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A 401(k) loan allows you to borrow money from your retirement savings and pay it back to yourself over time, with interest. While this type of loan can provide quick access to cash at a relatively low cost, it comes with some downsides. Read on to learn how 401(k) loans work, when it may be appropriate to borrow from your 401(k), and when you might want to consider an alternative source of funding.

What Is a 401(k) Loan & How Does It Work?

A 401(k) loan is a provision that allows participants in a 401(k) plan to borrow money from their own retirement savings. Here are some key points to understand about 401(k) loans.

Limits on How Much You Can Borrow

The Internal Revenue Service (IRS) sets limits on the maximum amount that can be borrowed from a 401(k) plan. Typically, you can borrow up to 50% of your account balance or $50,000, whichever is less, within a 12-month period.

Spousal Permission

Some plans require borrowers to get the signed consent of their spouse before a 401(k) loan can be approved.

You Repay the Loan With Interest

Unlike a withdrawal, a 401(k) loan requires repayment. Typically, you repay the loan (plus interest) via regular payroll deductions, over a specified period, usually five years. These payments go into your own 401(k) account.

Should You Borrow from Your 401(k)?

It depends. In some cases, getting a 401(k) can make sense, while in others, it may not. Here’s a closer look.

When to Consider a 401(k) Loan

•  In an emergency If you’re facing a genuine financial emergency, such as medical expenses or imminent foreclosure, a 401(k) loan may provide a timely solution. It can help you address immediate needs without relying on more expensive forms of borrowing.

•  You have expensive debt If you have high-interest credit card debt, borrowing from your 401(k) at a lower interest rate can potentially save you money and help you pay off your debt more efficiently.

When to Avoid a 401(k) Loan

•  You want to preserve your long-term financial health Depending on the plan, you may not be able to contribute to your 401(k) for the duration of your loan. This can take away from your future financial security (you may also miss out on employee matches). In addition, money removed from your 401(k) will not be able to grow and will not benefit from the effects of compound interest.

•  You may change jobs in the next several years If you anticipate leaving your current employer in the near future, taking a 401(k) loan can have adverse consequences. Unpaid loan balances may become due upon separation, leading to potential tax implications and penalties.

How Is a 401(k) Loan Different From an Early Withdrawal?

When you withdraw money from your 401(k), these distributions typically count as taxable income. And, if you’re under the age of 59½, you typically also have to pay a 10% penalty on the amount withdrawn.

You may be able to avoid a withdrawal penalty, if you have a heavy and immediate financial need, such as:

•  Medical care expenses for you, your spouse, or children

•  Costs directly related to the purchase of your principal residence (excluding mortgage payments).

•  College tuition and related educational fees for the next 12 months for you, your spouse, or children.

•  Payments necessary to prevent eviction from your home or foreclosure

•  Funeral expenses

•  Certain expenses to repair damage to your principal residence

While the above scenarios can help you avoid a penalty, income taxes will still be due on the withdrawal. Also keep in mind that an early withdrawal involves permanently taking funds out of your retirement account, depleting your nest egg.

With a 401(k) loan, on the other hand, you borrow money from your retirement account and are obligated to repay it over a specified period. The loan, plus interest, is returned to your 401(k) account. During the term of the loan, however, the money you borrow won’t enjoy any growth.

Recommended: Can I Use My 401(k) to Buy a House?

Pros and Cons of Borrowing From Your 401(k)

Given the potential long-term cost of borrowing money from a bank — or taking out a high-interest payday loan or credit card advance — borrowing from your 401(k) can offer some real advantages. Just be sure to weigh the pros against the cons.

Pros

•  Efficiency You can often obtain the funds you need more quickly when you borrow from your 401(k) versus other types of loans.

•  No credit check There is no credit check or other underwriting process to qualify you as a borrower because you’re withdrawing your own money. Also, the loan is not listed on your credit report, so your credit won’t take a hit if you default.

