What Happens When a Public Company Goes Private?

What Happens When A Company Goes Private?

While there are plenty of benefits to going public, there are also some downsides to being listed on a major stock exchange. Public companies must abide by strict government compliance and corporate government statutes and answer to shareholders and regulatory bodies. Plus they’re subject to the whims of the broader stock market on a regular basis.

So, public companies can opt to go private and delist from a public stock exchange. What happens when a public company goes private? Here’s what you need to know about that process.

Key Points

•   When a company transitions from public to private, it is delisted from stock exchanges and its shares are no longer publicly traded.

•   This change means the company is exempt from the Sarbanes-Oxley Act and other stringent public compliance requirements.

•   Going private can reduce financial and pricing stability due to decreased liquidity and fewer financing options.

•   The process involves a buyout through a tender offer, often funded by private equity and requiring shareholder approval.

•   Privatization allows for more autonomous control over business decisions and operations by reducing public and governmental scrutiny.

What Is Going Private?

When a company goes from public to private, the company is delisted from a stock exchange and its shareholders can no longer trade their shares in a public market. It also means that a private company no longer has to abide by the Sarbanes-Oxley Act of 2002. That legislation required publicly-traded companies to accommodate expansive and costly regulatory requirements, especially in the compliance risk management and financial reporting areas. (The legislation was created by lawmakers to help protect investors from fraudulent financial practices by corporations.)

Going private may also mean less pricing and financial stability, as private company shares typically have less liquidity than a public company traded on a stock exchange. That can leave a private company with fewer financing options to fund operations.

Going private also changes the way a company operates. Without public shareholders to satisfy, the company’s founders or owners can control both the firm’s business decisions and any shares of private stock. Private companies can consolidate power among one or a few owners. That can lead to quicker business decisions and a clear path to take advantage of new business opportunities.

By definition, a private company, or a company that has been “privatized”, may be owned by an individual or a group of individuals (i.e., a consortium) that also has a specific number of shareholders.

Unlike traditional stocks, investors in a private company do not purchase shares through a stock broker or through an online investment platform. Instead, investors purchase private equity shares from the company itself or from existing shareholders.

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What Is Privatization?

Privatization is the opposite of an initial public offering. It’s the process by which a company goes from being a publicly traded company to being a private one. A private company may still offer shares of stock, but those shares aren’t available on public market exchanges. There’s no need to satisfy public shareholders and the company has less governmental oversight into its governance and documents.

(Note that privatization is also a term used to describe when a public or government organization switches to ownership by a private, non-governmental group.)

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What Happens if You Own Shares of a Company That Goes Private?

If shareholders approve a tender offer to take a public company private, they’ll each receive a payment for the number of shares that they’re giving up. Typically, private investors pay a premium that exceeds the current share price and shareholders receive that money in exchange for giving up ownership in the company.

This is the opposite of IPO investing, in which the public buys stock in a newly listed company, and private owners have a chance to cash out.

💡 Recommended: Partner Buyout Financing

Why a Company May Go Private

Likely the biggest reason why a company would choose to go private are the costs associated with being a public company (largely to accommodate regulatory demands from local, state, and federal governments).

Those costs may include the following potential corporate budget challenges:

•   The legal, accounting, and compliance costs needed to accommodate company financial filings and associated corporate governance oversight obligations.

•   The costs needed to pay compliance, investor relations, and other staffing needs – or the hiring of third-party specialty firms to handle these obligations.

•   The costs associated with paying strict attention to company share price – a public company always has to keep its eye on maximizing its stock performance and on keeping shareholders satisfied with the firm’s stock performance.

In addition, going private enables companies to free up management and staff to turn their attention to firm financial growth, instead of regulatory and compliance issues or shareholder concerns. Some public companies struggle to invest for the long-term because they’re worried about meeting short-term targets to keep their stock price up.

Going private also enables companies to keep critical financial and operational data away out of the public record — and the hands of competitors. Privatization could also help companies avoid lawsuits from shareholders and curb some litigation risk.

How to Take a Company Private

Typically, companies that go private work with either a private-equity group or a private-equity firm pooling funds to “buy out” a public company’s entire amount of publicly-traded stock. This typically requires a group of investors since, in most cases, it takes an enormous amount of financial capital to buy out a company with hundreds of millions (or even billions) of dollars linked to its publicly-traded stock.

