Cons of Bond Options

The risk of unlimited investment loss. Although call options provide a buyer with the potential for unlimited gain if the underlying security rises in value, the seller of a call option faces the risk of unlimited potential loss, since the price of the underlying asset could theoretically continue to rise.

Should the underlying assets plummet to zero, the seller of a put option could face substantial loss, as they would lose the difference between the strike price and the asset’s zero value.

The risk of losing money quickly. As options are short-term investment instruments by nature, investors need to have extensive knowledge of near-term price movements and also be aware of the potential for loss when pursuing gains through options trading.

That means all options investors must master two key trading objectives — knowing the right time to purchase an options contract and knowing when to sell that contract, or cut losses by allowing the contract to expire without exercising the option to buy or sell by the expiration date. Although allowing an option to expire may sometimes be the best strategy, it can still result in the loss of premium and fees, which may add up over time.

Recommended: A Beginner’s Guide to Options Trading

Types of Bond Options

Bond options offer investors the right to buy or sell (via calls and puts) an underlying investment security at a specific time and at a set price.

Call Option Bonds

With a bond call option, if the price of the underlying bond rises, the contract holder (or buyer) can earn a profit by exercising the option to purchase the asset at a lower price and then selling it at the higher market price. A call option is in the money if the strike price is lower than the current market price of the underlying bond.

Conversely, the seller of a bond option hopes that the price of the bond stays below the strike price. If the bond price rises above the strike price, they would be required to sell the bond at loss for the lower strike price if the buyer exercises the option.

While a call option bond buyer stands only to risk the premium paid for the option, a call option seller, as mentioned previously, could face significant losses if the price of the bond rises significantly above the strike price.

Bond Put Options

While an investor who expects the bond’s price to increase might purchase a call option on that bond, an investor who expects the bond’s price to decrease might purchase a put option.

In this scenario, the holder is hoping the price of the underlying bond will fall below the strike price of the bond put option, so they can sell the bond for more than it’s worth, realizing a profit.

Conversely, bond put option sellers take on the risk that the bond’s price will decline. If the bond’s value falls below the strike price, the seller is obligated to buy it at a loss. However, their maximum loss is limited since a bond’s price cannot drop to zero like a stock.

Understanding Price Movements

Both of the above scenarios assume that the price moves in the direction the trader had hoped. What a bond investor strives to avoid is being on the wrong side of an options trade, selling below market rate or buying at an above-market rate.

For example, if an investor anticipates that bond prices will decline due to future market conditions, they may purchase a put option. If the face value of the underlying bond option were $1,000, a bond put option may give the contract holder the right to sell the option contract at the strike price of $900 — on or before the expiration date.

If bond prices fall, and assuming the underlying bond is now valued at $870, that bond option investor can still exercise the sale of the options contract at the strike price of $900, even though the bond’s value is lower. That can result in a profit for the investor.

Embedded Bond Options

Embedded bond options are features within certain bonds that grant either the bondholder or issuers specific rights under certain conditions. Examples of embedded bond options include:

• Call options, which allow the issuer to redeem the bond before maturity

• Convertible provisions, which allow the bondholder to convert the bond into equity

• Floating-rate provisions, which adjust the bond’s interest rate based on changes in a benchmark rate

Callable Bond Options

Callable bond options come with an embedded call feature that allows issuers to redeem the bond before maturity at face value. These options are often used if the issuer expects interest rates to fall, which allows them to refinance at a lower rate.

Callable bond options offer flexibility, but they also face the risk of being called early. This prevents the investor from collecting interest payments against the full life of the bond.

Bond Options Pricing

Given all the variables, including the current price and future price of a bond, volatility levels, interest rates, and time to expiration, it can be very complicated to properly price a bond option.

Investors rely on several mathematical formulas for this, including the Black-Derman-Toy Model and Black’s Model (an elaboration of the well-known Black-Scholes model used for options pricing).

All of those options pricing models are complex, but they all rely on a few primary factors that determine the investment value of an options contract:

• The market price of the asset that underlies the option (a.k.a. the spot price)

• The current intrinsic value of the option

• The time until the option expires

• Volatility

For a bond option, interest rate movements are also a key determinant in pricing.

The Takeaway

Options traders may use a bond option as a hedge against economic volatility in key areas, such as interest rates and bond yield rates. Depending on your strategy, a bond option can be a useful portfolio management tool.

