Financial Topics Archives | Page 448 of 823

May

2024

Intrinsic Value and Time Value of Options, Explained

By Colin Dodds | 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.

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.

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.

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.

💡 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.

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.

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/Moyo Studio

SoFi Invest®

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

May

2024

Active vs Passive Investing: Differences Explained

By AJ Smith | Growing Wealth, invest, Investing | No Comments

Key Points

• Active investing strategies often underperform the market over time, while passive strategies tend to outperform.

• Active funds typically have higher fees, which can lower returns, while passive funds have lower fees.

• Active investing relies on human intelligence and skill to capture market upsides, while passive investing relies on algorithms to track market returns.

• Active investing is generally less tax efficient, while passive investing is typically more tax efficient.

• Passive investing may be less tied to market volatility, while active investing is more vulnerable to market shocks.

Active investing vs. passive investing generally refers to the two main approaches to structuring mutual fund and exchange-traded fund (ETF) portfolios. Active investing is a strategy where human portfolio managers pick investments they believe will outperform the market — whereas passive investing relies on a formula to mirror the performance of certain market sectors.

Which approach is better, active investing vs. passive? There seems to be no end to this debate, but there are factors that investors can consider — especially the difference in cost. Because active investing typically requires a team of analysts and investment managers, these funds are more expensive and come with higher expense ratios. Passive funds, which require little or no involvement from live professionals because they track an index, cost less.

Also, there is a body of research demonstrating that indexing typically performs better than active management. When you add in the impact of cost — i.e. active funds having higher fees — this also lowers the average return of many active funds. Following are a few more factors to consider when choosing active investing vs. passive strategies.

Active vs Passive Investing: Key Differences

The following table recaps the main differences between passive and active strategies.

Active Funds	Passive Funds
Many studies show the vast majority of active strategies underperform the market on average, over time.	Most passive strategies outperform active ones over time.
Higher fees can further lower returns.	Lower fees don’t impact returns as much.
Human intelligence and skill may capture market upsides.	A passive algorithm captures market returns, which are typically higher on average.
Typically not tax efficient.	Typically more tax efficient.
Potentially less tied to market volatility.	Tied to market volatility and more vulnerable to market shocks.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

Active Investing Definition

What is active investing? Active investing is a strategy where an investor attempts to beat the market by trading individual stocks, bonds, or other securities.

With active investing, either an individual investor could be the one trading securities in their own portfolios, or portfolio managers of actively managed exchange-traded funds (ETFs) and mutual funds could be the one buying and selling assets to outperform the market or a specific sector.

Active investors and actively-managed funds often trade stocks and securities to profit in the short term. Short-term trading, like day trading, can be difficult as it requires the investor to be an expert on the financial markets and the factors impacting stock prices. It also requires the investor to have a good deal of discipline, as short-term stock picking can be a volatile and risky endeavor.

Active Investing Pros and Cons

Active investing is what live portfolio managers do; they analyze and then select investments based on their growth potential. Active strategies have a number of pros and cons to consider when comparing them with passive strategies.

Pros and Cons of Active Investing
Pros	Cons
May be fun to follow the market and make your own investment decisions	Difficult to beat the market
May profit in up, down, and sideways markets	Time consuming
Can tailor a strategy based on your goals and risk tolerance	Higher fees and commissions

Pros

• One potential advantage of having a real person crunching numbers and making investment decisions is that they may be able to spot market opportunities and take advantage of them. A computer algorithm is not designed to pivot the way a human can, which might benefit the performance of an actively managed ETF or mutual fund.

• Whereas a passive strategy is designed to follow one market sector index (e.g. the performance of large cap U.S. companies via the S&P 500® index), an active manager can be more creative and is not limited to a single sector.

• The number of actively managed mutual funds in the U.S. stood at about 6,585 as of June 2023 vs. 517 index funds, according to Statista. Given that there are many more active funds than passive funds, investors may be able to select active managers who have the kind of track record they are seeking.

Cons

• The chief downside of active investing is the cost. Hedge funds and private equity managers are one example, charging enormous fees (sometimes 10%, 15%, 20% of returns) for their investing acumen.

