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Q: Can I put all of my bonus into a 401k?

Possibly. You can put all of your bonus in your 401k if you haven’t reached the contribution limit for that particular year, and if you won’t surpass it by adding all of your bonus.

May

2024

Should I Put My Bonus Into My 401(k)? Here’s What You Should Consider

By Paulina Likos | Growing Wealth, invest, Investing, Preparing for Retirement | Comments Off

If you received a bonus and you’re wondering what to do with the bonus money, you’re not alone. Investing your bonus money in a tax-advantaged retirement account like a 401(k) has some tangible advantages. Not only will the extra cash help your nest egg to grow, you could also see some potential tax benefits.

Of course, we live in a world of competing financial priorities. You could also pay down debt, spend the money on something you need, save for a near-term goal — or splurge! The array of choices can be exciting — but if a secure future is your top goal, it’s important to consider a 401(k) bonus deferral.

Here are a few strategies to think about before you make a move.

Key Points

• Investing a bonus in a 401(k) can significantly enhance retirement savings and offer potential tax benefits.

• Bonuses are subject to income tax withholding, which may reduce the expected amount.

• The 2024 contribution limit for a 401(k) is $23,000, with an additional $7,500 allowed for those 50 and older.

• If 401(k) contributions are maxed out, considering an IRA or a taxable brokerage account is beneficial.

• Allocating a bonus to a 401(k) or IRA can reduce taxable income for the year, potentially lowering the tax bill.

Receiving a Bonus Check

First, a practical reminder. When you get a bonus check, it may not be in the amount that you expected. This is because bonuses are subject to income tax withholding. Knowing how your bonus is taxed can help you understand how much you’ll end up with so you can determine what to do with the money that’s left, such as making a 401(k) bonus contribution. The IRS considers bonuses as supplemental wages rather than regular wages.

Ultimately, your employer decides how to treat tax withholding from your bonus. Employers may withhold 22% of your bonus to go toward federal income taxes. But some employers may add your whole bonus to your regular paycheck, and then tax the larger amount at normal income tax rates. If your bonus puts you in a higher tax bracket for that pay period, you may pay more than you expected in taxes.

Also, your bonus may come lumped in with your paycheck (not as a separate payout), which can be confusing.

Whatever the final amount is, or how it arrives, be sure to set aside the full amount while you weigh your options — otherwise you might be tempted to spend it.

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement by opening an IRA account. The money you save each year in a traditional IRA is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

What to Do With Bonus Money

There’s nothing wrong with spending some of your hard-earned bonus from your compensation. One rule of thumb is to set a percentage of every windfall (e.g. 10% or 20%) — whether a bonus or a birthday check — to spend, and save the rest.

To get the most out of a bonus, though, many people opt for a 401k bonus deferral and put some or all of it into their 401(k) account. The amount of your bonus you decide to put in depends on how much you’ve already contributed, and whether it makes sense from a tax perspective to make a 401(k) bonus contribution.

Contributing to a 401(k)

The contribution limit for 401(k) plans in 2024 is $23,000; for those 50 and older you can add another $7,500, for a total of $30,500. The contribution limit for 401(k) plans in 2023 is $22,500; for those 50 and older you can add another $7,500, for a total of $30,000. If you haven’t reached the limit yet, allocating some of your bonus into your retirement plan can be a great way to boost your retirement savings.

In the case where you’ve already maxed out your 401(k) contributions, your bonus can also allow you to invest in an IRA or a non-retirement (i.e. taxable) brokerage account.

Contributing to an IRA

If you’ve maxed out your 401k contributions for the year, you may still be able to open a traditional tax-deferred IRA or a Roth IRA. It depends on your income.

In 2024, the contribution limit for traditional IRAs and Roth IRAs is $7,000; with an additional $1,000 if you’re 50 or older. In 2023, the contribution limit for traditional IRAs and Roth IRAs is $6,500; with an additional $1,000 if you’re 50 or older. But if your income is over $161,000 (for single filers) or over $240,000 (for married filing jointly) in 2024, you aren’t eligible to contribute to a Roth. For 2023, you can’t contribute to a Roth if your income is over $153,000 (for single filers) or over $228,000 (for married filing jointly). And while a traditional IRA doesn’t have income limits, the picture changes if you’re covered by a workplace plan like a 401(k).

If you’re covered by a workplace retirement plan and your income is too high for a Roth, you likely wouldn’t be eligible to open a traditional, tax-deductible IRA either. You could however open a nondeductible IRA. To understand the difference, you may want to consult with a professional.

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

Contributing to a Taxable Account

Of course, when you’re weighing what to do with bonus money, you don’t want to leave out this important option: Opening a taxable account.