•  Low fees Typically, the cost to borrow money from your 401(k) is limited to a small loan origination fee. There are no early repayment penalties if you pay off the loan early.

•  You pay interest to yourself With a 401(k) loan, you repay yourself, so interest is not lost to a lender.

Cons

•  Borrowing limits Typically, you are only able to borrow up to 50% of your vested account balance or $50,000 — whichever is less.

•  Loss of growth When you borrow from your 401(k), you specify the investment account(s) from which you want to borrow money, and those investments are liquidated for the duration of the loan. Therefore, you lose any positive earnings that would have been produced by those investments for the duration of the loan.

•  Default penalties If you don’t or can’t repay the money you borrowed on time, the remaining balance would be treated as a 401(k) disbursement under IRS rules. This means you’ll owe taxes on the balance and, if you’re younger than 59 1 ⁄ 2, you will likely also have to pay a 10% penalty.

•  Leaving your job If you leave your current job, you may have to repay your loan in full in a very short time frame. If you’re unable to do that, you will face the default penalties outlined above.

Alternatives to Borrowing From Your 401(k)

Because withdrawing or borrowing from your 401(k) comes with some drawbacks, here’s a look at some other ways to access cash for a large or emergency expense.

Emergency fund Establishing and maintaining an emergency fund (ideally, with at least three to six months’ worth of living expenses) can provide a financial safety net for unexpected expenses. Having a dedicated fund can reduce the need to tap into your retirement savings.

Home equity loans or lines of credit If you own a home, leveraging the equity through a home equity loan or line of credit can provide a cost-effective method of accessing extra cash. Just keep in mind that these loans are secured by your home — should you run into trouble repaying the loan, you could potentially lose your home.

Negotiating with creditors In cases of financial hardship, it can be worth reaching out to your creditors and explaining your situation. They might be willing to reduce your interest rates, offer a payment plan, or find another way to make your debt more manageable.

Personal Loans Personal loans are available from online lenders, local banks and credit unions and can be used for virtually any purpose. These loans are typically unsecured (meaning no collateral is required) and come with fixed interest rates and set terms. Depending on your lender, you may be able to get funding within a day or so.

The Takeaway

Borrowing from your 401(k) can provide short-term financial relief but there are some downsides to consider, such as borrowing limits, loss of growth, and penalties for defaulting. It’s a good idea to carefully weigh the pros and cons before you take out a 401(k) loan. You may also want to consider alternatives, such as using non-retirement savings, taking out a home equity loan or line of credit, or getting a personal loan.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

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

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So, you’ve decided to move. Be it for a new job, a fresh start, or just for an adventure in an exciting new locale, moving can be a great way to kick off change in your life.

But before you start assembling boxes, folding clothes, and bubble wrapping your most prized possessions, there are a few key steps — some financial and some practical — you might want to take to ensure a seamless transition. Here’s a moving checklist that can help you get from your old home to your new place with relative ease.

3 Months Before the Move

Pick a Date and Make a Moving Budget

Pick a Day to Move

Assuming your new place is ready to go and you’ve already discussed the move with your current landlord (or have sold your current home), a good first step is to decide on a moving day.

The least expensive times to move are typically during the week. Moving companies will often offer better rates on a Monday, Tuesday, Wednesday, or Thursday because they aren’t typically as busy as on weekends.

You might also want to try to schedule your move in the morning. This is helpful during the summer, since temperatures aren’t as hot. Also, if you aren’t moving far, an early move will give you a good portion of the day to start getting settled in your new home.

Choose a Moving Company

Once you’ve picked the day, it’s time to pick the mover. You might start your search by asking people you know who have recently moved for recommendations. You can also check out the reviews online and send out a few quote requests to local movers. It can be a good idea to interview and get estimates from at least three movers before making a choice.