But even standard actively managed funds, which may charge 1% or 1.5% or even 2% annually, are far higher than the investment fees of most passive funds, where the annual expense ratio might be only a few basis points.

• The majority of active strategies don’t generate higher returns over the long haul. According to the well-known SPIVA (S&P Indices vs. Active) 2022 year end scorecard report, 95% of U.S. active equity funds underperformed their respective S&P indexes over the last two decades. So investors who are willing to pay more for the insight and skill of a live manager may not reap the rewards they seek.

• A professional manager may create more churn in an actively managed fund, which could lead to higher capital gains tax.

Passive Investing Definition

Passive investing strategy is when an investor buys and holds a mix of assets for an extended period. Many passive investors will invest in passively-managed index funds, which attempt to replicate the performance of a benchmark index. Passive investors are not necessarily trying to beat the market.

Passive Investing Pros and Cons

The term “passive investing” may not have a strong positive connotation, yet the funds that follow an indexing strategy typically do well vs. their active counterparts.

Pros

• Passive strategies are more transparent. Because index funds simply track an index like the S&P 500 or Russell 2000, there’s really no mystery how the constituents in the fund are selected nor the performance of the fund (both match the index).

• As noted above, index funds outperformed 79% of active funds, according to the SPIVA scorecard.

• Passive strategies are generally much cheaper than active strategies.

• Passive strategies can be more tax efficient as there is generally much less turnover in these funds.

Cons

• Because passive funds use an algorithm to track an existing index, there is no opportunity for a live manager to intervene and make a better or more nimble choice. This could lead to lost opportunities.

• Passive strategies are more vulnerable to market shocks, which can lead to more investment risk.

Which Should You Pick: Active or Passive Investing?

Deciding between active and passive strategies is a highly personal choice. It comes down to whether you believe that the active manager you pick could be among the few hundred who won’t underperform their benchmarks; and that the skill of an active manager is worth paying the higher investment costs these strategies command.

You could also avoid treating the active vs. passive investing debate as a forced dichotomy and select the best funds in either category that suit your goals.

The Takeaway

Active vs. passive investing is an ongoing debate for many investors who can see the advantages and disadvantages of both strategies. Despite the evidence suggesting that passive strategies, which track the performance of an index, tend to outperform human investment managers, the case isn’t closed.

After all, passive investing may be more cost efficient, but it means being tied to a certain market sector — up, down, and sideways. That timing may or may not work in your favor. Active investing costs more, but a professional may be able to seize market opportunities that an indexing algorithm isn’t designed to perceive.

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).

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What is the difference between active and passive investing?

The main difference between active and passive investing is that active investing is when a portfolio manager — or the investor themselves — manages their portfolio, buying and selling investments to try to outperform the market. Passive investing is when an investor buys assets and holds onto them for a long period. Passive investing usually means investing in index funds, which track the performance of an index.

What are the examples of active funds?

According to a Morningstar February 2024 analysis, some examples of actively managed ETFs include the Avantis U.S. Equity ETF (AVUS), the Capital Group Dividend Value ETF (CGDV), and the Dimensional Core U.S. Equity 1 ETF (DCOR). Note that these are just examples. An investor should always do their own research before making any investments.

Does active investing have high risk?

Active investing is considered higher risk. Active investors and actively-managed funds often trade stocks and securities to profit in the short term. Short-term trading typically requires knowledge about financial markets and the factors impacting stock prices. It can be volatile and risky.

Should I invest in active or passive funds?

Deciding whether to invest in active or passive funds is a personal choice that only you can make. It depends on your personal situation, goals, and risk tolerance, among other factors. In general, passive investing is better for beginners, and active investing is better for experienced investors with knowledge of the market and who understand the risk involved.

Are ETFs active or passive?

ETFs can be active or passive. Passive ETFs track indexes such as the S&P 500 and may make sense for investors pursuing a buy and hold strategy. Active ETFs rely on portfolio managers to select and allocate assets in an effort to try to outperform the market.