While employer-sponsored retirement accounts typically have some restrictions on what you can invest in, taxable brokerage accounts allow you to invest in a wider range of investments.

So if your 401(k) is maxed out, and an IRA isn’t an option for you, you can use your bonus to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, and more in a taxable account.

Deferred Compensation

You also may be able to save some of your bonus from taxes by deferring compensation. This is when an employee’s compensation is withheld for distribution at a later date in order to provide future tax benefits.

In this scenario, you could set aside some of your compensation or bonus to be paid in the future. When you defer income, you still need to pay taxes later, at the time you receive your deferred income.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

Your Bonus and 401(k) Tax Breaks

Wondering what to do with a bonus? It’s a smart question to ask. In order to maximize the value of your bonus, you want to make sure you reduce your taxes where you can.

One method that’s frequently used to reduce income taxes on a bonus is adding some of it into a tax-deferred retirement account like a 401(k) or traditional IRA. The amount of money you put into these accounts typically reduces your taxable income in the year that you deposit it.

Here’s how it works. The amount you contribute to a 401(k) or traditional IRA is tax deductible, meaning you can deduct the amount you save from your taxable income, often lowering your tax bill. (The same is not true for a Roth IRA or a Roth 401(k), where you make contributions on an after-tax basis.)

The annual contribution limits for each of these retirement accounts noted above may vary from year to year. Depending on the size of your bonus and how much you’ve already contributed to your retirement account for a particular year, you may be able to either put some or all of your bonus in a tax-deferred retirement account.

It’s important to keep track of how much you have already contributed to your retirement accounts because you don’t want to put in too much of your bonus and exceed the contribution limit. In the case where you have reached the contribution limit, you can put some of your bonus into other tax deferred accounts including a traditional IRA or a Roth IRA.

How Investing Your Bonus Can Help Over Time

Investing your bonus may help increase its value over the long-run. As your money potentially grows in value over time, it can be used in many ways: You can stow part of it away for retirement, as an emergency fund, a down payment for a home, to pay outstanding debts, or another financial goal.

While it can be helpful to have some of your bonus in cash, your money is typically better in a savings or investment account where it has the potential to work for you. If you start investing your bonus each year in either a tax-deferred retirement account or non-retirement account, this could help you save for the future.

Investing for Retirement With SoFi

The yearly question of what to do with a bonus is a common one. Just having that windfall allows for many financial opportunities, such as saving for immediate needs — or purchasing things you need now. But it may be wisest to use your bonus to boost your retirement nest egg — for the simple reason that you may stand to gain more financially down the road, while also potentially enjoying tax benefits in the present.

The fact is, most people don’t max out their 401(k) contributions each year, so if you’re in that boat it might make sense to take some or all of your bonus and max it out. If you have maxed out your 401(k), you still have options to save for the future via traditional or Roth IRAs, deferred compensation, or investing in a taxable account.

Keeping in mind the tax implications of where you invest can also help you allocate this extra money where it fits best with your plan.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

FAQ

Is it good to put your bonus into a 401(k)?

The short answer is yes. It might be wise to put some or all of your bonus in your 401(k), depending on how much you’ve contributed to your workplace account already. You want to make sure you don’t exceed the 401(k) contribution limit.

How can I avoid paying tax on my bonus?

Your bonus will be taxed, but you can lower the amount of your taxable income by depositing some or all of it in a tax-deferred retirement account such as a 401(k) or IRA. However, this does not mean you will avoid paying taxes completely. Once you withdraw the money from these accounts in retirement, it will be subject to ordinary income tax.

Can I put all of my bonus into a 401(k)?

Possibly. You can put all of your bonus in your 401(k) if you haven’t reached the contribution limit for that particular year, and if you won’t surpass it by adding all of your bonus. For 2023, the contribution limit for a 401(k) is $22,500 if you’re younger than 50 years old; those 50 and over can contribute an additional $7,500 for a total of $30,000. In 2024, the contribution limit for a 401(k) is $23,000 if you’re under age 50, and those 50 and up can contribute an additional $7,500 for a total of $30,500.

You may also be interested in:

How Much Should I Contribute to My 401k?

Guide to Maxing Out Your 401(k)

The Average 401(k) Balance by Age

Photo credit: iStock/Tempura

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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.

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.

SoFi Invest®

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

May

2024

Investing in Options vs Stocks: Trading Differences to Know

Buying Options vs Stocks: Trading Differences to Know

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.

Stocks and options are two of the most popular investment types that investors might include in their portfolio. There are reasons to invest in each, and they both come with their own risks, timelines, pros, and cons.

When deciding whether to invest in stocks vs. options, or any type of security or asset, it’s important to consider your personal investing goals, experience, risk tolerance, and investing horizon.