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 SoFi does not offer bond option trading at this time, SoFi members can buy call and put options to try to benefit from stock movements or manage risk.

Photo credit: iStock/PeopleImages

SoFi Invest®

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.

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. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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-Q125-122

Mar

2025

What Are Over-the-Counter (OTC) Options? Pros & Cons

What Are Over-the-Counter (OTC) Options? How Do They Work?

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Over-the-counter (OTC) options are a type of customized derivative not listed on public exchanges. That means they are typically not available for purchase through standard brokerage accounts.

Instead, investors trade OTC contracts directly, between the buyer and the seller, without using a third-party platform.

Key Points

• Over-the-counter (OTC) options are privately traded options that allow for customized terms, unlike public exchange-traded options.

• The primary advantage of OTC options is their ability to be tailored to meet specific goals and needs of the parties involved.

• A significant disadvantage of OTC options is their illiquidity, as they lack a secondary market, making them harder to sell and often more costly.

• Pricing of OTC options depends on factors such as the underlying asset’s volatility, time to expiration, and interest rates.

• Trading OTC options through platforms offers flexibility in terms and conditions but involves higher costs and risks due to lack of standardization and liquidity.

OTC Options Definition

As a quick refresher, options are derivatives that give holders the right to buy or sell stocks or other assets. An options holder holds the right, but not the obligation, to buy or sell the underlying asset at a certain price, on or before a specific date.

While most options trade through brokers via exchanges, over-the-counter options trade privately, between a buyer and a seller. Over the counter options are sometimes tied to an exotic asset — a stock that may not be available for purchase through most brokers’ platforms.

OTC options are not standardized, and allow both parties to define expiration dates and strike prices on their own.This can make them appealing to those with a more complex options trading strategy.

How Does OTC Trading Work?

OTC securities include any types of investments that do not appear on U.S. exchanges. That can include stocks in foreign companies and small or mid-sized domestic companies; it can also include OTC options and futures. Some brokerages do allow investors to trade OTCs on their platforms, though not all do, and there may be additional fees charged by the broker to do so.

With that in mind, if you plan on investing in the OTC market, you may need to do some research beforehand to ensure that the brokerage account allows for OTC trading. SoFi’s options trading platform does not currently support OTC trading.

What is the Difference Between OTC Options and Stock Options?

OTC options and regular old stock options, or listed or exchange-traded options, have some key differentiators worth reviewing. Here is a short rundown of those differences:

OTC Options vs Stock Options

OTC Options	Stock Options
Customized	Standardized
Illiquid	Liquid
No secondary market	Secondary Market

1. Customization

A typical listed stock option is a standardized contract. The exchange, then, is determining expiration dates, strike prices, lot sizes, and other details. By standardizing contracts, exchanges can, as a result, increase the liquidity of the options contract.

Customization is the main and perhaps biggest difference between typical exchange-traded or listed stock options and OTC options. OTC options are customized with the terms hashed out by the involved parties.

2. Liquidity

OTC options are largely illiquid compared to their vanilla cousins. That’s because they’re more or less bespoke contracts — they’ve been customized according to the criteria set forth by the parties involved.

The customizations OTC options come with may not be appealing to many traders and, as a result, may not be quite as easy to sell. In other words, there’s less demand for tailor-made options contracts like those in the OTC market, meaning they’re less liquid, and often more costly.

3. Secondary Markets

Another key difference between vanilla stock options and OTC options is the secondary market — or lack thereof, in the case of OTC options.

Primary markets are where investors buy fresh securities, when they’re first offered. Secondary markets are what most investors engage in when they’re buying or selling securities. These include exchanges such as the New York Stock Exchange.

While the primary market for OTC options is where parties meet to come to terms and develop an options contract, there is no secondary market. In many cases, OTC options can only be closed through an offsetting transaction — a new trade with the original counterparty — that cancels out the existing position.

What are the Risks of Trading OTC Options?

Given the complex and bespoke nature of OTC options, trading them can come with some serious risks. Chief among those risks is the fact that OTC options lack the protection provided by clearinghouses on regulated exchanges, which essentially “guarantees” that the contractual obligations are fulfilled.

That means that typical exchange-traded options are overseen, like other derivatives, by regulating authorities like the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The guarantee cements into place that contract buyers can exercise their options, knowing that the counterparty will fulfill their obligation, thus avoiding counterparty risk.