Often a consortium of private equity investors gets help financing with a privatization campaign from an investment bank or other large financial institution. The fund usually comes in the form of a massive loan — with interest — that the consortium can use to buy out a public company’s shares.

With the funding needed to close the deal on hand, the private equity consortium makes a tender offer to purchase all outstanding shares in the public company, which existing shareholders vote on. If approved, existing shareholders sell their stock to the private investors who become the new owners of the company.

The goal is that the private investors will take the gains accrued through stronger company revenues and rejuvenated stock, to pay down the investment banking loan, pay off any investment banking fees accrued, and begin managing the income and capital gains garnered from their investment in the company. While this can take some time, the process of going private is much less intensive than the IPO process.

Company executives, meanwhile, can focus on growing the company. In many instances, newly-minted private companies may roll out a new business plan and prospectus that firm executives can share with potential shareholders, hopefully bringing more capital into the company. Sometimes private owners will plan to IPO the business again in the future.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

Pros and Cons of Going Private

Taking a company private has both benefits and drawbacks for the company.

The Pros

In addition to lower costs, there are several other advantages to delisting a company.

•   Establishing privacy. When a company goes public, it relinquishes the right to keep the company private. By taking a company private, it makes it easier to operate outside of the public eye.

•   Fewer shareholders. Public companies don’t have to deal with external company sources that may make life difficult for company executives and may result in a loss of operational independence. Once a company goes private, the founders or new owners retain full control over the business and have the last word on all company decisions.

•   A private company doesn’t have to deal with financial regulators. A private company doesn’t need to file financial disclosures with the U.S. Securities and Exchange Commission and other government regulatory bodies. While a private company may have to file an annual report with the state where it operates, the information is limited and financial information remains private.

The Cons

There are some disadvantages to taking a company private.

•   Capital funding challenges. When a company goes private, it loses the ability to raise funds through the publicly-traded financial markets, which can be an easy and efficient way to boost company revenues. Yet by privatizing the company, publicly-funded capital is no longer an option. Such companies may have to borrow funds from a bank or private lender, or sell stock based on a state’s specific regulatory requirements.

•   The owner may have more legal liability. Private companies, especially sole proprietorships or general partnerships, aren’t protected from legal actions or creditors. If a private company is successfully sued in court, the court can garnish the business owner’s personal assets if necessary.

•   More powerful shareholders. While there are not as many shareholders at a private company, new owners, such as venture capitalists or private equity funds, may have strong feelings about the operational business decisions, and as owners, they may have more power over seeing their wishes carried out.

The Takeaway

Going private can be an advantage for companies that want more control at the executive level, and no longer want their shares listed on a public exchange. However, taking a company private may impact the company’s bottom line as corporate financing options thin out when public shareholders can no longer buy the company’s stock.

If a company you own stock in goes private, you will no longer own shares in that company or be able to buy them through a traditional broker. For investors, having different types of assets in an investment portfolio may be helpful in case something happens to or changes with one of them.

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FAQ

Is it good for a public company to go private?

Going private can have benefits for a public company, including lower costs related to legal, accounting, and compliance obligations, as well as costs associated with maximizing stock performance and keeping shareholders happy. In addition, going private may allow a company’s staff to focus more fully on financial growth, and keep critical company data out of the public record (and the hands of competitors).

However, there are potential drawbacks as well. For instance, a company may face capital funding challenges once it goes private since it can no longer raise funds through publicly-traded financial markets.

What happens to my private shares when a company goes public?

Once a company goes public (typically done through a process called an IPO, or initial public offering), your private shares become public shares, and they become worth the public trading price of the shares.

How long does it take for a public company to be private?

How long it takes for a public company to become private depends on the time it takes to complete the steps involved. For instance, the company has to buy out all of its publicly-traded stock; it usually works with a group of private investors to do this since the process is costly. Once they have the founding secured, a tender offer is made to purchase all outstanding shares in the public company, which the existing shareholders vote on. If that is approved, the shareholders sell their stock to the owners of the company. How long all this takes generally depends on the company and the specific situation.


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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.

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

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

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Time Decay of Options: How It Works & Its Importance

Time Decay of Options: How It Works & Its Importance


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.

Time decay, as it relates to options trading, has to do with an option contract’s loss of value as it nears its expiration date. There are numerous variables in the mix when it comes to time decay, but knowing the basics of what the terms means, and how it can affect an investment strategy, can be important for investors.

