Feb
22
2022
Bollinger Bands Explained

Bollinger Bands Explained

By | Growing Wealth, invest, Investing | Comments Off on Bollinger Bands Explained

What Are Bollinger Bands?

Bollinger Bands® are popular tools used in technical analysis of securities. They are a set of three bands that measure the relative high or low of a security’s price in relation to previous trades.

These defined trend lines are the simple moving average (SMA) of the price of the security plus plotted lines two standard deviations away from the SMA. The bands are plotted positively and negatively from the SMA, which measures the volatility of a security, and the trader can adjust them based on their particular use case. When the security becomes more volatile the bands widen, when it becomes less volatile they get closer together.

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

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

How Do Bollinger Bands Work?

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

Period is found by calculating the simple moving average of the security a trader is interested in. The calculation generally uses a 20-day SMA, an average of a security’s closing prices over a 20 day period — or roughly a month of trading days. The first data point on the graph would be the average of the first 20 days being tracked. The second data point would be the next 20 days, and so on.

That line shows the SMA over time, and the Bollinger Bands are then placed above and below it by calculating the standard deviation of the security’s price along each data point. The standard deviation is a calculation of the average variance of the SMA value, which shows how far apart values are from the SMA.

The standard deviation is calculated by first finding the square root of the variance, which is the average of the squared differences of the mean. After finding the square root of the variance, that number is generally multiplied by two, although the number can be adjusted. The resulting value is then added and subtracted from each SMA data point to form the upper and lower Bollinger Bands.

Key Things to Know About Bollinger Bands

A few key things to understand about Bollinger Bands:

•   When volatility is low, the bands get closer together. This indicates that volatility may increase in the future and therefore there could be a significant price movement up or down.

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

•   Generally the security’s price movements stay within the two bands. And once they touch one band they start moving towards the other band. But the price can also bounce off the band multiple times or it can cross over the band. If the price hits one of the bands and then crosses over the SMA line, that is an indicator that it is heading toward the opposite band’s price level.

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

Formula for Bollinger Bands

Below is the formula to plot Bollinger Bands:

BOLU=MA(TP,n)+m∗σ[TP,n]

BOLD=MA(TP,n)−m∗σ[TP,n]

where:

BOLU=Upper Bollinger Band

BOLD=Lower Bollinger Band

MA=Moving average

TP (typical price)=(High+Low+Close)÷3

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

m=Number of standard deviations (typically 2)

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

How Do You Read Bollinger Bands?

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

Trends can last for minutes, hours, days, weeks, months, and even years, so traders should understand how to set up the bands based on the timeline of their trading strategy. Here are some patterns and indicators traders might want to learn.

Uptrends

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

Downtrends

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

The Squeeze

When the bands are close together, this is known as a squeeze. The squeeze happens when the security has low volatility, but it indicates that the security will probably have increased volatility in the future. Traders look for high volatility periods to find trading opportunities, so the squeeze indicates that those opportunities may be showing up soon.

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

Breakouts

The SMA line doesn’t always stay between the Bollinger Bands — it can also move above or below the bands. Around 90% of price changes do happen between the bands, so if the price has a breakout above or below the bands it’s a significant event. However, breakouts are not used as trading signals and are not indicators that the security price will move in a particular direction in the future.

Bollinger Band Trading Strategies

Financial analyst Arthur Merrill, who identified a set of 16 trend patterns that have M patterns and W patterns. Here are two key patterns.

M Top

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

W Bottoms

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

Combining Bollinger Bands With Other Indicators

John Bollinger recommended that traders use Bollinger Bands in conjunction with other non-correlated indicators, such as the relative strength indicator (RSI) and the Stochastic Oscillator, in order to gain a comprehensive understanding of the security being assessed. While Bollinger Bands help traders understand price volatility and can show opportunities for upcoming trades, they aren’t strong indicators of potential upcoming price movements.