Essentially, a contract is a promise between two parties. If one party decides not to follow through on their end of the deal, when it comes to a traditional stock option, then the exchange will ensure that everything is smoothed out. But OTC options lack that protection from the exchanges.

Pros & Cons of OTC Options Contracts

Like just about every financial tool, instrument, or security out there, OTC options have their benefits and disadvantages.

Pros

The biggest and most obvious advantage to OTC options is that they’re tailored for specific parties. That means that the parties engaged in the options contract get precisely the terms that they want and a contract that fits with their specific goals.

Further, the OTC market allows for trading of both securities and derivatives (like options) for small companies (exotic options) that aren’t listed on the typical exchanges. This provides traders more investment choices, but introduces additional risks.Effectively, the OTC market, and OTC options, provide investors with more investment choices. That can increase the risk — but also the potential rewards — of such securities.

Cons

The drawbacks of OTC options concern the lack of standardization of contracts (which may be a con for some investors), and the illiquid nature of the market. Plus, that illiquidity can add additional costs. And, again, there’s no secondary market for OTC options.

The big thing investors should remember, too, is that there can be a lack of information and transparency in the OTC market. Many OTC securities, including stocks, lack readily available and reliable information. This increases their risk profiles.While with standard options, you can find data and availability through your broker’s portal, such information can be harder to come by for OTC options.

The Takeaway

There are some benefits to trading OTC options, but it requires a thorough understanding of how the market works and the risks that it presents.

While investors are not able to trade OTCs on the SoFi platform at this time, they can buy call and put options to try to gain exposure to exchange-traded stock movements or potentially manage risk.

That said, going over-the-counter can open up a whole new slate of potential investments.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Trade options with low fees through SoFi.

🛈 SoFi offers options trading on a user-friendly platform. However, it does not offer OTC options at this time.

FAQ

What is the difference between OTC and exchange options?

OTC options are traded over-the-counter (or, OTC), and may not be available to purchase through some brokerages or platforms. Exchange options, conversely, are traded on exchanges, and should be more widely accessible to investors.

How are OTC options priced?

Several factors influence the price of OTC options, and those could include the volatility of the underlying asset, the time to expiration, and applicable interest rates.

Photo credit: iStock/g-stockstudio

SoFi Invest®

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.

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.

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. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN-Q125-112

Mar

2025

Bollinger Bands Explained

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

Bollinger Bands are a popular technical analysis tool that helps traders assess price trends and market volatility. By measuring how far a security’s price moves above or below its average, Bollinger Bands provide insights into whether the price is relatively high or low compared to recent trading activity, indicating whether the security is overbought or oversold.

These bands can be applied to various assets, including options and stocks, making them versatile for different trading strategies. Although Bollinger Bands are often used to spot potential opportunities, they often work best when combined with other indicators to confirm trends and reduce the risk of false signals.

Key Points

• Bollinger Bands are technical analysis tools that measure a security’s price relative to its moving average and volatility.

• The bands consist of three lines: a simple moving average and two standard deviation lines.

• Bollinger Bands help identify overbought or oversold conditions and potential price reversals.

• This tool is more effective when used with other indicators like RSI and MACD.

• Bollinger Bands can be useful for day trading but are not predictive on their own.

What Are Bollinger Bands?

Bollinger Bands are a popular tool used in the technical analysis of securities. They are a set of three bands that measure a security’s relative price in comparison to its moving average and recent price volatility.

The center line is typically the 20-day simple moving average (SMA) of a security’s price, plus plotted lines two standard deviations away from the SMA. The bands are plotted positively and negatively from the SMA, which is what measures the volatility of a security, and the trader can adjust them based on their particular use case. These bands expand during periods of volatility and contract during periods of lower volatility, visually demonstrating market conditions.

Bollinger Bands were created to help investors understand whether a security is currently oversold or overbought, which may help determine whether it is likely to increase or decrease in value over time. When the upper band is close to the SMA, traders may see this as an overbought security. When the lower band is close to the SMA, they may consider the security to be oversold.

The bands, and a set of 22 rules about using them for trading, were developed in the 1980s by John Bollinger, a well-known technical trader.

How Do Bollinger Bands Work?

Bollinger Bands are plotted using two parameters: period and standard deviation.

Period is found by calculating the simple moving average of the security a trader is interested in. The calculation generally uses a 20-day SMA, an average of a security’s closing prices over a 20-day period — or roughly a month of trading days.