Create a Budget

Moving can be costly, and movers may be one of your biggest expenses. The average per-hour cost for a local move is $25 to $50 per mover, per hour. So if you use a two-person team for four hours, it can run at least $200 to $400, just for labor. You may also have to pay for transportation fees, materials, and gas.

For a long-distance move, costs go up considerably. You may need to factor gas, tolls, and lodging if the trip is more than one day, along with additional fees for drivers. All told, a long-distance move can run anywhere from $600 to $10,000 (or more), depending on the moving company you choose, the distance, and the size and amount of your belongings.

When you create your moving budget, you’ll want to factor in other moving costs, which may include:

•  Any penalties you might incur for leaving a lease early

•  Ending a phone, cable, or internet package early

•  Any and all repairs you need to make for your new home

•  Transportation cost to get to your new place

•  Any additional items you need to buy for your new place

Recommended: Things to Budget for After Buying a Home

Inform the Important People in Your Life

Now might be the time to share the news of your move. Your friends and family may already know, but don’t forget to tell other important people about your departure schedule, such as your children’s school and your employer. That way they have plenty of time to make any necessary arrangements.

You may also want to contact a few government agencies. For example, the U.S. Postal Service recommends setting up mail forwarding about two weeks in advance of a move. The service may be in place in as few as three days, but it’s smart to have some wiggle room.

If you’re moving to a new state, you may also want to set up an appointment at your new state’s department of motor vehicles, as you may be required to get a new driver’s license or register your vehicle in that state. And, if you’re moving during election season, reach out to your new area’s voter registration office to ensure you’re all set up to cast your ballot.

1 Month Before the Move

Evaluate Your Belongings and Declutter

Walkthrough

You might want to do a walkthrough of your current home and look at each and every item you own. Then grab two sticky note pads with different colors, one to represent the things you want to keep and one to represent the things that must go. Every single item should get a sticky note.

Start Selling

Instead of simply throwing away the things you no longer want, you could try to sell them online. After all, your trash could certainly be another person’s treasure. And this way you could have a few dollars in your pocket to spend on buying new things for your new home.

Donate Unwanted, but Still Usable, Items

If you’d prefer to donate some or all of your gently used but no-longer-needed possessions, you may want to reach out to The Salvation Army, Goodwill, Habitat for Humanity, a local thrift store, or a nearby homeless shelter to arrange for a pickup or delivery.

Recommended: 23 Easy Ideas to Pay It Forward

Call Your Cable, Internet, and Utility Providers

Now might be a good time to call your current cable, internet, and utility providers to let them know when you will be cutting off service. You’ll also want to reach out to providers that service your new home to set up services. That way, you’ll have electricity, WiFi, and everything you need up and running as soon as you get there.

Cancel Other Subscription Services

If you belong to a gym, community supported agriculture (CSA), or any other local group or subscription service, you’ll want to be sure to cancel your membership so you don’t continue to get charged after you move.

Three Weeks to One Week Before the Move

Collect Boxes and Start Packing

Collect Boxes

As the moving date gets closer, it’s time to acquire boxes. You can buy them or, to save money, start hunting down free boxes. Good sources include local restaurants, liquor stores, coffee shops, and supermarkets. Simply call or stop in and ask what days they typically get deliveries and if you can come to take the used boxes off their hands. Then, over the week or so, stop in and collect as many boxes as you can.

Buy the Moving Supplies You Need

You’ll also need to pick up some other items for packing, including heavy-duty packing tape, a marker for labeling things, and bubble wrap for fragile items. If you’re not hiring a moving company, you might consider renting a dolly, which can make moving heavy items much easier, plus furniture pads to protect your belongings from scratches and dings. Sheets and towels can also be used to protect furniture and as padding inside of boxes.

Start Packing

At this point, it’s probably safe to start packing the things you aren’t currently using — out of season clothes, most of your dishes, extra blankets, towels, framed photos, and decorations. You’ll want to leave out the essentials so you’re not looking through boxes to find things you use on a daily basis.