Key Points

• Options are derivatives that provide the right, but not the obligation, to buy or sell a stock at a set price before a certain date.

• Stocks represent shares of ownership in a company, potentially offering dividends and voting rights.

• Options can offer high leverage, allowing significant exposure to stock price movements without full investment in the stock.

• The value of options can decrease rapidly over time due to time decay, especially as expiration approaches.

• Stocks can be held indefinitely, providing potential for long-term gains, whereas options have an expiration date limiting their lifespan.

What Are the Differences Between Options and Stocks?

	Stocks	Options
Common types of Investors	Beginners and long-term investors	Experienced and active traders
Potential Downsides	Risks, Taxes, Fees	Risks, Costs, Complexity
Type of Investment	Equity	Derivative

Options

Options, or stock options, are a type of derivative investment. Rather than buying shares of a company, options contracts give buyers the right, but not the obligation, to buy or sell shares at a specified price, (known as the strike price in options terminology,) at a specified time in the future.

A call option gives the buyer the right, but not the obligation, to buy a stock at a specified price, at a specified time in the future. The options investor does not have any ownership of the company’s shares unless they choose to exercise the option and buy the shares.

A put option gives the buyer the right, but not the obligation, to sell a stock at a specified price, at a specified time in the future.

Over the time period of the option, the contract gets exponentially less valuable. This is known as time decay.

Investors may exercise their right to buy or sell a stock, or sell their option position to make a potential profit. Options trading strategies can get complicated, involving buying and selling multiple options on the same underlying security.

Recommended: A Guide to Options Trading

Stocks

Stocks are portions of ownership in companies, also known as shares. Investors can buy shares in companies and become fractional owners of that company in proportion to the number of outstanding shares that company has. For instance, if a company has 100,000 shares and an investor buys 10,000, they own 10% of the company.

Investors who purchase stocks typically hope to buy them at a lower price then sell them later at a higher price to make a profit. There are also other ways investors can earn profits on stocks. For instance, some stocks pay out dividends to owners. Every month, quarter, or year, an investor can earn money based on the number of shares they own.

Recommended: How to Start Investing in Stocks

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.

5 Key Differences in Stocks vs Options

Both stocks and options are popular investments, and there can be a place for both of them in a diversified portfolio. Here’s a look at some of of the differences to keep in mind when it comes to trading options vs. stocks:

1. Risk

Both stocks and options have associated risks. For stocks, the risk is that the value of the security will fall lower than the investor expected. For options, there are additional risks, including the risk that they could exacerbate losses or could expire without being exercised.

2. Ownership

When an investor buys stock, they become partial owners of that company. When they buy options, they do not.

3. Quantities

When buying stock, the number of shares an investor buys is the total number they have, and they can purchase any number of shares, including fractional shares. When buying options, each contract represents 100 shares of stock.

4. Timeline

Options are contracts that are only valid for a certain period of time until the expiration date. They lose value over time until they are worthless when the contract expires. When an investor buys stock, they can hold it as long as they want.

5. Time Commitment

Investors can buy stock and hold onto it without doing much additional work, whereas options traders are often more hands-on and prefer an eye on the market for the duration of the contract.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

When to Consider Trading Stocks

There are several reasons to consider trading stocks, depending on your goals, timeline, and risk tolerance. Like any asset, stocks come with their share of risks and downsides. Some of the pros and cons of stocks include:

Pros

It can be relatively easy to start investing in stocks. There are several other benefits as well:

• Investors don’t have to sell their stocks on any particular date, so they can choose the best time to sell.

• Some stocks pay out dividends to investors.

• Stocks are easier to research than options since they have market history.

• Being an owner of a company may allow investors to vote on certain corporate issues that can affect their investment.

• Stocks typically have more liquidity than options, meaning it’s easier for traders to buy and sell them at any given time.

Cons

Like all securities, there are risks involved with investing in stocks. Those include:

• Whether you buy and sell stocks quickly as a day trading strategy, or hold onto them for years, you will need to pay short or long-term capital gains taxes if you sell for a profit.

• While trading stocks can be very profitable, it’s generally considered a long-term strategy.

• It can be emotionally challenging to watch the market, and one’s portfolio, go up and down in value over months or years.

• Making a big profit on stocks can require a large upfront investment.

• When investing in stocks, traders risk losing all the money they put in.

• Stocks of certain companies are very expensive, making it difficult for smaller traders to even buy one.

When to Consider Trading Options

Like stocks or any investment, options come with their share of risks and downsides. Some of the main pros and cons of trading options are:

Pros

Options trading can be complicated, but there can be significant upside potential. Benefits include:

• Options may be an inexpensive way to participate in the market.

• Options provide investors with leverage. Essentially the investor has some control and access to shares.

• Options can help hedge against market volatility.