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.

SoFi Invest®

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

SOIN0124067

May

2024

A Walkthrough of What Leverage Trading Is

Understanding Leverage Trading

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

Leverage allows investors to allocate a small amount of capital to get exposure to a much bigger position. Leverage, also called margin, is effectively a way of borrowing cash for increased trading power. A leverage ratio of 20:1 means a $1 investment can buy $20 worth of an asset.

Using leverage, traders can place bigger bets and potentially earn higher returns on their initial capital. However, leveraged trading also increases a trader’s risk of losses; if the asset moves in the wrong direction, the trader not only suffers a loss but must repay the amount borrowed, plus interest and fees.

This is one reason that only experienced investors qualify for leverage accounts, e.g. margin accounts, and leveraged trading opportunities.

Key Points

• Leverage trading involves using borrowed funds to increase potential investment returns.

• A leverage ratio of 20:1 means a small investment can control a much larger position.

• Risks include the potential to lose more than the initial investment.

• Not all securities are eligible for leverage; rules vary by broker and security type.

• Leverage is typically reserved for experienced investors due to its high risk.

What Is Leverage Trading?

In both business and finance, the term leverage refers to the use of debt to fuel expansion or purchase securities. In leverage trading, traders can use margin to buy assets like stocks, options, and forex.

Leverage and margin are similar concepts, but they’re different. One way to think of the differences is that a trader can use margin to increase their leverage. Margin is the tool, and leverage is the force behind the tool, which can be used to potentially increase returns (or losses).

A margin account allows you to borrow from the brokerage to purchase securities that are worth more than the cash you have on hand. In this case, the cash or securities already in your account act as collateral.

Which Securities Are Eligible for Margin?

Not all securities can be bought using leverage, however. Industry rules dictate that equities known as penny stocks and Initial Public Offering (IPO) stocks are not marginable. Generally, stocks and exchange-traded funds (ETFs) that are worth more than $3 per share, as well as mutual funds and certain types of bonds are eligible for leverage trades using margin. Check with your broker, as rules can vary by jurisdiction.

Margin can be used to trade options and futures, but this type of leverage trading can be highly risky. Forex options trading, for example, allows traders to place big bets using very small amounts of cash.

While there is no standard amount of margin in the forex market, it is common for traders to post 1% margin, which allows them to trade $100,000 of notional currency for every $1,000 posted — a ratio of 100:1.

Leverage Risks and Rewards

Leverage trading can only be successful if the return on an investment is higher than the cost to borrow money, which you must repay with interest and fees.

Leverage trading can significantly increase potential earnings, but it is also very risky because you can lose more than the entire amount of your investment. For that reason leverage is usually only available to experienced traders.

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

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.

How Leverage Works in Trading

Leverage trading in a brokerage account consists of a trader borrowing money from the broker, then using that along with their own funds to enter into trades.

The key to understanding how using leverage can help generate higher returns, but also greater losses, is that the funds borrowed are a fixed liability. Suppose a trader starts with $50, and borrows $50 to buy $100 worth of stock. Whether the stock’s value goes up or down from there, the trader is on the hook to give back $50, plus interest, to the broker.

Example of Leverage Trading

Using the above example, suppose the stock appreciates by 10%, and the trader closes out the position. They return the $50 they borrowed, and keep the remaining $60. That equates to a $10 gain on their $50 of capital, and a 20% return — double the return of the underlying stock.

On the flip side, consider what happens if the stock declines in value by 10%. The trader closes out the position and receives $90, but has to give the broker back the $50 they borrowed, plus interest. They are left with $40, a loss of $10, plus any interest or fees, which is a 20% loss or more.

Understanding Leverage Ratio

Leverage is often expressed as a ratio. For example, a leverage ratio of 2:1 is generally the rule for using margin for equity trades. If you have $50, you can buy $100 worth of stock.

In the case of other types of securities, the leverage ratio can be much higher. A leverage ratio of 20 means a $1,000 investment would allow you to open a trading position of $20,000; 50:1 would allow you to take a position of $50,000.