Recommended: How to Move Across the Country

1 Week Before the Move

Tie Up Any Loose Ends

Finalize Important Details

By now, you’ve likely already canceled your local services, subscriptions and memberships, but there will likely still be a few loose ends to tie up. Think about how you can make the transition into your new life as seamless as possible. For example, do you need to switch banks? If you have a pet, you may want to select a vet in your new neighborhood in case your pet needs care soon after you move.

Confirm Bookings

You’ll have a lot of things to do before moving, but it’s important to take some time to double check all of your bookings. Confirm when your movers are coming, what time your flights are booked (if applicable), and that you’ve arranged for your new utilities to turn on. There are a lot of moving parts that come with a move, so it’s easy to get booking details mixed up or to let things fall through the cracks.

1 Day Before the Move

Pack Your Final Belongings and Say Goodbye

Pack Up

Pack up any of the remaining items you’ve left out for day-to-day living and make sure all your boxes and suitcases are ready to go for the move.

Create a Folder of Important Documents

Have a folder ready for the move that includes your old lease (if you’re renting), along with the new signed lease, the contract for the movers, and all receipts from the move.

Say Goodbye — Your Way

Consider ordering your favorite local takeout, having friends over for a farewell drink, and giving thanks to everything this home has provided for you. It deserves it.

Move-In Day Checklist

Embrace a Blank Slate

Make Sure Everything Arrived

On move-in day, you’ll want to focus on finalizing your move. There will be plenty of time later to rearrange furniture and to organize your new walk-in closet. Instead, you may want to concentrate on making sure all of your belongings made it from your old home to your new one, so you can start fresh tomorrow without making a trip back to grab that last box you forgot.

Clean Up

As tempting as it can be to start unpacking right away, this can be a great time to give your new home a deep clean. Once you unpack, it won’t be so easy to clean the inside of every cabinet and to vacuum every inch of carpet. This may not be one of the most fun things to do when moving, but it can be a good way to make your new house more homey.

Recommended: 32 Inexpensive Ways to Refresh Your Home Room by Room

Unpacking Checklist

Unpack and Get To Know Your New Home

Unpack

Now that the hustle and bustle of the move is over, you can focus on unpacking and taking your time to find the right spots for all of your belongings. Unpacking in the reverse order of how you packed allows you to access your most-needed belongings first.

Think Ahead

While you’re unpacking, you’ll get a lot more familiar with your new home and all of its needs. Keep a pen and paper at hand so you can create a post-moving to-do list. Take note of any repairs you want to make now and create a maintenance checklist you can refer back to in the future.

The Takeaway

Moving can be stressful, but you avoid ever feeling completely overwhelmed by making a moving checklist well ahead of your move date, then tackling each project one at a time.

Moving can also be costly, so you may also want to make a plan for how you’ll pay for your move well in advance. This gives you time to save up what you’ll need or, if necessary, explore financing options. You may be able to get an unsecured personal loan to cover the cost of a move. Sometimes referred to a moving or relocation loan, this type of financing typically comes with fixed rates and set repayment terms, and rates tend to be much lower than credit cards.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

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.

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.

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A bachelor’s degree is an undergraduate degree that usually requires you to take 120 credit hours of courses, typically around 40 classes. There are several types of bachelor’s degrees, including Bachelor of Arts, Bachelor of Science, and Bachelor of Fine Arts degrees. When you pursue a bachelor’s degree, you can major in a wide variety of focus areas, including arts, sciences, and humanities.

You may consider a second bachelor’s degree due to a change in career (such as switching from teaching to engineering — the number of classes you have to take for a master’s may encourage you to get a second bachelor’s degree instead). Taking advantage of career opportunities, adapting to job changes, or getting credit for specific skills may also be reasons you dive in again.

But can you get financial aid for a second bachelor’s degree?