Cons

Since fewer traders buy and sell options than stocks, there can be lower liquidity making it difficult to get out of an options contract. Other drawbacks include:

• If an investor buys a stock option, they must pay a premium to enter into the contract. If the stock doesn’t move the way they hope it will and they choose not to exercise the option, they lose that premium they had put in.

• Options lose value over time.

• Trading options may require more ongoing management than stocks.

💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options trading account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.

The Takeaway

Stocks and options are two popular types of investments traders use to earn profits and build a diversified portfolio. Depending on your investment strategy, you might invest in a combination of the two. Note that both have their own associated risks and potential benefits.

Options trading, however, is typically something that experienced investors delve into, and often requires traders to actively invest, rather than leave their portfolios idle. If you’re interested in options, it may be a good idea to speak with a financial professional for guidance.

Qualified investors who are ready to try their hand at options trading, despite the risks involved, might consider checking out SoFi’s options trading platform. The platform’s user-friendly design allows investors to trade 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.

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.

Photo credit: iStock/fizkes

SoFi Invest®

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

May

2024

What Is Excess Margin & How Do You Use It?

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

The excess margin in a trading account indicates how much available funds it contains above the required minimum amounts. Knowing your excess margin helps determine how many securities you can trade on margin, as well as how much you can withdraw from your account to use for other purposes.

In other words, knowing your excess margin helps an investor get a better idea of their overall buying power, which can be critical in guiding investing decisions.

Key Points

• Excess margin in a trading account indicates available funds above the required minimum.

• It provides a gauge of overall buying power, influencing investment decisions.

• Excess margin can be used as collateral for margin loans or withdrawn.

• A Special Memorandum Account holds the excess margin from a trading account.

• Understanding and managing excess margin is crucial to maintaining account standing and leveraging investment strategies.

What Is Excess Margin?

Excess margin is a trading account‘s equity above the legal minimum required for a margin account, or the amount of equity above the broker’s maintenance margin requirement.

Excess margin is generated from cash or securities a trader deposits in a margin account above required levels. Excess margin can be used as collateral for margin loans, or it may be withdrawn from the account. It is important to monitor your excess margin ratio so you can keep your account in good standing.

Special Memorandum Account

A special memorandum account (SMA) is where excess margin generated from a margin trading account is held. Trading margin is also sometimes called usable margin, available margin, or “free” margin — but to be clear, “free” margin isn’t free in the sense that it doesn’t involve interest charges or fees, it’s “free” in that it’s not tied up in a current position.

Excess margin, on the other hand, is only the margin above the required minimum.

Understanding Trading Margin Excess

Trading margin excess tells you how much buying power you have, but no trader should feel compelled to use all of it just because it is there. Excess cash margin can be thought of as funds left over after you have taken positions during the trading day. You can use excess margin to buy new positions or add to an existing holding.

Understanding how to trade excess margin requires a grasp of how margin accounts work. A margin account allows you to borrow from a broker if you meet initial margin requirements. You will need the greater of either the $2k minimum margin requirement or 50% of the security’s purchase price in your account to buy on margin. For example, if you were to purchase 10 shares of a stock trading at $30, 50% is $1,500.

Since that is less than $2,000, you’ll need to deposit $2,000 in order to purchase the 10 shares on margin. On the other hand, if you wanted to purchase 10 shares of a stock selling for $50, 50% is $2,500 — and you would need to deposit $2,500, not $2,000, in order to make your purchase on margin.In the United States, Regulation T set by the Federal Reserve states that a trader with a margin account can borrow up to 50% of the purchase price of a stock (assuming the stock is fully marginable).

There are also maintenance margin requirements set at 25% by the Financial Industry Regulatory Authority (FINRA) — your equity relative to your account value must not fall below that threshold. Finally, a broker might set stricter margin requirements than the governing authorities.

The value of assets in a margin account that exceeds these requirements is the excess margin deposit. Since you are trading with leverage, the maintenance margin excess amount indicates how much is left that you can borrow against — it is not actual cash remaining in your account. According to FINRA, maintenance margin excess is the amount by which the equity in the margin account exceeds the required margin.

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 12%* and start margin trading.

*For full margin details, see terms.

Risks and Benefits of Excess Margin

An account is in good standing as long as it has margin levels above those set by regulators and the broker. There are dangers with trading excess margin securities, though. Since you trade with leverage in a margin account, there is the risk that your account value could drop dramatically if the market goes against you. Your account can be in good standing one day, but then face a margin call the next day.

If your account violates margin requirements, you will be faced with a margin call. To meet the call, you must deposit cash, deposit marginable securities, or liquidate securities you own. If you do not meet the call, your broker can perform a forced sale. In extreme cases, your account’s trading privileges can be suspended.