The first data point on the graph would be the average of the first 20 days being tracked. The second data point would be the next 20 days, and so on.

That line shows the SMA over time, and the Bollinger Bands are then placed above and below it by calculating the standard deviation of the security’s price along each data point. The standard deviation measures how much a security’s price deviates from its average, reflecting price volatility against its SMA, representing price volatility.

The standard deviation is calculated by first finding the square root of the variance, which is the average of the squared differences of the mean. The standard deviation is typically multiplied by two to create the bands, but traders can adjust this multiplier based on their strategy. The resulting value is then added and subtracted from each SMA data point to form the upper and lower Bollinger Bands.

Key Things to Know About Bollinger Bands

Bollinger Bands adjust dynamically to market conditions, expanding and contracting based on volatility. Here are a few things to keep in mind when using them:

• When volatility is low, the bands get closer together. This contraction reflects a lower volatility period, which may precede future price movements.

• When volatility is high, the bands get farther apart. This indicates that an existing price trend could be coming to a close in the future.

• Generally the security’s price movements stay within the two bands. And once they touch one band they start moving towards the other band. But the price can also bounce off the band multiple times or it can cross over the band. If the price touches one band and crosses the SMA, traders may watch to see if it moves toward the opposite band.

When the price crosses to the outside of the bands, this is a strong indicator of a trend in that direction.

Formula for Bollinger Bands

Below is the formula to plot Bollinger Bands:

BOLU=MA(TP,n)+m∗σ[TP,n]

BOLD=MA(TP,n)−m∗σ[TP,n]

where:

BOLU=Upper Bollinger Band

BOLD=Lower Bollinger Band

MA=Moving average

TP (typical price)=(High+Low+Close)÷3

n = Number of days in smoothing period (typically 20)

m = Number of standard deviations (typically 2)

σ[TP,n]=Standard Deviation over last n periods of TP

Recommended: 7 Technical Indicators of Stock Trading

How Do You Read Bollinger Bands?

Bollinger Bands help traders understand whether a security’s price is relatively high or low so that they might make trades based on trends. Bollinger Bands can indicate uptrends and downtrends as well as possible upcoming price reversals.

Trends with Bollinger Bands can vary based on the asset and trading strategy, lasting anywhere from minutes to years. Traders should understand how to set up the bands based on their timeline. Here are some patterns and indicators traders might want to learn.

Uptrends

Traders can use Bollinger Bands to see whether there is a bullish trend in a security’s market price. If the center line hits the upper band multiple times, this may suggest an uptrend. If the price hits the upper band, decreases but stays above the center line, then hits the upper band again, that is a strong indicator of an uptrend. If the price then hits the lower band, it may indicate a reversal or a loss of strength in the uptrend.

Downtrends

The lower band can indicate a downtrend or an upcoming reversal towards an uptrend. If the price hits the lower band continuously and stays below the center line, this indicates a downtrend. Traders typically avoid making trades during downtrends, but if there is an indicator of a reversal, they might choose to buy.

The Squeeze

When the bands are close together, this is known as a squeeze. The squeeze happens when the security has low volatility, but it indicates that the security will probably have increased volatility in the future. Traders look for high volatility periods to find trading opportunities, so the squeeze reflects decreased volatility and often precedes periods of higher volatility, though it does not predict price direction.

Traders typically like to exit trades during periods of lower volatility, so they look for far-apart bands as a clue that volatility may soon decrease. The squeeze is not used as a trading signal, and doesn’t show whether a security will increase or decrease in value. However, it may help traders figure out the potential timing of upcoming trades.

Breakouts

The SMA line doesn’t always stay between the Bollinger Bands — it can also move above or below the bands. Around 90% of price changes do happen between the bands, so if the price has a breakout above or below the bands it’s a significant event. Breakouts can signal significant price movement outside the bands, however, but they are not reliable predictors of future trends on their own.

Bollinger Band Trading Strategies

Financial analyst Arthur Merrill identified a set of 16 trend patterns, including M patterns and W patterns, that traders can use to recognize potential price reversals. Here are two key patterns.

M Top

The M top pattern indicates that the security price may decrease to a new low. It forms an M pattern at the upper band, where the price nearly hits or hits the upper band but doesn’t cross over it, then decreases to below the low in the center of the M pattern.

W Bottoms

W patterns can be used to identify W bottoms, which is when the second low is lower than the first low but neither low goes below the lower band. If the security rises above the high in the center of the W, this is an indicator that the price will likely reach a new high.