Yes, you can! Read on to learn more about how to get financial aid for a second bachelor’s degree and the type of financial aid you might want to pursue for your second go-round.

Is It Possible to Get Financial Aid for a Second Bachelor’s Degree?

Yes, it’s possible to receive financial aid for a second bachelor’s degree, which can include federal student aid like federal grants, work-study, and federal student loans. We’ll detail the definitions of these types of federal student aid below when we explain how adult learners pay for college.

It’s important to note that you will be limited to a certain amount of financial aid in certain situations. For example, the aggregate federal student loan limit for dependent students (those claimed by their parent(s) on their parents’ taxes) is $31,000 and no more than $23,000 can be in Subsidized Student Loans.

Independent students (students who are at least 24 years old, married, veterans, members of the armed forces, who have their own legal dependents, who are homeless, and/or meet other qualifications) cannot borrow more than $57,500. No more than $23,000 of this amount may be in Subsidized Loans. In other words, if you’ve already borrowed the maximum amount for your first undergraduate degree, you could not borrow any more.

Certain grants also impose limits on what you can receive for a second bachelor’s degree.

Recommended: Can You Negotiate Financial Aid?

Can a Student Receive a Pell Grant for a Second College Degree?

A Pell Grant is a type of need-based federal grant. Grants are a type of aid that you don’t have to repay.

You cannot receive a Pell Grant if you’ve already received an undergraduate degree.

In some cases, students enrolled in a post-baccalaureate teaching program may be eligible to receive the Pell Grant. However, there are more stipulations — you cannot receive an unlimited amount of Federal Pell Grant funds, according to federal law. The Federal Pell Grant limit you can receive over your lifetime — Federal Pell Grant Lifetime Eligibility Used (LEU) — is limited to six years.

During a single award year, you can receive up to 100% of a scheduled Pell Grant Award, though it is possible to receive up to 150% of your scheduled award. For example, you may take classes during the fall, spring, and summer and therefore receive more than the scheduled 100%. However, you can receive the Pell Grant for no more than 12 terms, or about six years, because the six-year percentage equals 600%.

Using Funding From Financial Aid for Second Bachelor’s Degree

Financial aid for a second bachelor’s degree can include work-study, scholarships, federal student loans, and student aid for military spouses. You can think of your financial aid award as a jigsaw puzzle — these individual pieces fit together to form your award. Let’s take a look at the types of aid you might receive.

Work-Study

When you file the Free Application for Federal Student Aid (FAFSA®), you may receive a work-study award — yes, even if you’re working toward earning a second bachelor’s degree. As long as you apply for part-time work-study jobs for a second degree on campus (sometimes off-campus jobs are available) you may work up to the amount you receive on your work-study award. The amount you can make depends on factors including your level of need and the funds your school has available for work-study.

It’s important to remember that work-study is not “automatic money” — you must apply for a job and work toward the number of hours shown on your award.

Scholarships

Scholarships have a diverse eligibility requirements and some may be open to learners seeking a second bachelor’s degree. Scholarships may come from a wide variety of sources, including the institution you apply to. It’s a good idea to ask the financial aid office at each school for more information about the types of scholarships available to you because each college and university has various requirements for earning scholarships. For example, some may be based on merit and others may be based on financial need.

Other organizations, such as clubs, foundations, charities, businesses, local and state governments, and individual philanthropists, may also offer scholarships.

Recommended: Scholarship Search Tool

Federal Student Loans

You may qualify for federal student loans as long as you are under the aggregate federal student loan limit for dependent students of $31,000, with no more than $23,000 in subsidized student loans. Independent students are limited to $57,500 and cannot go over more than $23,000 in subsidized loans.

Undergraduate students can take advantage of Direct Subsidized Student Loans or Direct Unsubsidized Loans, which must be repaid with interest. Subsidized student loans are need-based federal student loans in which the government pays the interest while you’re in school (though you’ll pay the interest after school). Unsubsidized student loans are non-need-based federal student loans in which the government does not pay the interest while you are in school.