On the upside, there is potential to make larger profits by trading on margin. Returns are amplified by leverage. You can also benefit from declining share prices by short selling (it’s worth noting that margin requirements are different for short selling — 30% in most cases). There are other benefits when trading on margin so long as you maintain excess margin. You can use your margin account for loans by borrowing against your assets, often at a competitive interest rate. Margin trading also lets you diversify a concentrated portfolio.

Excess Margin Risks vs Benefits

Risks	Benefits
Trading with leverage can amplify losses	Trading with leverage can amplify returns
A broker can perform a forced sale if you face a margin call	Excess margin tells you how much money you can use for new purchases or to withdraw from the account
You can lose more than what you put in during extreme events	You can hold a diversified portfolio and short positions

What Is an Excess Margin Deposit?

An excess margin deposit is the collateral held in a margin account that is above required margin levels. When the value of your excess margin deposit drops under the required margin amount, you might face a margin call. An excess margin deposit is calculated as the difference between an account’s value and its minimum maintenance requirement. Required margin levels are often higher for equity and options trading accounts versus futures trading accounts.

Managing excess margin securities is important when trading. If you trade positions without understanding risk, then you are more likely to eventually get hit with a margin call. A way to manage excess margin is to trade securities and positions sizes that fit your risk and return preferences.

Excess Margin Deposit Example

An example helps illustrate what excess margin is. Let’s say your margin trading account has $50,000 of unmargined securities. The Reg T requirement dictates that your initial margin is $25,000 (a 50% margin requirement), so excess initial margin is $25,000. Assuming a 25% maintenance margin requirement, $12,500 of equity must be kept after opening the account.

With $25,000 of equity, there is $12,500 of excess margin above the 25% maintenance margin requirement. You can buy more securities with that amount or withdraw it to use for other purposes.

If the account value drops to $45,000, then your equity has fallen to $20,000 ($45,000 of stocks minus the $25,000 loan). Assuming the account has a 25% maintenance requirement, the account would need to have equity of at least $11,250 (25% of $45,000). With $20,000 of equity, the account meets the requirements and is in good standing.

The Takeaway

Excess margin is your margin trading account’s equity above all margin requirements. It is a balance that tells you how much more securities you can buy on margin. The excess cash margin also indicates how much you can pull from the account to use for other purposes.

Excess margin, conceptually, is related to an investor’s buying power, which is why it’s important to understand. There are also rules and regulations in the mix, such as Regulation T, which investors need to keep in mind, too, and risks related to margin calls.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Get one of the most competitive margin loan rates with SoFi, 12%*

FAQ

What happens if you go over margin?

If you go over margin, you might be faced with a margin call. A margin call happens when your excess margin deposit falls below zero. Satisfying a margin call involves depositing more cash or securities or liquidating existing holdings to bring the account’s excess margin ratio back within proper limits.

What is excess intraday margin?

Excess intraday margin is the amount of funds in a margin trading account above the intraday margin requirement. It is a balance that tells you how much money is in the account above an intraday margin requirement. Intraday margin is also referred to as day trading margin if you engage in pattern day trading. Note: There are different requirements for a pattern day trader.

Can margin trading put you in debt?

In extreme circumstances, trading excess margin securities can put you in debt due to positions losing value and margin interest being owed. Margin calls issued by brokers help to reduce this risk since the calls require the trader to deposit more funds into the account or liquidate existing holdings. If the trader does not act, the broker might automatically sell securities. If the trader has borrowed too much and market movements are drastically against the trader, equity can turn negative.

Photo credit: iStock/Geber86

*Borrow at 12%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
SoFi Invest®

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

May

2024

What Is a Put Option? How They Work and How to Trade Them

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Key Points

• A put option grants the right, but not the obligation, to sell a specific security at a predetermined price by a certain date.

• Put options are used to speculate on price declines or hedge against potential losses in underlying assets.

• The value of a put option increases as the price of the underlying asset decreases.

• There are three positions for a put option relative to the asset’s price: in-the-money, at-the-money, and out-of-the-money.

• Trading put options requires careful consideration of the underlying asset’s current price, expected price movements, and the premium cost of the option.

What Is a Put Option?

In options trading, a put option is the purchase of a contract that gives an investor the right, but not the obligation, to sell a specific security at a certain price by a certain date. Put options are different from call options, the purchase of which gives buyers the right, but not the obligation, to buy a particular security at a certain price by a certain date.

Investors can use put options to trade a variety of securities, including stocks, bonds, futures and commodities. Trading options can potentially lead to greater returns, but it can also amplify losses, making it a potentially riskier strategy.

Understanding certain options terminology — including what a put option is and how it works — can be helpful if you’re thinking about incorporating options trading strategies into your portfolio.