Drawbacks of Bollinger Bands

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

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

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

•   The standard settings of 20-day SMA and 2 standard deviations is an arbitrary measurement that doesn’t convey relevant information for every security and trading situation, so it’s important that traders understand how to adjust the band calculations for their particular situation.

Using Bollinger Bands for Crypto Trading

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

The Takeaway

Bollinger Bands are a useful tool for technical analysis of stocks, which measure the relative high or low of a security’s price in relation to previous trades over typically the past 20 trading days. One of many trend indicators, Bollinger Bands are also sometimes used in crypto trading.

If you’re looking to get started trading options, SoFi offers an intuitive and approachable options trading platform. Investors are able to make trades from the mobile app or web platform, and they can access a library of educational resources about options.

Trade options with low fees through SoFi.

Photo credit: iStock/blackCAT

SoFi Invest®

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

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

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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.

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Feb
22
2022
What Is Buy to Cover & How Does It Work?

What Is Buy to Cover & How Does It Work?

By | Growing Wealth, invest, Investing | Comments Off on What Is Buy to Cover & How Does It Work?

Buy to cover refers to when investors purchase shares in a stock that they had previously shorted. This is a form of margin trading that involves higher risk than more traditional buying and selling.

In this article, we’ll take a look at the buy to cover order, how it fits into short selling and margin trading, and when you might want to use a buy to cover order.

Buy to Cover Meaning

Traditionally, you buy a stock on which you have a bullish outlook, and sell to close out your position. In an ideal situation, you buy low and sell high, securing the difference between the purchase price and the sale price as your profit. If you think a stock is currently overpriced, you might sell the stock before you have actually purchased it, via a short sale. This requires temporarily borrowing the shares, usually from your broker or dealer. Then, once the stock (hopefully) goes down, you purchase the shares, closing out your position.

Buying to cover is that after-the-fact purchase of shares that you previously shorted. When you do a short sale by selling first, you will eventually need to repay your short sale by purchasing shares.

What Is a Buy to Cover Limit?

When placing a buy-to-cover order, there are two ways that you can close your position. The first is a market order, in which you simply close the position at the first available market price. The other method involves using a buy-to-cover limit order, in which you set a maximum price at which you’re willing to purchase the share.

One advantage of the latter approach is that you know exactly the price that you’ll get for your shares. This can help you when planning your overall strategy. A drawback, however, is that if the market moves against you, your order may not get filled.

How Does Buy to Cover Work?

A buy-to-cover order works much in the same way as a traditional buy order. The main difference is the order in which you make your buy and sell transactions. In a traditional buy order, you purchase shares that you intend to later sell. With a buy-to-cover order, you’re buying shares to cover a sale that you previously made.

Example of a Buy to Cover Stock

Here’s a buy to cover stock example to help illustrate how the process works:

•   Let’s say that you think stock ABC is overpriced at $50.

•   You sell short 100 shares of ABC, borrowing $5,000 on margin from your broker.

•   After a few days, stock ABC’s price has dropped to $45.

•   You issue a buy to cover order for 100 shares of ABC, paying $4,500.

•   Your profit is $500 — the difference between the amount you receive from the short sale and the amount you pay to close the position.

Sell Short vs Buy to Cover

“Selling short” and “buying to cover” are two sides of the same transaction. If you think that a particular stock or investment is likely to go down in price, you can use a short sale to first sell shares that you’ve borrowed on margin, generally from your broker or dealer.

When you’re ready to close out your short sale transaction, you can place a buy-to-cover order. This will purchase the shares that you sold originally, either at the market price or with a buy-to-cover limit order at a particular price. If the stock has gone down in price as you expected, you will profit from selling high and then buying low.

Buy to Cover and Margin Trades

Using a buy to cover order is intricately tied in with both short selling and margin trading. When you sell short, you are using margin trading to borrow shares to sell that you don’t yet own.