Key Points

•   Time decay refers to the reduction in an option’s value as its expiration date approaches.

•   The rate of time decay is represented by theta, which accelerates as expiration nears.

•   Options lose more value in the final month before expiration due to increased time decay.

•   Intrinsic and extrinsic values are key components in options pricing, affected by time decay.

•   Understanding time decay is crucial for options traders to manage potential profits and losses effectively.

What Is Time Decay?

Time decay is the loss of an option’s value as it gets closer to expiration. An option’s time value refers to the extent to which time factors into the value — or the premium — of the option. Time decay accelerates, or declines more quickly, as the expiration date gets closer because investors have less time to exercise the contract.

For options traders, understanding the power of time decay is important whether you’re buying call options or put options. Here are the basics you need to know.

Recommended: Options Trading: A Beginner’s Guide

How Time Decay Works

The rate of change in the time value of an option is known as theta. For traders who buy options with the intention of holding them until expiration, theta usually isn’t of great concern. That’s because traders who hold contracts until the expiry date are hoping that the underlying security moves so far in their favor that the reward in terms of intrinsic value will outweigh any loss in extrinsic value.

But traders who want to close their options position prior to expiration may be more concerned about time decay. Because the security will have less time to move in their favor, the potential profit from intrinsic value is reduced, and the potential loss of extrinsic value becomes greater.

While both intrinsic and extrinsic value are important for options traders of all kinds, the type of options trading strategy a trader is using can influence which factors they put more emphasis on.

Understanding Options Pricing

Time decay isn’t a difficult concept, but it does require a quick refresher about how options are traded and priced.

Four of the main variables that impact the price of an option are:

1.    The underlying price and strike price

2.    Time left until expiration

3.    Implied volatility

4.    Time decay

The underlying price, strike price, and expiration date of the options contract are the main factors that determine its intrinsic value, while implied volatility and time decay are the factors that determine its extrinsic value.

•   Intrinsic value. An option’s intrinsic value refers to the option’s value at the time of expiration, which depends on the price of its underlying security relative to the strike price of the contract. In other words, whether the option is in the money, out of the money, or at the money.

•   Extrinsic value. Extrinsic value refers to how time can impact the option’s value, i.e. its premium. As the expiration date of the options contract approaches, there’s less time for an investor to profit from the option, so time decay or theta, accelerates and the option loses value.

Interest rates can also affect options prices, but this is more of a macro factor that doesn’t have to do with the specific contract itself.

Thus, time value represents the added value an investor has to pay for an option above the intrinsic value. Options are sometimes referred to as depreciating or wasting assets because they tend to lose value over time, since the closer the option is to expiration, the faster its time value erodes.

Recommended: Popular Options Trading Terminology to Know

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How to Calculate Time Decay

The rate of an option’s time decay is measured by theta.An option with a theta of -0.05 (theta is expressed as a negative value) would be expected to fall about $0.05 each day until expiration, but this would likely accelerate during the days and weeks leading up to the expiry date.

Greek values like theta are constantly changing, and can therefore be one of the most difficult factors to take into account when trading options.

Example of Time Decay of Options

Imagine an investor is thinking about buying a call option with a strike price of $40. The current stock price is $35, so the stock has to rise by at least $5 per share for the option to be in the money. The expiration date is two months in the future, and the contract comes with a $5 premium.

Now imagine a similar contract that also has a strike price of $40 but an expiration date that is only one week away and comes with a premium of just $0.50. This contract costs much less than the $5 contract because the stock would have to gain almost 15% in value in one week to make the trade profitable, which is unlikely.

Thus, the extrinsic value of the second option contract is lower than the first, because of time decay.

How Does Time Decay Impact Options?

Option time decay is pretty straightforward in principle. Things can be more complicated in practice, but in general, options lose value over time. The more time there is between now and the expiry date of the option, the more extrinsic value the option will have. The closer the expiry date is to the current date, the more time decay will have taken effect, reducing the option’s value.

The basic idea is that because there’s less time for a security to move one way or the other, options become less valuable the closer they get to their expiration dates. This isn’t a linear process though. The rate of time decay accelerates over time, with the majority of decay occurring in the final month before expiration.

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The Takeaway

If you think about it, the time value of an option is similar to other things that have a value which is time dependent. A fresh loaf of bread, a new car, a newly built home — these items would have an intrinsic value, but you might also pay a premium when they’re at full value.