Options Basics

Before digging into the details of put options, it’s helpful to understand a little about how options trading works in general. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying security at a certain price — this is called the strike price. Options must also be exercised by a specific expiration date.

An investor who buys an options contract pays a premium to do so, which can be determined by the volatility of the underlying asset and the option’s expiration date. If the option holder does not exercise the option by the expiration date, they lose their right to buy or sell the underlying security and the option has no value.

Options are derivative investments, since they derive their value from the underlying assets. They can be bought and sold on an exchange, just like the underlying assets they’re associated with.

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.

How Does a Put Option Work?

A put option is a specific type of options contract. Here’s an example: The buyer of the put option has the right, but not the obligation, to sell shares of an underlying asset at the agreed-upon strike price up until the option’s expiration date. Meanwhile, the seller of the put option has an obligation to buy those shares from the buyer if the buyer chooses to exercise the put option.

Put options increase in value as the price of the underlying security decreases. Likewise, put options lose value as the price of the underlying stock increases. Depending on where the underlying asset’s price is in relation to a put option’s strike price, the option can be one of the following:

• In the money: An in-the-money put option has a strike price that’s higher than the underlying asset’s price.

• At the money: An at-the-money (or on-the-money) put option has a strike price that’s equal to the underlying asset’s price.

• Out of the money: An out-of-the-money put option has a strike price that’s below the underlying asset’s price.

Of the three, the in-the-money put option is more desirable because it means a put option has intrinsic value. If you’re the buyer of a put option and that option is in the money, it means you can sell the underlying asset for more than what it’s valued at by the market.

Put Option Example

An example might make things even more clear.

Assume you own shares of XYZ stock. The stock is currently trading at $50 a share but you believe its price will dip to $40 per share in the near future.
You purchase a put option which would allow you to sell the stock at its current price of $50 per share. The options contract conveys the right to sell 100 shares of the stock, with a premium of $1 per share.

If your hunch about the stock’s price pays off and the price drops to $40 per share, you could exercise the option. This would allow you to sell each of the 100 shares in the contract for $10 more than what it’s worth, resulting in a gross profit of $1,000. When you factor in the $1 per share premium, your net profit ends up being $900, less any commission fees paid to your brokerage.

Difference Between Put and Call Option

It’s important to understand the difference between put and call options in trading. A call option is an options contract that gives the buyer the right, but not the obligation, to purchase shares of an underlying asset at the strike price by the expiration date. The seller of the call option is obligated to sell those shares to the call option buyer, should they decide to exercise the option.

Like put options, call options can also be in the money, at the money, or out of the money. An in-the-money call option has a strike price that’s below the underlying asset’s actual price. An out-of-the-money call option has a strike price that’s above the underlying asset’s actual price.

Here’s a simple way to think of the differences between put options and call options: With buying put options, the goal is to sell an underlying asset for more than its market value. With buying call options, the goal is to buy an underlying asset for less than what it’s worth.

Pros and Cons of Trading Put Options

Options trading may appeal to a certain type of investor who’s comfortable moving beyond stock and bond trading. Like any other investment, put options can have both advantages and disadvantages. Weighing them both in the balance can help you decide if options trading is something you should consider pursuing.

Pros	Cons
• Low initial investment required compared to trading stocks. • The option buyer has the right but no obligation to sell the underlying asset. • Higher return potential, on a percentage basis.	• Losses may be amplified. • The option seller has the obligation to buy the underlying asset at the strike price if the buyer decides to execute the contract, which could result in greater downside for the seller. • Unforeseen volatility may drastically affect price movements.

Pros

Cons

• Low initial investment required compared to trading stocks.

• The option buyer has the right but no obligation to sell the underlying asset.

• Higher return potential, on a percentage basis.

• Losses may be amplified.

• The option seller has the obligation to buy the underlying asset at the strike price if the buyer decides to execute the contract, which could result in greater downside for the seller.

• Unforeseen volatility may drastically affect price movements.

Pros of Trading Put Options

• Lower investment. When you purchase a put option, you’re paying a premium and your brokerage’s commission fees. When you purchase shares of stock, you may be investing hundreds or even thousands of dollars at a time. Between the two, put options may be more attractive if you don’t want to tie up a lot of cash in the markets.

Also, buying a put option gives you the right to sell a particular asset at a set strike price but you’re not required to do so. You can always choose to let the option expire; you’d just be out the premium and commission fees you paid.

• Return potential. Trading put options can be lucrative if you’re able to sell assets at a strike price that’s well above their actual price. That might result in a higher profit margin than if you were trading the underlying asset itself.

Cons of Trading Put Options

• Loss amplification. While trading put options can potentially lead to better returns, it can also potentially amplify your losses. If you’re selling put options, you’re obligated to sell the underlying asset at the strike price, even if that strike price is not in your favor.