When you are ready to close out your position, you issue a buy-to-cover order, purchasing the shares you need to correspond to the shares that you earlier sold on margin. Keep in mind that if the stock moves against you after your short sale (the stock’s price goes up instead of down), you face a margin call, in which your broker forces you to either liquidate your position or add extra money to cover your position.

The Takeaway

A buy to cover is a purchase order executed to close out a short sale position. In a traditional sale, you purchase a stock first and then later sell the shares. When you sell short, you place a buy-to-cover order to close your position.

Trading options can be tricky, so it’s important to study up as you invest, which is where an options trading platform like SoFi’s comes in handy. It provides access to a library of educational resources about options. Plus, the platform’s intuitive and approachable design gives investors the ability to trade options from the mobile or web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/Ridofranz

SoFi Invest®

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

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

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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Feb
22
2022
What Is a Bear Call Spread? How It Works

What Is a Bear Call Spread? How It Works

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is a Bear Call Spread? How It Works

Like other aggressively-named options trading strategies, the bear call spread has more to do with numbers and market timing than it does with fur and fangs (or horns). But it’s yet another options trading strategy that can help you beef up your returns.

If you’re an options trader — or an aspiring one — you likely know many of the common strategies for trading options, including calls, puts, and bull put spreads.

But options strategies can get very complicated, very fast — and the bear call spread is no different. Here’s what to know about the bear call spread and how it works.

What is a Bear Call Spread?

A bear call spread is one of four basic vertical options spreads that traders put to regular use. It is the opposite of a bull call spread, and it’s particularly useful if you’re anticipating a bear market.

A trader utilizing a bear call spread strategy is trying to capitalize on a decrease in value of the option’s underlying asset. Hence, the “bear” in the strategy’s name. And as such, a trader would use a bear call spread only in the instance that they believed the underlying asset’s value was going to fall.

How Does a Bear Call Spread Work?

A trader creates a spread by buying and selling two call options at the same time, attached to the same underlying asset, with the same expiration date. The key difference is that the two call options have different strike prices. One call option one is a long call option strategy, and the other is short (similar to shorting a stock), with the short call having a lower strike price than the long call.

When the trader simultaneously purchases a long call and sells a short call (with a lower strike price), it creates a credit in the trader’s account, since the calls the trader is buying are less expensive than the calls the trader is selling. The short call generates income for the trader by creating a premium, and the long call helps limit the trader’s risk.

Setting up these two positions creates a spread, and the trader benefits when the underlying asset’s value declines. The maximum potential profit is capped at the value of the premium received.

If the underlying asset’s value increases, the spread can become a loser for the trader — but that maximum potential loss is capped at the difference between the strike prices of the two options, minus the premium.

Example of a Bear Call Spread Strategy

As an example, in its simplest form a bear call spread could involve a trader selling a short call option on stock XYZ, which expires in one month, with a strike price of $10, for a premium of $2. Simultaneously, they buy a call option with the same expiration and a strike price of $12 for a premium of $1. By selling the short calls, they’ve received a net premium of $1. Since an option contract typically controls 100 shares, their total credit is $100.

With that, a bear call spread has been set up. The trader has two calls with the same expiration date, but two different strike prices. The short call’s strike price is less than the long call’s strike price.

To continue this example, let’s say a month goes by, and the trader’s bearish instincts have proven correct. Stock XYZ’s price declines and their call options expire below the $10 strike price of the short call. They keep the net premium of $100, and walk away with a profit.

We should also consider the downside scenario where the stock price does not move in the trader’s favor. Suppose instead that XYZ climbs to $13 on expiration day. The trader closes out both contracts for a net loss of $2 per share, or $200 for each set of contracts. This is offset by the $100 they received upfront, so their net loss is just $100.

Finally, let’s analyze the breakeven point. This will occur at the strike price of the short call, plus the net premium received. In our example, the $10 lower strike, plus $1 of net premium, or $11.