For loans disbursed during the 2023-2024 academic year, undergraduate students can take advantage of both Direct Subsidized or Unsubsidized Loans for an interest rate of 5.50%.

Recommended: Types of Federal Student Loans

Student Aid for Military Spouses

If you are the spouse of a military member, you may be able to have your military member transfer Post-9/11 GI Bill benefits to you based on your loved one’s military service, particularly if they are on active duty or in the Selected Reserve.

Your loved one must have completed at least six years of service, agreed to add four more years of service, and must also be enrolled in the Defense Enrollment Eligibility Reporting System (DEERS). Your active duty military member must use a Transfer of Entitlement (TOE) before you can apply for benefits.

What Do I Need to Do to Use Financial Aid for a Second Bachelor’s?

You can file the FAFSA for second bachelor’s degree financial aid and accept the aid award that comes from the school of your choice. Let’s go over each of these steps. Don’t forget to check out SoFi’s FAFSA guide.

Applying for FAFSA

You must file the Free Application for Federal Student Aid, commonly known as the FAFSA, to qualify for federal student aid. The FAFSA form online asks you to report on your personal financial information, including tax information and your savings and checking account balances. The FAFSA information also helps colleges, universities, and private financial aid providers decide how much state and institutional aid you may receive.

Once you file the FAFSA, you’ll get a Student Aid Report (SAR), which summarizes the information you’ve entered on the FAFSA. The SAR reports a variety of information including:

•   Your Student Aid Index (SAI), a number that determines your eligibility for student aid

•   Your eligibility for federal student loans

•   Your eligibility for Federal Pell Grants

•   Whether you’ve been selected for verification, which is a process that some students undergo to confirm that all the information is accurate on the FAFSA. Students may get selected randomly for verification and the school may also select them for verification. They may also get selected if the Central Processing System found problems with the FAFSA. The financial aid offices at the schools on your list can help you through the verification process.

Once you complete everything, you’ll receive a financial aid award from the schools on your shortlist.

Accepting Financial Aid

After receiving your financial aid award, it’s important to go through your full award to make sure you understand it, line by line. If you don’t understand a portion of your award, call the financial aid office of the school that sent it to you. They should be able to explain your full award to you in detail.

The school will generally explain how to accept your financial aid award in the email or packet that you receive. You can go through each type of loan, grant, and scholarship and accept or decline the awards you want. You can also accept the entire award. The financial aid office will let you know about your next steps after your award acceptance and after you pay your enrollment deposit.

Recommended: Ca$h Course: A Student’s Guide to Money

Ways to Pay for a Second Bachelor’s Degree

You can pay for your education using financial aid for a second bachelor’s degree using the types of aid described above (through grants, scholarships, and federal student loans). You may also want to pay for college using some money you’ve saved or that you are currently earning through a part- or full-time job.

Learners can also take advantage of private student loans, which are student loans that don’t come from the federal government. They typically offer higher interest rates than federal student loans but are a great way to fill in the gaps that other financial aid for second bachelor’s doesn’t cover.

Before you choose a private student loan lender, ask questions about interest rates, terms, and repayment options. Note that you’ll lose the option to tap into federal student loan benefits like income-driven repayment plans and loan forgiveness options if you go the private student loan route.

The Takeaway

If you’re wondering, “Can I get financial aid for a second bachelor’s degree?” you now know that the answer is a resounding “Yes!”

But will financial aid pay for a second bachelor’s degree? The answer is that federal financial aid and scholarships may not fully cover all your education expenses, which is why you might consider looking into private student loans.

Let SoFi help you fill the gap. For example, you may want to lean on a combination of scholarships, federal student loans, the money you’ve saved, and private loans. If you borrow too much, you might even be eligible for refund checks from financial aid.