Recommended: How to Analyze Stocks: 4 Ways

Combining Bollinger Bands With Other Indicators

John Bollinger recommended that traders use Bollinger Bands in conjunction with other non-correlated indicators, such as the relative strength indicator (RSI) and the Stochastic Oscillator, in order to gain a comprehensive understanding of the security being assessed.

Although Bollinger Bands help traders understand price volatility and can show opportunities for upcoming trades, they aren’t strong indicators of potential upcoming price movements.

Drawbacks of Bollinger Bands

There are a number of caveats to consider with Bollinger Bands. In particular, they are best used with other stock indicators, to form a fuller picture.

• They show old security price data with equal importance to new data, so data that is outdated may be counted with too much importance.

• They are more of a reactive indicator than a predictive indicator, so they show current market conditions and can indicate trends, but are not strong indicators of what will happen to a security’s price in the future.

• The standard settings of 20-day SMA and two standard deviations is an arbitrary measurement that doesn’t convey relevant information for every security and trading situation, so it’s important that traders understand how to adjust the band calculations for their particular situation.

Using Bollinger Bands for Crypto Trading

Bollinger Bands have become a popular tool for crypto traders to track volatility and trends. They can be used for trading crypto in a similar way to stocks, but some traders choose to use a 28 or 30 SMA instead of 20, to better represent a month of trading days, since the crypto markets are open 24/7.

The Takeaway

Bollinger Bands are a useful tool for technical analysis in options trading, which measure the relative high or low of a security’s price in relation to previous trades over typically the past 20 trading days.

While investors are not able to sell options on SoFi’s options trading platform at this time, they can still employ some of these strategies when they buy call and put options on the platform, whether that’s to try to benefit from stock movements or manage risk.

Explore SoFi’s user-friendly options trading platform.

FAQ

What do Bollinger Bands tell you?

Bollinger Bands show how a security’s price moves over time, and whether it’s relatively high or low compared to its recent average. They also help gauge volatility: when the bands are far apart, the price is more volatile. When they’re close together, it’s less volatile.

Are Bollinger Bands good for day trading?

Yes, Bollinger Bands can be helpful for day trading because they show short-term price trends and volatility, helping traders spot potential opportunities for quick trades.

How reliable are Bollinger Bands?

Bollinger Bands are useful for identifying trends and volatility, but they’re not foolproof. They work best when combined with other indicators to confirm signals and reduce false predictions.

What indicator pairs well with Bollinger Bands?

The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) pair well with Bollinger Bands to confirm trends and spot potential reversals.

Photo credit: iStock/blackCAT

SoFi Invest®

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

SOIN-Q125-098

Mar

2025

What Is a Naked Call Options Strategy?

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

A naked call, or uncovered call, is generally considered a high-risk option strategy. Naked calls are when an investor sells or writes call options for an underlying security they don’t own.. The seller is anticipating that the underlying stock price will not increase before the call’s expiration date, which may require them to purchase shares that are higher than the market price to close the position.

It is almost always safer for traders to sell calls on a stock they already own — known as a “covered call” position — than those they don’t. This way, if the stock price increases sharply, the trader’s net position is hedged. Naked calls, on the other hand, may be considered speculative trades. You keep the premium if the underlying asset is at or in the money at expiration, but you also face the potential of seeing unlimited losses if the option to buy is exercised.

Key Points

• Naked call options involve selling calls without owning the underlying asset, aiming to profit from time decay.

• This strategy carries high risk, with potential for unlimited losses if stock prices rise sharply.

• Covered calls, using owned assets, are a less risky alternative to naked calls.

• Exiting a trade can be done by buying back options or shares to close the position.

• Risk management and liquidity are essential to handle adverse price movements and margin requirements.

Understanding Naked Calls

When a trader sells or writes a call option, they are selling someone else the right to purchase shares in the underlying asset at the strike price. In exchange, they receive the option premium. While this immediately creates income for the option seller, it also opens them up to the risk that they will need to deliver shares in the underlying stock, should the option buyer decide to exercise.

For this reason, it is generally much less risky to use a “covered call strategy” and sell an option on an underlying asset that you own. In the case of stocks, a single option generally represents 100 shares, so the trader would want to own 100 shares for each option sold.