Maximum Leverage

Brokers have limits on how much they’ll lend traders based on the amount of funds the trader has in their account, their own regulations, and government regulations around leverage trading. If you’re considering using leverage, be sure to understand the rules.

• Stocks. Thanks to the Federal Reserve Board’s Regulation T, plus a FINRA rule governing margin trades in brokerage accounts, the maximum you can borrow is 50% for an equity trade.

• Forex. The foreign currency market tends to allow greater amounts of leverage. In some cases, you can place bets as high as 100:1 in the U.S.

• Commodities. Commodities rules around maximum leverage, and leverage ratios can fluctuate based on the underlying.

Types of Leverage Trading

There are a few different types of leverage trading, each with similarities and differences.

Trading on Margin

Margin is money that a trader borrows from their broker to purchase securities. They use the other securities in their account as collateral for the loan. If their leveraged trade goes down in value, a trader will need to sell other securities to cover the loss.

Many brokers charge interest on margin loans. So in order for a trader to earn a profit, the security has to increase in value enough to cover the interest.

Leveraged ETFs

Some ETFs use leverage to try and increase potential gains based on the index they track. For example, there is an ETF that specifically aims to return 3x the returns that the regular S&P 500 index would get.

It’s important to note that most funds reset on a daily basis. The leveraged ETF aims to match the single day performance of the underlying index. So over the long term even if an index increases in value, a leveraged ETF might decrease in value.

Derivatives

Traders can also use leverage trading with derivatives and options contracts. Buying a single options contract lets a trader control many shares of the underlying security — generally 100 shares — for far less than the value of those 100 shares. As the underlying security increases or decreases in value, the value of the options contract changes.

Options are derivatives contracts that give buyers the right, but not the obligation, to buy (in the case of a call) or sell (in the case of a put) an asset at a specified price within a certain period of time. Traders can choose to sell call options on a stock if they think it is going to decrease in value.

Options trading is one of the riskiest types of leverage trading. A trader could potentially lose an unlimited amount of money if they sell a call option and the underlying stock price skyrockets in value.

If the option seller exercises the trade, the trader will have to purchase the associated amount of the underlying security to sell to the option seller. If the security has gone up a significant amount this could cost millions of dollars or more.

Recommended: Options Trading 101

Leverage Trading Terms to Know

There are several key terms to know in order to fully understand leverage trading.

Account balance: The total amount of funds in a trader’s account that are not currently in trades.

Buying power: This is the total amount a trader has available to enter into leverage trades, including both their own capital and the amount they can borrow.

Coverage: The ratio of the amount of funds currently in leveraged trades in one’s account to the net balance in their account.

Margin Requirement: This is the amount of funds a broker requires a trader to have in their margin account when entering into leverage trades. If a trader incurs losses, those funds will be used to cover them. Traders can also use securities they hold in their account to cover losses. Margin requirement is often a percentage. For example, at a leverage amount of 100:1, the margin requirement is 1%.

Margin call: If a trader’s account balance falls below the margin requirement, the broker will issue a margin call. This is a warning telling the trader they have to either add more funds to their account or close out some of their positions to meet the minimum margin requirement. The broker does this to make sure the trader has sufficient funds in their account to cover potential losses.

Used margin: When an investor enters into trades, some of their account balance is held by the broker as collateral in case it needs to be used to cover losses. That amount will only be available for the trader to use after they close out some of their positions.

Usable margin: This is the money in one’s account that is currently available to put into new trades.

Open position: When a trader is currently holding an asset they are in an open position. For instance, if a trader owns 100 shares of XYZ stock, they have an open position on the stock until they sell it.

Close position: The total value of an investment at the time the trader closes it out.

Stop-loss: Traders can set a price at which their asset will automatically be sold in order to prevent further losses if its value is decreasing. This is very useful if a trader wants to hold positions overnight or if a stock is very volatile.

Pros and Cons of Leveraged Trading

On the surface, leverage can sound like a powerful tool for investors — which it can be. But it’s a tool that can cut both ways: Leverage can add to buying power and potentially increase returns, but it can also magnify losses, and put an investor in the hole.