• Volatility. Volatility can threaten returns with put options if an asset’s price doesn’t move the way you were expecting it to. So it’s possible you might walk away with lower gains than anticipated if you choose to exercise a put option during a period of heightened volatility.

How Do You Trade Put Options?

It’s possible to trade put options inside an online brokerage account that allows for options trading (not all of them do). When deciding which put options contracts to buy, it’s important to consider:

• Where the underlying asset is trading currently

• Which way you think the asset’s price is most likely to move

• How much of a premium you’re willing to pay to purchase an options contract

It’s also important to consider the expiration date for a put option. Keep in mind that options with a longer expiration period may come with a higher premium.

Different Put Option Styles

There’s a difference between European-style and American-style put options.

With European-style options, you can only exercise the option on its expiration date.

With American-style put options you can exercise the option at any time between the date you purchased it and its expiration date, offering more flexibility for the investor.

Put Option Trading Strategies

Different options trading strategies can be used with put options. These strategies vary in terms of reward potential and risk exposure. As you get more familiar with how to trade stock puts, you might begin exploring more advantaged techniques. Here are some of the most common put option plays.

Long Put

A long put strategy involves purchasing a put option with the expectation that the underlying asset’s price will fall. For example, you might want to buy 100 shares of XYZ stock which is trading at $100 per share, which you believe will drop to $90 per share. If the stock’s price drops to $90 or below, you could exercise your contract at the higher $100 per share price point.

Short Put

A short put is the opposite of a long put. In a short put strategy, you’re writing or selling the put option with the expectation that the underlying security’s price will rise or remain above the strike price until it expires. The payoff comes from being able to collect the premium on the option even if the buyer doesn’t exercise it.

Recommended: How to Sell Options for Premium

Married Put

A married put strategy involves holding a long position in an underlying security while also purchasing an at-the-money option for the same security. The idea here is to minimize downside risk by holding both the asset itself and an at-the-money put option.

Long Straddle

A long straddle strategy involves buying both a call option and a put option for the same security, with the same strike price and expiration date. By straddling both sides, you can still end up turning a profit regardless of which the underlying asset’s price moves.

The Takeaway

Options trading may be right for retail investors who are comfortable taking more risk in exchange for a chance to potentially earn higher returns. Getting familiar with put options and how a stock put works is the first step.

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SOIN0224038

May

2024

Intrinsic Value and Time Value of Options, Explained

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Intrinsic value and time value are two major determining factors of the value of an options contract. An option’s intrinsic value is the payoff the buyer would receive if they exercised the option right away. In other words, the intrinsic value is how profitable the option would be, based on the difference between the contract’s strike price and the market value of the underlying security.

An option’s time value is not quite as straightforward. Time value is based on a formula that includes the expected volatility of the underlying asset, as well as the amount of time until the option contract expires.

Key Points

• Intrinsic value of an option is the profit from exercising it immediately, based on the current market value versus the strike price.

• Time value of an option reflects its potential profitability over time until expiration.

• The formula for intrinsic value involves subtracting the strike price from the current price of the underlying asset.

• Time value decreases as the option nears expiration, a concept known as time decay.

• Volatility of the underlying asset significantly impacts the time value, with higher volatility increasing the premium.

What Is the Intrinsic Value of an Option?

An investor who purchases an options contract may be buying the right, but not the obligation, to buy or sell the option’s underlying asset at an agreed-upon price, known as the strike price. Options are considered derivatives, because they are tied to the value of the underlying security. The contract may allow the investor to purchase or sell a security at that strike price at any point up until the contract expires.

There are two main kinds of options: calls and puts. The purchaser of a call option buys the right (but not the obligation) to purchase the underlying asset at a given price until a particular date.

The buyer of a put option purchases the right (but not the obligation) to sell the underlying asset at a given price until a particular date.

Important terms: In the Money, At the Money, Out of the Money

There are a few more key terms to know as it relates to options: in the money, at the money, and out of the money.

In the Money

An option is considered to be “in the money” if the investor could sell it at that moment for a profit. For a call option, that means that the price of the underlying asset is higher than the strike price specified in the options contract. For a put option to be in the money, the price of the underlying asset would have to be lower than the strike price in the contract.

At the Money

If an option is “at the money,” the price of the underlying security is equal to the strike price in the contract, and it’s not considered profitable. If an option is “out of the money,” e.g. above the market price for a call option or below the market price for a put option, the contract is also not profitable.

Out of the Money

If an option is not profitable when it expires, then it expires with no value, except for the premium. In those instances, the buyer takes a loss on the premium they paid to enter into the options contract, while the seller, or writer, of the contract collects the premium.