Trading naked calls, on the other hand, is among the more speculative options strategies. The term “naked” refers to a trade in which the option writer does not own the underlying asset. This is a neutral to bearish strategy in that the seller is betting the underlying stock price will not materially increase before the call option’s expiration date.

In both the naked and the covered scenarios, the option seller gets to collect the premium as income. However, selling a naked call requires a much lower capital commitment, since the seller is not also buying or owning the corresponding number of shares in the underlying stock. While this increases the potential return profile of the strategy, it opens the seller up to potentially unlimited losses on the downside.

How Do Naked Calls Work?

The maximum profit potential on a naked call is equal to the premium for the option, but potential losses are limitless. In a scenario where the stock price has gone well above the strike price, and the buyer of the option chooses to exercise, the seller would need to purchase shares at the market price and sell them at the lower strike price.

Hypothetically, a stock price has no upper limit, so these losses could become great. When writing a naked call, the “breakeven price” is the strike price plus the premium collected; a profit may be achieved when the stock price is below the breakeven price.

Investing in naked calls comes with significant risk and requires discipline and a firm grasp of common options trading strategies.

Writing a Naked Call

Although there are significant risks to naked calls, the process of writing them can be straightforward. An individual enters an order to trade a call option; but instead of buying, they enter a sell-to-open order. Once sold, the trader hopes the underlying stock moves sideways or declines in value.

So long as the shares remain below the strike price at expiration, the naked call writer will keep the premium (or credit) collected. However, if the company that issued the shares releases unexpected good news, or the shares simply have positive price momentum, the stock price can go upward and expose the naked call writer to potentially significant losses should the buyer exercise the call option.

There are dozens of options on stocks and exchange-traded funds (ETFs) with differing expiration dates and strike prices. For this reason, a trader must take a directional position on the underlying stock price while also accounting for the impact of time decay leading up to expiration. Keeping a close eye on implied volatility is important, too.

Closing Out a Naked Call

When the trader wants to exit the trade, they create a buy-to-close order on their short calls. Alternatively, a trader can buy shares of the underlying asset to offset the short call position.

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Naked Call Example

Let’s say a trader wants to sell a naked call option on shares of a stock. Let’s also assume the stock trades at $100 per share.

For our example, we’ll assume the trader sells a call option at the $110 strike price expiring three months from today. This option comes with a premium of $5 per share, which they receive for selling their options. This call option would be considered “out of the money” since the strike price is above the underlying stock’s current price.

Thus, the option only has extrinsic value (also known as time value). This naked call example seeks to benefit from the option’s time decay, also known as theta. At initiation, the trader sells to open the trade, and then collects the $5 premium per share.

As the option nears its expiration date, time value diminishes, and the option price may decrease if the stock price does not significantly rise. If the stock price ends below the strike price by expiration, the option could expire worthless, allowing the trader to retain the full premium as profit.

Conversely, if the stock price increases significantly — say from $50 to $60 — the traders who sold the call at a $52 strike price could face a loss of at least $8 per share ($60 market price minus the $52 strike price, less any premium received). If multiple contracts are sold, the losses can add up quickly.

For example, if the stock price rises during the contract period, the trader who sold the call option may face increasing losses as the stock moves further above the strike price.

Using Naked Calls

In general, naked calls are best suited for experienced traders who have a risk management strategy in place already.

Naked calls may appeal to traders seeking speculative opportunities, since they may profit if the underlying stock price remains stable or declines. The strategy comes with the risk of potentially unlimited losses and other considerations, such as liquidity concerns and the potential need for a margin account or leverage.

The challenge of trading naked calls is the need for sufficient liquidity to manage adverse price movements. If the underlying stock experiences unexpected positive momentum, its price may rise sharply, leading to substantial losses for the trader. This risk is compounded when a trader does not have adequate funds to cover the margin requirements associated with the position.

This strategy may require you to open a margin account with a broker so you can tap into their liquidity if necessary. Brokers typically enforce strict margin requirements for naked calls to mitigate this risk, which can result in margin calls if the account value drops too low.

Naked call strategies are most appropriate for seasoned traders who thoroughly understand options mechanics, as well as the factors that influence price movements (volatility, time decay, and underlying stock performance). These traders should implement stringent risk controls, such as predefined exit strategies and position sizing, to limit exposure.