Pros of Leverage	Cons of Leverage
Increases buying power	Leverage funds must be repaid, with interest
Potential to earn higher returns	Potential to lose more than your initial investment
Relatively easy to use, if you qualify	Investors must meet specific criteria in order to use leverage or open a margin account

Pros

Using leverage can increase your trading power, sometimes to a large degree. It’s important to know the rules, as leverage ratios vary according to the securities you’re trading, the jurisdiction you’re in, and sometimes your broker’s discretion.

If you meet the criteria for using leverage or opening a margin account to trade, it’s relatively easy to access the funds and open bigger positions. Sometimes, placing that bigger bet can pay off with a much higher return than you would have gotten if you invested just the capital you had on hand.

Cons

Just as using leverage can amplify gains, it can amplify losses — in some cases to the point where you lose your initial investment, you must repay the money you borrowed, and you may owe fees and interest on top of that.

For that reason, many brokers require investors to meet certain criteria before they can place leveraged trades.

Tips for Managing the Risks of Leveraged Trading

Experience and skill can help you manage the risk factors inherent in leveraged trades, and a couple of basic protective strategies may help.

Hedge Your Bets

It might be possible to hedge against potential losses by taking an offsetting position to the leverage trade.

Limit Potential Loss of Capital

One rule of thumb suggests that traders limit their loss of capital to no more than 3% of the actual cash portion of the trade. While it’s difficult to know the exact risk level.

Decide Whether Leverage Trading Is Right for You

Although there is potential for significant earnings using leverage trading, there is no guarantee of any earnings, and there is also potential for significant loss. For this reason leverage trading is often said to be best left to experienced traders.

If an investor wants to try leverage trading it’s important for them to assess their financial situation, figure out how much they’re willing to risk, and conduct detailed analysis of the securities they are looking to trade.

Setting up a stop-loss order may help decrease the risk of losses, and traders can also set up a take-profit order to automatically take profits on a position when it reaches a certain amount.

The Takeaway

Leveraged trading is a popular strategy for investors looking to increase their potential profits. By using borrowed funds it’s possible to take much bigger positions, and possibly see bigger wins. But using leverage is very risky, and you can lose more than you have (because the money you borrow has to be repaid in full, plus interest).

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

Get one of the most competitive margin loan rates with SoFi, 11%*

FAQ

What leverage is good for $100?

If you only wanted to invest a small amount of capital, say $100, you would first need to check the policies at your brokerage about the use of lower amounts. If approved, you might want to use a lower amount of leverage, e.g. 10:1. That means for every $1 of cash you put down, you can get $10 in leverage. So a $100 leverage trade would be worth $1,000.

How much leverage is too high?

Knowing how much you can afford to lose is an important calculation when making leveraged trades. In addition, the amount of leverage available to you will also be restricted by existing regulations or brokerage rules. And remember, if a trade goes south, your broker can liquidate existing assets to cover your losses and any margin.

Photo credit: iStock/ljubaphoto

*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.

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.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at https://sofi.app.link/investchat. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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

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.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

SOIN0124040

May

2024

Dollar Cost Averaging: Definition, Formula, Examples

By AJ Smith | Growing Wealth, invest, Investing | No Comments

Dollar cost averaging is a way to manage volatility as you continue to save and build wealth. Volatility is a natural part of investing. Virtually every part of the market is impacted by volatility in one way or another — thus, nearly every investor must contend with inevitable price fluctuations, and one way to do this is by using dollar cost averaging.

With this strategy, you decide on the securities you want to purchase, and the dollar amount you want to invest each month (or the interval you choose), and then ideally automate that amount to be invested on a regular basis.

Key Points

• Dollar cost averaging (DCA) is an investment strategy that helps manage volatility by investing a fixed dollar amount regularly.

• DCA involves buying securities at regular intervals, regardless of market prices, to avoid trying to time the market.

• Dollar cost averaging works by investing the same amount consistently, resulting in buying more shares when prices are low and fewer when prices are high.