Photo credit: iStock/millann

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student Loans are not a substitute for federal loans, grants, and work-study programs. You should exhaust all your federal student aid options before you consider any private loans, including ours. Read our FAQs. SoFi Private Student Loans are subject to program terms and restrictions, and applicants must meet SoFi’s eligibility and underwriting requirements. See SoFi.com/eligibility-criteria for more information. To view payment examples, click here. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change.

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.

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The typical options investor is trying to leverage options trading to speculate on directional moves in the prices of underlying assets. However, there are more sophisticated traders who would like to profit from other characteristics of options.

To pursue these trading strategies, investors need to minimize the effect of price changes and create portfolios that profit from and are more sensitive to these other factors. Delta neutral approaches allow investors to create these portfolios.

What Is Delta?

Delta is one of the Option Greeks and measures how much an option will change in price, given a $1 change in the price of the underlying asset. By definition, the delta of the underlying asset is always 1.

What Does Delta Neutral Mean?

Delta neutral means that a position’s value will not change when there are small market price changes. By holding a combination of assets and options, or combinations of various call and put options, a trader can create a portfolio with an overall delta of zero (in actual practice, very close to zero).

Traders use delta neutral strategies to minimize the effect of price changes while aiming to profit from shifts in implied volatility, the time decay of options, or simply to hedge against price movements.

How Does Delta Neutral Function?

A portfolio’s overall delta is determined by the sum of the deltas of its individual positions. Let’s take a closer look at the delta in options and securities.

Basic Mechanics

A trader holding shares (“going long”) benefits one-for-one from increases in the stock price. The delta for long shares is 1.

Investors short a stock will experience losses one-for-one as the share price rises, but they will benefit in the same amount when it falls. The delta for short shares is -1.

In the options trading world, a long call option has a delta of 0 to 1, while a long put option has a delta of –1 to 0.

Deep in the money long call options are most likely to feature a delta near 1. Deep out of the money long call options will have a delta near 0. At the money long call options typically have a delta near 0.5.

Deep in the money long put options typically have deltas near -1. Deep out of the money long puts have deltas near 0 and at the money long puts have deltas near -0.5.

Deltas values are for each individual security held and need to be adjusted based on your actual holdings. If you own 200 shares of stock, the delta for this position is 200. If you own an at the money call options contract, the delta for this position would be 100 x 0.5 or 50 due to options representing 100 shares of the underlying asset.

If you are writing (“going short”) options, the deltas values are reversed. If you write a call option with a delta of 0.75, then the delta for the position would be -75. Similarly, the delta for shares sold short is -1 per share.

The investor must also be aware that any delta neutral portfolio will only be neutral over a range of asset prices. An option’s delta is always in flux as it moves in and out of the money. A portfolio must be constantly adjusted to maintain delta neutrality – many delta neutral trades must be executed.

An Example of Delta-Neutral in Use

A trader might employ a delta neutral trading strategy when they are long shares of stock but are concerned about a near-term pullback in its price. Assume the trader owns 100 shares of XYZ stock at $100 per share. A long stock position has a delta of 1. Multiplied by 100 shares, the position has a total delta of 100.

The goal of a delta neutral strategy is to use a combination of calls and puts to bring the portfolio’s net delta to 0. One possibility is to purchase at the money put options that have a delta of -0.5. Two of these put option contracts have a total delta of -100 (-0.5 multiplied by 200 options). Recall that an options contract represents 100 shares of stock.

Here, the $100 strike is the delta neutral strike. As the underlying price moves away from $100, the delta of the portfolio will move.

Combining the deltas of 100 shares together with 2 long put option contracts with a -0.5 delta yields a delta neutral portfolio.

Stock position delta = 100 shares x delta of 1 = 100

Long put position delta = 2 contracts x 100 shares/option x delta of -0.5 = -100

Portfolio delta = stock position delta + long put position delta

Portfolio delta = 100 + -100 = 0 or delta neutral

The net position is protected from losses by being long put options while still having exposure to upside from the long stock position. Of course, there is a cost to purchasing put options.