Risks and Rewards

The potential for unlimited losses makes naked call writing a risky strategy. The reward is straightforward — keeping the premium received at the onset of the trade. Here are the pros and cons of naked call option trading:

Pros	Cons
Potential profits from a flat or declining stock price	Unlimited loss potential
Can allow time decay (theta) to work in your favor	Reward is limited to the premium collected
May generate income	May result in a margin call when the underlying asset appreciates

Naked Call Alternatives

One common alternative to naked calls is known as “covered call writing.” This strategy includes owning the underlying stock while selling calls against it. This can be a more risk-averse alternative to naked calls, but the trader must still have enough cash to purchase the necessary shares (unless they are using margin trading).

There are other, more complex options strategies that can help achieve results similar to naked call writing. Covered puts, covered calls, and bear call spreads are common alternatives to naked calls. Experienced options traders have strategies to manage their risk, but even sophisticated traders can become overconfident and make mistakes.

Selling naked puts is another alternative that takes a neutral to bullish outlook on the underlying asset. When selling naked puts, the trader’s loss potential is limited to the strike price (minus the premium collected) since the stock can only go to $0 — however, that loss can be significant.

The Takeaway

A naked call strategy is a high-risk technique in which a trader seeks to profit from a declining or flat stock price. The maximum gain is the premium received while the risk is unlimited potential losses. As with all option trading strategies, traders need to understand the risks and benefits of selling naked calls.

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SOIN-Q125-096

Mar

2025

Can You Lose Money in an Index Fund?

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

As is the case with any investment, you can absolutely lose money in an index fund. Still, index funds allow investors to track the market in a low-cost, consistent way, according to most analysts and advisors. That’s because an index fund provides exposure to a diverse selection of publicly traded securities that are intended to perform identically to a market index.

However, index funds don’t always perform in an exact one-to-one ratio, as we will see. But in general, most high-quality index funds perform in close lockstep with their underlying indexes.

Key Points

• Index funds provide a low-cost method for tracking market performance.

• These funds consist of multiple assets, enabling investors to mirror a specific market index.

• Not all index funds perform identically to the index they track; some may underperform due to fees or strategies.

• Despite diversification, index funds can lose value, particularly in volatile market conditions.

• They are less ideal for short-term investments due to low volatility and fees.

How Can You Lose Money in an Index Fund?

All investments carry risk. An index fund, like anything else, can potentially lose value over time.

That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk). This is largely due to the fact that index funds are greatly diversified, distributing risk throughout many securities. Risk is also lowered by reducing an individual’s responsibility in managing the funds — investors can simply buy and hold for years, or even decades.

As you weigh the risks, also keep in mind that most financial experts agree that the biggest risk is not investing at all. While saving money is important, inflation steadily eats away at savings over time.

How Does an Index Fund Work?

Index funds are part of a growing trend of what’s referred to as “passive investments.” Similar to an exchange-traded fund (ETF), an index fund is composed of many different assets packaged into a single security that investors can trade like a regular stock.

When you buy shares of an index fund, many people think that you are almost buying a tiny piece of a share of every company in that index all at once. An S&P 500 index fund, for example, gives investors exposure to most 500 companies in the S&P 500, or so the story goes. And some index funds do work this way.

But in reality, things are not always so straightforward. The goal of an index fund is to track the performance of a stock market index, and the fund can invest in any number of assets to achieve this end. That often does include a substantial amount of holdings of the stocks contained in a specific index, but there can be other assets included as well.

Some funds might not actually hold any of the assets that are present in the index they are supposed to be tracking. Instead, they might invest only in derivatives, like options and futures, that are intended to perform similarly to the index.

Some funds also provide leverage, meaning they are designed to provide returns or losses greater than what their respective index provides. If a fund has 3x leverage, for example, then it might produce a return or loss three times as high as what its index does. Leveraged bets of any kind are generally considered to have higher risks, and are more speculative.

How Likely Are Index Funds to Go to Zero?

Index funds are generally not as volatile as individual stocks because of their level of diversification. But of course, if the underlying index is volatile, then the index fund will be, too, assuming it tracks the index’s performance well.

Investors who stick to well-established index funds that own real assets probably don’t have too much to worry about — but they aren’t 100% free of risk either.

Markets don’t go up or down in a straight line, so over the short term, funds will fluctuate. But index funds can provide a good option to gain exposure to broad swaths of the market without having to select individual stocks or manage a portfolio actively.

Although any index fund comes with risk of loss, like all investments, some funds may have a real possibility of losing a significant portion of investment capital. Leveraged funds and funds that invest in derivative products have a higher-than-average chance to produce suboptimal returns.