• The strategy can help investors stay the course and avoid emotional decision-making based on market fluctuations.

• While dollar cost averaging has benefits like consistency and automation, it may not maximize returns compared to lump-sum investing and may not address the need for portfolio rebalancing.

What Is Dollar Cost Averaging (DCA)?

Dollar cost averaging is a basic investment strategy where you buy a fixed dollar amount of an investment on a regular basis (e.g. weekly or monthly). The goal is not to invest when prices are high or low, but rather to keep your investment steady and repeatable, and thereby avoid the temptation to time the market.

That’s because with dollar cost averaging (DCA) you invest the same dollar amount each time, so that, effectively, when prices are lower, you buy more; when prices are higher, you buy less. Otherwise, you might be tempted to follow your emotions and buy less when prices drop, and more when prices are increasing (a common tendency among investors).

How Dollar Cost Averaging Works

Dollar cost averaging works by making more or less the same investment over and over on a repeating basis. For an investor, it may be as simple as investing $5 in Stock A every Monday, or something similar, no matter what’s going on in the market.

That way, you’re investing the same amount whether the market goes up, down, or sideways. For example, if you invest $100 in Stock A at $20 per share, you get 5 shares. The following month, say, the price has dropped to $10 per share, but you stay the course and invest $100 in Stock A — and you get 10 shares.

Over time, the average cost of your investments – the dollar amount you’ve paid – may end up being a little lower, which can benefit the overall value of your portfolio.

Example of Dollar Cost Averaging

Here’s an example of how dollar cost averaging might look in practice.

Investor A might buy 20 shares of an exchange-traded fund (ETF) at $50 per share, for $1,000 total. This would be investing a lump-sum, rather than using a dollar cost averaging strategy.

Investor B, however, decides to use a dollar cost averaging strategy.

• The first month, Investor B buys shares of the same ETF at $50/share, but spends $300 and gets six shares.

• The next month the ETF price drops to $30 per share. So Investor B once again invests $300 and now gets 10 shares.

• By the third month, the ETF is worth $50 per share again, and their regular $300 investment gets them six shares.

Investor B now owns 22 shares of the ETF, at an average price of $40.90 per share, compared with Investor A, who paid $1,000 ($50 per share for 20 shares) in one lump sum.

💡 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.

Benefits and Disadvantages of DCA

Every strategy has its pros and cons, of course. Here are some of the advantages and disadvantages of DCA.

Dollar Cost Averaging Benefits

DCA forces you to stay the course, regardless of volatility. It keeps you from trying to “time the market.” By investing the same amount of money every month, you will buy more shares when the market is down and fewer shares when the market is up. You’re not investing with your emotions, which can lead to impulsive choices.

DCA allows you to “set it and forget it.” Investing the same dollar amount every month is a straightforward strategy, and technology makes it easy to automate. You don’t have to keep your eye on different investments or even market volatility. Just stick to the plan.

You also don’t have to be wealthy in order to use the dollar cost averaging method. You can start small, but all the while, you will be contributing to and growing an investment portfolio.

Dollar Cost Averaging Disadvantages

In some cases, investing a lump sum may net you a higher return over time. Although DCA works well in terms of helping to manage the impact of volatility, the reality is that over the course of many years, the market trends upward, as the average market return shows. Although there are many factors to consider when it comes to investing returns — including the impact of fees, of selling when the market is down and locking in losses, and so forth — the market’s upward trajectory is something to bear in mind.

When you use any kind of “set it and forget it” strategy, you run the risk of missing out on certain market opportunities — and red flags. Although the upside of dollar cost averaging is its consistency, the potential downside is that you may be less aware if there are new opportunities or the need to avoid losses.

Last, dollar cost averaging doesn’t solve the problem of rebalancing — another strategy that’s designed to mitigate volatility.

💡 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.

When to Use Dollar Cost Averaging

There are certain times when dollar cost averaging makes sense, and certain investments that are suited to this strategy.

• For example, many people believe they need to invest large sums of money to invest successfully. In fact, DCA is evidence that you can invest small amounts, steadily over time, and reap the benefits of market growth.