A diagram might help illustrate what is delta neutral.

Profit & Loss Diagram Using the Above Example (Not Including the Put Option Cost)

Profiting From Delta-Neutral Trading

It is possible to profit from changes other than price movements in the underlying stock. For example, an options trader can use delta neutral strategies to benefit from declining or rising volatility. Vega is the Options Greek that tells a trader how much the price of an option will move in response to changes in volatility.

Delta neutral strategies can also be used to profit from time decay or – as in the earlier example – to hedge an existing long stock position. Writing options allows you to benefit from the effect of time decay, but there is a risk of assignment. If the underlying stock price moves significantly, the contracts could be assigned to you.

Shorting Vega

Shorting vega is a more advanced options trading strategy. A delta neutral approach can be used to benefit from collapsing volatility.

You might look to short volatility after a period of extreme movements in the market or a single stock. The key is to short vega when implied volatility is still high and you expect it to come back down.

When implied volatility is high, you pay a significant premium to be long options. You can take advantage of expensive options when implied volatility is high by selling options while still being delta neutral. The risk is that implied volatility levels continue to jump, which can lead to losses on a short vega play.

Waiting for Collapse in Volatility

A short vega position relies on the implied volatility on the underlying security to drop in order to turn a profit. It might take patience for implied volatility to drop to historical norms. To remain delta neutral, other positions might have to be put on to mitigate the risk of a change in the underlying stock price.

Pros and Cons of Delta Neutral Positions

Some of the pros of crafting a delta neutral portfolio have been highlighted, but there are downsides as well. Having to closely monitor your portfolio can be a burden, while trading costs mount as you constantly layer on or reduce hedges to keep near delta neutral.

Delta Neutral Straddle

A delta neutral straddle uses a combination of puts and calls to keep the position’s delta near zero while having exposure to volatility changes.

For example, if XYZ stock trades at $100, and it’s at the money call has a delta of 0.5 and it’s at the money put has a delta of -0.5, you can buy the put and call with the goal of selling them after implied volatility jumps. With this delta neutral long straddle strategy, your delta is effectively 0 but you are long volatility.

A delta neutral short straddle is an options trade that seeks to profit from minimal changes in the underlying stock price and a large drop in implied volatility. So, the reverse of a long straddle can be used when you believe implied volatility will drop.

Other options trading strategies used to profit from changes in volatility and time decay are calendar spreads, diagonal spreads, iron butterflies, iron condors, among others.

The Takeaway

Building and maintaining a delta neutral portfolio can be a challenging task, but profiting from time decay and changes in volatility can make it worthwhile and profitable.

Delta neutral trading can also hedge your portfolio from short-term declines while continuing to hold stock for the long-term.

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

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors.

FAQ

How do you make money with a delta neutral strategy?

You profit from a delta neutral option strategy when there are changes in a stock’s variables other than its share price. Changes in implied volatility create opportunities to go long or short volatility while being agnostic to the stock price’s change. You can also benefit from time decay by selling options while being delta neutral.

What is a delta neutral strike?

A delta neutral strike marks the price at which a portfolio is precisely delta neutral. In practice, it is more of a theoretical price rather than an exact level. When the underlying asset price moves up or down from the delta neutral strike, its delta will stray from zero; it will take additional hedging trades to get back to delta neutral.

How can you calculate the value of your delta neutral position?

To calculate your position’s delta, simply multiply each security’s delta by your position size. For example, one call option contract with a delta of 0.75 has a delta of 75 (0.75 x 100 options per contract). While being long 100 shares of stock with a delta of 1 has a delta of 100 (1 x 100 shares).

You combine the deltas of all positions in your portfolio to determine your overall delta. At that point, you can trade options to make your portfolio delta neutral.

Photo credit: iStock/Delmaine Donson

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