Over long periods of time, though, most indexes have seen healthy returns, as the large companies that are included in most indexes continue growing.

What Are the Benefits of Investing in Index Funds?

The benefits of index funds involve everything described so far. Low risk and high diversification provide an excellent way to grow wealth steadily over time. For this reason, index funds can be a reasonable option for most long-term portfolios.

For the most part, major index funds with an established track record don’t require much active management. That’s why they fall under the umbrella term “passive investments.” This is another reason why some investors like index funds: They don’t have to keep track of a bunch of different securities, their performance, or their latest news releases and company fundamentals.

Some Common Misconceptions About Index Funds

Not all index funds are created equal, and not all of them work in a simple, straightforward manner. While the general concept may be simple enough, in practice things don’t always work out the same way.

Here are a few notes about some of the most common misconceptions about index funds.

Index Funds Always Perform the Same

Sometimes, some index funds might provide returns less than the actual index they track. This can happen for a number of reasons. A high expense ratio, for example, might mean that there are hidden fees associated with owning the fund, making it more expensive.

To this end, it can be important for investors to make sure their funds won’t underperform. Index funds are generally a good way to minimize bad decisions, but only if someone chooses a fund that has broad exposure and low fees.

All Index Funds Are Low Risk

As mentioned, index funds tend to be on the lower end of the risk spectrum. But not all index funds are created the same. For investors looking for minimal risk, it might be wise to seek out a fund that directly owns shares of stocks, offers the most diversification possible, and has a long-standing track record of performance that mimics its underlying index.

Index Funds Work Well As Short-Term Investments

In general, some advisors might suggest that index funds ought to be held for at least five years, if not 10 or more.

Funds of this type don’t make for good short-term investments because they usually don’t move a lot over short time periods, and the fees or commissions involved tend to eat into the meager profits investors might gain.

There are certain leveraged funds and ETFs that are better suited to short-term trading, but we won’t get into those here.

The Takeaway

Can you lose money in an index fund? Of course you can. But index funds still tend to be an appealing choice for investors due to their built-in diversification and comparatively low risk. Just make sure to note that not all index funds always perform the same, and that now every index fund out there is low-risk.

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SOIN-Q125-025

What Is a Bond Option? Definition & Examples

What Are Bond Options?

Pros and Cons of Bond Options

Pros of Bond Options

Cons of Bond Options

Types of Bond Options

Call Option Bonds

Bond Put Options

Understanding Price Movements

Embedded Bond Options

Callable Bond Options

Bond Options Pricing

The Takeaway

What Are Over-the-Counter (OTC) Options? How Do They Work?

OTC Options Definition

How Does OTC Trading Work?

What is the Difference Between OTC Options and Stock Options?

1. Customization

2. Liquidity

3. Secondary Markets

What are the Risks of Trading OTC Options?

Pros & Cons of OTC Options Contracts

Pros

Cons

The Takeaway

FAQ

What is the difference between OTC and exchange options?

How are OTC options priced?

Bollinger Bands Explained

What Are Bollinger Bands?

How Do Bollinger Bands Work?

Key Things to Know About Bollinger Bands

Formula for Bollinger Bands

How Do You Read Bollinger Bands?

Uptrends

Downtrends

The Squeeze

Breakouts

Bollinger Band Trading Strategies

M Top

W Bottoms

Combining Bollinger Bands With Other Indicators

Drawbacks of Bollinger Bands

Using Bollinger Bands for Crypto Trading

The Takeaway

FAQ

What do Bollinger Bands tell you?

Are Bollinger Bands good for day trading?

How reliable are Bollinger Bands?

What indicator pairs well with Bollinger Bands?

What Is a Naked Call Options Strategy?

Understanding Naked Calls

How Do Naked Calls Work?

Writing a Naked Call

Closing Out a Naked Call

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Naked Call Example

Using Naked Calls

Risks and Rewards

Naked Call Alternatives

The Takeaway

Can You Lose Money in an Index Fund?

How Can You Lose Money in an Index Fund?

How Does an Index Fund Work?

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How Likely Are Index Funds to Go to Zero?

What Are the Benefits of Investing in Index Funds?

Some Common Misconceptions About Index Funds

Index Funds Always Perform the Same

All Index Funds Are Low Risk

Index Funds Work Well As Short-Term Investments

The Takeaway

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