• Funds: Mutual funds allow you to purchase a share, which represents a very small allocation of the underlying investment portfolio. This means that you can diversify with much smaller dollar amounts than if you purchased the securities on your own.

• ETFs (exchange-traded funds): Similar to mutual funds, ETFs provide an opportunity to diversify with smaller dollar amounts. Additionally, ETFs are available to trade throughout the day, generally have low expenses, no investment minimums, and may offer greater tax-efficiency.

The Takeaway

Dollar cost averaging is a fairly straightforward strategy that can help mitigate the impact of volatility on your portfolio, and also help you avoid giving into emotional impulses when it comes to buying or selling. Thus, dollar cost averaging can help you stay in the market, even when it’s fluctuating, with the result that you buy more when prices are low and less when prices are high — but overall, you may end up paying less on average.

But dollar cost averaging isn’t an excuse for literally “setting and forgetting” your portfolio. It’s still important to check on your investments in case there are any new opportunities or bona fide laggards. And once a year, it’s wise to rebalance your portfolio to restore your original asset allocation (unless of course your risk tolerance or goals have changed).

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

Is dollar cost averaging a good idea?

Dollar cost averaging may be a good strategy for many investors to employ, as it has certain advantages that beginner investors, in particular, may use to their benefits. But it’s important to consider the downsides or disadvantages, too.

When is the best time to do dollar cost averaging?

There isn’t really a bad time to use a dollar cost averaging strategy, as such, investors interested in implementing one could likely do it at nearly any time.

How often should you do dollar-cost averaging?

When using a dollar cost averaging strategy, investors can choose a cadence that is best suited to their overall financial goals. For some, it may involve weekly investments, while it may involve daily or monthly investments for others.

Where is dollar-cost averaging most commonly done?

Dollar cost averaging is a strategy commonly used in retirement plans, such as 401(k)s, although it can be used in various types of investment accounts.

SoFi Invest®

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

SOIN0124049

May

2024

What Is Theta in Options? All You Need to Know

By Dan Miller | Growing Wealth, invest, Investing, Terminology | Comments Off

Theta, in relation to options, describes the rate in change in an option’s value. Options have two sources of value: intrinsic value and time value. From the moment an options contract is created, the time value component decays. This rate of change in value with respect to time is known as theta.

Understanding theta is crucial if you are going to trade options. Several factors, including an option’s moneyness and the time to expiration, will impact theta. Here are the basic concepts that you should know about.

Key Points

• Theta measures the rate at which an option’s value decreases over time, specifically due to the passage of time.

• As options approach their expiration date, their time value decays, which is quantified by theta.

• Theta is typically represented as a negative dollar amount, indicating the daily loss in value of the option.

• The impact of theta is more pronounced as the expiration date nears, accelerating the decay of the option’s time value.

• Understanding theta is essential for options traders, as it helps in timing the market and managing potential risks and returns.

How Does Theta Work?

Holding all other factors equal, options tend to decline in value over time as they approach their expiration date. The intuition behind this relationship is simple: once an option expires, it can no longer be exercised, and thus it no longer has any value.

This rate of change in value of an option is referred to as theta. Usually displayed as a negative dollar amount, an option’s theta value represents how much an option’s price decreases per day as it matures.

💡 Interested in Theta? Check out the other Greeks in options trading.

What Are Examples of Theta?

One way to think of theta in options trading is an analogy of an ice cube sitting on a countertop. As the ice cube sits on the warm countertop, it gradually melts away, and the melting becomes more rapid as time passes. Similarly, an option’s time value always decreases, with the decrease becoming more rapid the closer an option is to expiring.

Let’s say there is a stock ABC with a price of $80. The theta for an options contract expiring in three months with a strike price of $85 might be -$0.05. That means you can expect to lose five cents per day due to time decay, or theta. That doesn’t necessarily mean that the security’s price will go down each day, since it will also be affected by up and down movements of the underlying stock price itself.