Advantages & Disadvantages of a Bear Call Spread

Advantages

 Disadvantages
Flexibility Capped potential gains
Capped potential losses Limited potential use
Relative simplicity The strategy could backfire completely

Advantages of a Bear Call Spread

There are some advantages to bear call spreads, which is why some traders use them to pad their returns.

•   Flexibility: There is a lot of wiggle room for traders in how they set up the strategy. Depending on the specific calls sold and purchased, traders can see a profit under a variety of scenarios, such as when the underlying asset’s value remains the same, or when it declines.

•   Capped potential losses: There’s a maximum that a trader can lose, and that can be comforting to some. These types of strategies are used not only to increase profits, but to limit risk, and limiting risk can be a very attractive attribute in a volatile market.

•   Relative simplicity: When you think about it, traders are really just making two transactions: Buying a call option, and selling another. Given that other options trading strategies involve even more moving parts, the fact that a bear call spread only requires two moves at the onset can be advantageous to some traders.

Disadvantages of a Bear Call Spread

Bear call spreads can have their disadvantages.

•   Capped potential gains. Like other vertical spread strategies, potential gains are capped — in this case, at the initial net premium credited to the account.

•   Limited potential use. The strategy is best used when dealing with assets that are volatile and that may experience a decline in value. It’s hard to say when, or if, the right market conditions and an appropriate asset align in such a way that a trader would use the strategy to profit.

•   The strategy could backfire completely. The risk is that the underlying asset sees a dramatic rise in value, rather than a fall in value, as the trader predicted, blowing up their short call. This could mean that the trader has to buy the underlying asset at market value, potentially leading to a loss.

Bear Call Spread Considerations and Tips

There are a few other things worth keeping in mind when it comes to the bear call spread strategy.

•   There’s an early assignment risk. Since options can be exercised at any time, traders with short option positions should remember that they’re putting themselves at risk of early assignment — or, the trader needs to fulfill their obligation and may need to buy the underlying asset to do so.

•   The strategy can be used in variations. A bear call spread is only one of several vertical options spreads that traders can put to use. Depending on market conditions, it may be wise to use a bullish strategy instead.

•   This is all speculative! It’s critical to remember that options trading is speculative. There are no guarantees, and the risk of loss is real. No matter how good any trader thinks they are at predicting the market, things can go sideways at any point. It’s important for investors to calculate the risk-reward ratio before choosing their speculative tools.

The Takeaway

The bear call spread is one of many options trading strategies a trader may employ in trying to reap as much profit from their investments as possible. But as with all strategies, it is not foolproof, and positive results are never guaranteed.

When getting started with trading options, it can help to have educational resources about options on hand and a user-friendly platform, both of which SoFi offers. With SoFi, investors can trade options from the mobile app or the web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/PeopleImages

SoFi Invest®

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

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

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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Feb
22
2022
How Are Leverage and Margin Similar and Different?

How Are Leverage and Margin Similar and Different?

By | Growing Wealth, invest, Investing | Comments Off on How Are Leverage and Margin Similar and Different?

Margin and leverage are often thought to be the same thing. However, while both can be used to amplify an investor’s buying power when trading stocks, they have some key differences.

Margin trading, or “buying stocks on margin” refers to the practice of borrowing money from your brokerage and using that to purchase stocks. You are taking out a loan to purchase more of whatever stock you are trading than you would be able to with a cash account. After buying an asset on margin, you’re likely to see amplified gains or losses because of the out of pocket investment compared to a cash account, or conversely, the margin call. You will also pay interest on the amount borrowed from the broker.

Leverage is the result of using margin, but it also has a much broader meaning and usage within the world of finance. In general, it refers to the concept of using borrowed money as a source of funds for an investment. When it comes to trading, it is important to understand what your leverage ratio is so that you know the amount of risk you are taking.

We’ll explain all the details of margin vs. leverage in this article.