As time passes, though, consumers will pay less for loaf of bread that isn’t fresh — or a car or home that’s older — because time has eroded some of the value. Similarly, as an option gets closer to its expiration date, it too loses value owing to the effects of time decay or theta.

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®.

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.


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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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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.
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A Guide to Callable Bonds

Callable Bonds (or Redeemable Bonds), Explained

Callable bonds give issuers the option to redeem the bond before it matures. They’re also referred to as redeemable bonds. Bond investors lend their money to entities or issuers for a certain period of time and in return investors receive interest on the principal. These entities typically return the borrowed principle to the bond investors by the bond’s maturity date.

An exception to this process of bond investing is using callable bonds, which allows the issuer to pay off its loans early by buying back its bonds before they reach their date of maturity. You can define a callable bond as one with a built-in call option.

Key Points

•   Callable bonds allow issuers the option to redeem the bond before its maturity date.

•   These bonds can be advantageous for issuers during periods of falling interest rates, allowing them to refinance at lower rates.

•   Investors receive higher interest rates on callable bonds to compensate for the risk of early redemption.

•   The value of callable bonds is influenced by changes in interest rates, with their desirability decreasing as interest rates fall.

•   There are various types of callable bonds, including optional redemption, sinking fund redemption, and extraordinary redemption bonds.

What Is a Callable Bond?

Callable bonds, also referred to as redeemable bonds, allow the issuer the right, but not the obligation, to redeem the bond before it reaches its maturity date. The entity that issues callable bonds has the right to prepay, or in other words, the bond is callable before its maturity date.

Issuers may use callable bonds when they expect interest rates to fall. That way, they can redeem their bonds and issue new ones at a lower coupon rate, reducing their overall interest expenses.


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How Do Callable Bonds Work?

When the issuer calls the bond, it pays investors the call price or the face value of the bond, along with the accrued interest to date. After that, the issuer no longer has to make payments on the bond.

Businesses may prefer callable bonds, since they have built-in flexibility that could lower costs in the future. For example, if market rates are 5% when a company first issues its bonds but they drop to 2.5%, a bond issuer paying 5% would call their bonds and get new ones at 2.5%.

Some bonds have call protection which forbids the issuer to buy it back for a certain period of time. During this period, the company can not call their bonds. However, at the end of this period, the issuer can redeem the bond at its specified call date.

Callable bond prices correlate to interest rates, since falling interest rates make callable bonds less valuable.

Finding the Value of Callable Bonds

The main difference between a non-callable bond and a callable bond is that a callable bond has the call option feature. This feature impacts the calculation of the value of the bond. To find the value of callable bonds, take the bond’s coupon rate and add 1 to it.

For example, a callable bond with a 7% coupon would be 1.07. Next, raise 1.07 to the number of years until the bond is callable. If the bond is callable in two years, you would raise 1.07 to the power of two, which would be 1.1449. Then, multiply that number by the bond’s par value or face value.

If the bond’s par value is $10,000, you would multiply $10,000 by 1.1449 to get 11,449, which is the value of the callable bond.

Recommended: How to Buy Bonds: A Guide for Beginners

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Types of Callable Bonds

Bonds have different types of issuers. Municipalities and corporations both may issue callable bonds. Here’s a look at three common types of callable bonds.

1. Optional Redemption Callable Bonds

Some municipal bonds have a redeemable option 10 years after the issue of the bond was issued. However, bonds with higher yields might have a protection or waiting period according to the bond’s maturity date. For example, a five-year bond might not be able to be recalled until two years after it is issued.

2. Sinking Fund Redemption Callable Bonds

This requires the issuer to recall a certain amount or all of the bonds according to a fixed schedule. A sinking fund is money that a company reserves on the side to pay off a bond.

3. Extraordinary Redemption Callable Bonds

Extraordinary redemption is when the issuer recalls the bond before maturity if certain specified events in the bond contract occur such as a business scenario that impacts bond revenue.

Callable Bond Example

A callable bond with a par value of $1,000 and a 5% coupon rate issued on January 1, 2022 has a maturity date of January 1, 2030. The annual interest payments investors would receive is $50. This bond has a protection feature which doesn’t allow the issuer to recall the bond until January 1, 2026, but after that date, the bond can be redeemed.