In this scenario, not all options of stock ABC will have the same theta value of -$0.05. An option with the same strike price of $85 but a year until expiration will usually have a lower theta than one expiring next month.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

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.

What Is a Negative Theta in Options?

Because theta represents the amount of money an option contact loses every day, it is customarily represented as a negative number. A theta value of -$0.15 for a particular option means that particular option will lose 15 cents of time value each day.

But because the time value loss of an option (theta) isn’t linear, you shouldn’t expect it to lose exactly 15 cents of time value every day. Theta will increase as the option expiration date gets closer. This is very important to know if you’re attempting to time the market, since it will help you understand when the best time is to make your move.

Understanding Options Theta Decay

There are many different strategies for trading options, and theta affects them differently. Since theta is a negative number, it works against buyers of options. But if you are selling an option (like in a covered call or other option strategy), theta works in your favor.

When you are selling an option contract, you are hoping that the option will decrease in value or expire worthless. So a high theta value works for an option seller since it represents the amount of money the contract will lose each day.

Calculating Theta

Calculating theta, or any of the other Greeks, requires using advanced mathematical formulas, and depends on the particular pricing model you choose. Options investors typically calculate theta on a daily or weekly basis.

Generally theta will be smaller for options that are far away from their expiration date and larger as you get closer to expiration. You can use this knowledge to determine your best plan depending on your time horizon for investing.

The Takeaway

Whether you’re trading basic options or more complicated options spreads, it is important to understand theta. It represents how much value your option will lose as time moves closer to its maturity, holding other factors constant. One needs to be especially careful to take note of theta when trading out-of-the-money options.

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

Intrinsic Value and Time Value of Options, Explained

What Is the Intrinsic Value of an Option?

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

In the Money

At the Money

Out of the Money

Finally, user-friendly options trading is here.*

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

Formula for the Intrinsic Value of an Options Contract

Intrinsic value formula for a call option:

Intrinsic value formula for a put option:

Example of Intrinsic Value Calculation

What Is the Time Value of an Option?

Formula for the Time Value of an Options Contract

How Does Volatility Impact Time Value?

How Can Intrinsic and Time Value Help Traders?

The Takeaway

Active vs Passive Investing: Differences Explained

Active vs Passive Investing: Key Differences

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

Active Investing Definition

Active Investing Pros and Cons

Pros

Cons

Passive Investing Definition

Passive Investing Pros and Cons

Pros

Cons

Which Should You Pick: Active or Passive Investing?

The Takeaway

FAQ

What is the difference between active and passive investing?

What are the examples of active funds?

Does active investing have high risk?

Should I invest in active or passive funds?

Are ETFs active or passive?

Understanding Leverage Trading

What Is Leverage Trading?

Which Securities Are Eligible for Margin?

Leverage Risks and Rewards

Increase your buying power with a margin loan from SoFi.

Borrow against your current investments at just 11%* and start margin trading.

How Leverage Works in Trading

Example of Leverage Trading

Understanding Leverage Ratio

Maximum Leverage

Types of Leverage Trading

Trading on Margin

Leveraged ETFs

Derivatives

Leverage Trading Terms to Know

Pros and Cons of Leveraged Trading

Pros

Cons

Tips for Managing the Risks of Leveraged Trading

Hedge Your Bets

Limit Potential Loss of Capital

Decide Whether Leverage Trading Is Right for You

The Takeaway

FAQ

What leverage is good for $100?

How much leverage is too high?

Dollar Cost Averaging: Definition, Formula, Examples

What Is Dollar Cost Averaging (DCA)?

How Dollar Cost Averaging Works

Example of Dollar Cost Averaging

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

Benefits and Disadvantages of DCA

Dollar Cost Averaging Benefits

Dollar Cost Averaging Disadvantages

When to Use Dollar Cost Averaging

The Takeaway

FAQ

Is dollar cost averaging a good idea?

When is the best time to do dollar cost averaging?

How often should you do dollar-cost averaging?

Where is dollar-cost averaging most commonly done?

What Is Theta in Options? All You Need to Know

Student Loan
Refinancing

Personal
Loans

Online
Investments