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Formula for the Intrinsic Value of an Options Contract

Time to get down to the math! Here are the formulas for calculating intrinsic values of call and put options.

Intrinsic value formula for a call option:

Call Option Intrinsic Value = Underlying Stock’s Current Price – Call Strike Price

Intrinsic value formula for a put option:

Put Option Intrinsic Value = Put Strike Price – Underlying Stock’s Current Price

Example of Intrinsic Value Calculation

Imagine that hypothetical XYZ stock is selling at $48.00. A call option for XYZ with a strike price of $40 would have an intrinsic value of $8.00 ($48 – $40 = $8). So in theory, the option holder could exercise the option to buy XYZ shares at $40, then immediately sell them for a $8.00 profit in the market. Another way to phrase it: The contract would be in the money at $8.

But what if the strike price is higher than the $48.00 market price of XYZ stock? Let’s say the call option strike is $50 ($48 – $50 = –$2.00. The option would be considered out of the money and worth zero, because the intrinsic value of an option can never be negative.

What if it’s a put option? In this scenario, with an underlying price of $48.00 for XYZ stock, a put option with a strike price of $44.00 would have an intrinsic value of zero ($44 – $48 = –$4.00), again because the value of an option cannot fall below zero.

But a put option with a strike price of $50 would be considered in the money, and have an intrinsic value of $2 ($50 – $48 = $2).

While intrinsic value as a term sounds all encompassing, it isn’t. Investors should remember when calculating options strategies that an option’s intrinsic value does not include the premium the investor has to pay in order to buy the options contract in the first place. To get a better sense of the profit of an options trade, it’s important to include that initial premium, along with any other trading commissions and fees charged by the broker.

What Is the Time Value of an Option?

When an investor buys an option, they pay in the form of a premium, or fee. When they do, that premium is typically based on the option’s intrinsic value, plus its extrinsic value. While higher volatility can result in higher premiums, time value plays a large role as well.The opportunity for an option to be profitable over time is, in essence, its time value.

The more time an investor in an options contract has, the better their chances of being able to exercise that option in the money, simply because the underlying security has a greater chance of moving in the desired direction. Longer time periods come with greater possibility for profit.

Conversely, as an options contract gets closer to expiring, its value goes down. The reason is that there is less time for the security underlying the options contract to make profitable moves.

One rule of thumb is that an option loses a third of its value during the first half of its life, and two-thirds during the second half. This phenomenon is known as the time decay of options. It’s a critical concept for options investors because the closer the option gets to expiration, the more the underlying security must move to impact the price of the option.

The intrinsic value of the option plays a role in how fast the time value of an option decays. An in-the-money option faces less dramatic time decay, because the elimination of time value takes the overall value of the option to the level of its intrinsic value. But for an out-of-the-money option, time decay is more dramatic, since the option will be entirely worthless if it expires out of the money.

Formula for the Time Value of an Options Contract

The formula for the time value of an options contract is as such:

Time Value = Option Price − Intrinsic Value

How Does Volatility Impact Time Value?

Another important factor that can impact time value is the volatility of the underlying asset.

Stocks with higher volatility typically have the potential for greater price movements — and thus related options may have a higher probability of expiring in the money. That’s one reason why time value, as reflected by the option’s premium, is typically higher when the underlying asset is more volatile.

With stocks and other assets that have lower volatility and therefore are not expected to show big price fluctuations, the time value and the option premium is likely to be lower.

Volatility, as every investor knows, cuts both ways. It can help generate gains or lead to losses.

How Can Intrinsic and Time Value Help Traders?

When calculating the value of the options contracts that they’re buying and selling, intrinsic value and time value can be vital to help traders gauge the potential risks and rewards of the options trade. While the intrinsic value is easy to assess, it only tells part of the story. Traders need to understand the extrinsic or time value of options as well in order to gauge how profitable the option is likely to be.Investors use this deeper understanding to inform which options trading strategies they use.

When it comes to the profitability of an options trade, investors also need to take into account the premiums they pay to buy an option, along with related commissions and fees. There are also other factors that play a role in the pricing of an options contract, such as the option’s implied volatility. This is the aspect of options pricing that takes into account the market sentiment as to the future volatility of an option’s underlying security, and can have a major influence on the price of an option as well.

💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.

The Takeaway

Understanding how options are priced is a complicated business, and knowing the two main components — intrinsic value and time value — is essential. While intrinsic value is simply the tangible face value of the contract — because it’s the amount the buyer would receive if they exercised the option right now — time value is a more complex calculation.

The time value of an option, expressed as its premium, is part of an option’s extrinsic value and it includes the volatility of the underlying asset and the time to expiration. The more volatility and the more time to the option’s expiry date, the higher the premium or value of the option.

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