The issuer believes interest rates will decrease within the next four years and decides to recall the bond on January 1, 2026. If the investor bought the callable bond through their broker at its $1,000 par value, and the issuer chooses to redeem it when the protection period expires in 2026, they would calculate the value of the callable bond as follows:

•   Take the coupon rate and add 1 to it, to make 1.05.

•   Next, multiply 1.05 to the fourth power since the issuer will hold on to it for four years.

•   This calculation will yield 1.2155.

•   Next, multiply 1.255 by the bond’s par value of $1,000 to get $1,215, the value of the callable bond.

Interest and Callable Bonds

From the perspective of the callable bond issuer, falling interest rates are an opportunity to recall your bonds and lower your interest rate. While the investor is compensated at the outset with a higher yield or coupon rate for investing in callable bonds, they must be aware of the added risks associated with this investment.

If interest rates stay the same or increase, there’s a lower chance the issuer will recall its bonds. But if investors believe interest rates will drop prior to the bond’s maturity date, they should be compensated for this additional risk. The investor must determine if the higher yield from callable bonds is worth the risk of investment because the call feature is an advantage to the issuer, not the investor.


💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Pros and Cons of Callable Bonds

Like any other investment, callable bonds have benefits and risks. It’s important to keep in mind the pros and cons of investing in callable bonds when considering a long-term investing strategy.

Callable bonds are financial instruments that may carry more risk for investors than noncallable bonds (bonds only paid out at maturity) because there is the chance of the bond being called prior to it reaching maturity.

Pros

Cons

Companies issue callable bonds at higher interest rates to compensate for the risk of early redemption. This means the possibility of greater investment returns. If an issuer calls its bonds early as a result of lower interest rates, bond investors risk not being able to find bonds with lower coupon rates. This could pose a challenge for income-seeking investors who want a reliable stream of passive income from bond investing.
One of the benefits of callable bonds is the option to call the bond early. Instead of waiting until the bond reaches maturity, the issuer can recall the bond earlier to suit their financial business needs. Callable bond investors who pay a premium, or more than a bond’s face value risk only getting back the face value of the bond. This means the investor would lose their money on the premium they already paid.
Callable bonds have benefits that mostly favor the issuer. When interest rates fall, the company can redeem the bonds early and issue new bonds at a lower rate to save on interest payments. Another risk is the bond’s maturity. The longer it takes for the bond to mature, the greater the likelihood for the bond to be called early, especially if there is a change in interest rates. Investing in bonds with a shorter maturity date carries lower interest rate risk.

The Takeaway

Again, callable bonds give issuers the option to redeem the bond before it matures. They’re also referred to as redeemable bonds. Callable bond investors lend their money to entities or issuers for a certain period of time and in return investors receive interest on the principal.

Some investors might consider buying callable bonds as one way to diversify an investment portfolio or to achieve higher yield, however, it’s important for investors to keep the risks associated with this investment top of mind. In an environment where interest rates are falling, callable bonds may not work for long-term investors looking for income.

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).

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.

FAQ

Are callable bonds a good investment?

Callable bonds may be a good investment depending on an investor’s strategy, risk tolerance, and time horizon, but the overriding interest rate environment may also determine how good of an investment they are as well.

What does it mean if a bond is callable?

If a bond is callable, it means that bonds can be redeemed or paid off by their issuer before they reach their maturity date.

What is the call rule on a callable bond?

The call rule on callable bonds refers to the ability of a bond to be redeemed or repaid by its issuer prior to its maturity date.

What happens to callable bonds when interest rates rise?

When interest rates rise, callable bonds are less likely to be called, though there are no guarantees.

Are callable bonds cheaper?

Generally, callable bonds tend to be less expensive than normal bonds because of the call option, which are of value to their issuer, and may lead to a relative discount for the buyer.

Do callable bonds have higher yields?

Callable bonds do tend to have higher yields, but often not greatly so, and there’s no guarantee that the yields would be higher than those of other types of bonds.


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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.
For a full listing of the fees associated with Sofi Invest please view our fee schedule.


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


External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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.

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.

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Investing in Options vs Stocks: Trading Differences to Know

Buying Options vs Stocks: Trading Differences to Know


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.


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.

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®.

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

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

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.

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What Is Excess Margin & How Do You Use It?

What Is Excess Margin & How Do You Use It?

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 11%* 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.

💡 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.

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, 11%*

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 11%. 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

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

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.

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