Leverage vs Margin

A trader uses margin to trade with leverage. A margin account allows you to have increased buying power. Leverage lets you trade bigger positions than the amount of cash in your account. Leverage and margin have an inverse relationship — the higher the margin requirement, the lower your leverage ratio will be.

You can trade stocks and ETFs on margin to make use of leverage. However, you don’t necessarily need to use margin in order to increase your leverage; there are also leveraged ETFs that effectively accomplish the same goal, that can be purchased in a cash brokerage account.

In futures trading and forex trading, brokers often allow large leverage ratios. Since the leverage ratios in these markets are greater, the risk is amplified. New traders should learn the basics of trading on margin and might consider trading a stocks and options account before venturing into the high-risk world of futures and forex trading.

Recommended: Margin Trading vs Futures: Compared and Explained

A Closer Look at Margin

Margin trading is a method by which your portfolio holdings are used as collateral to acquire a loan from a broker. Margin is the difference between an investor’s account value and the loan they request from a broker to execute a trade. An investor can use proceeds from the loan to invest in more securities like stocks, bonds, and exchange-traded funds (ETFs).

Margin trading can also allow you to diversify your portfolio with other assets without having to use more equity.

How Margin Trading Works

Margin trading works by using loan proceeds to invest in more assets. The goal is to enhance returns, but there also can be drawbacks.

Pros vs Cons of Margin Trading

Pros

 Cons
Increases buying power Must meet and maintain margin requirements
Greater return potential Higher risk than trading a cash account
Ability to diversify into other assets You must pay interest on borrowed funds

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.

A Closer Look at Leverage

Leverage in finance is a word used to describe borrowing money to increase returns. Investors might borrow capital from a broker or bank in order to make trades that are larger than your account’s equity, increasing your trading power. Companies might use leverage to invest in parts of their business that they hope will ultimately raise the value of the company.

How Leverage Works

Leverage in a stock account is the result of borrowing money to trade securities, using an account’s margin feature. Leverage can work to the benefit or detriment of an investor depending on the movements of an account’s holdings.

Companies often use leverage to amplify returns on their investment projects, and the same logic applies to trading equities. You may see huge returns on the upside — or see your account value drop rapidly if the market moves against you. Trading with leverage is riskier than strictly using your own cash.

Futures and forex trading often use high leverage ratios versus a stock trading account. For example, let’s say you purchased $100,000 of assets based on the value of a stock index, and posted a margin deposit of $2,000. Your leverage ratio is 50:1. If the underlying index rises 1%, your assets would increase to $101,000. Your equity would go up by 50% to $3,000.

If the trade works against you, though, your account balance would dwindle quickly. If the index falls to $99,000, your equity would be just $1,000. You might face a margin call requiring you to deposit more cash or securities.

Pros and Cons of Leverage Trading

Pros

 Cons
Potential for enhanced returns with a minimal deposit Losses can happen fast, leading to margin calls
Greater access to high-priced stocks Borrowing fees and margin interest can be costly
Access to many markets with limited capital Managing multiple leveraged positions can be cumbersome

The Takeaway

Margin trading and leverage can be used to enhance returns, but there are risks you should consider. It is important to weigh the pros and cons of both strategies to determine what trading method works best for you. Knowing the differences between margin vs. leverage is important before trading.

A margin account with stocks allows you to borrow against cash and securities when trading stocks online. Leverage measures the increase in trading power because of using margin.

It’s important to understand your personal risk tolerance before trading on margin and using leverage. Risk-averse investors might prefer a cash account; for those more comfortable with risk, trading with borrowed funds might be appealing.

If you’re ready to try your hand at options trading, a user-friendly options trading platform like SoFi’s can feel easier to navigate. Investors can trade from either the mobile app or web platform, and they can reference a library of educational content about options.

Pay low fees when you start options trading with SoFi.

FAQ

Is leverage the same as margin?

Leverage is different from margin. You use a margin account to increase your leverage ratio when trading stocks. Futures and forex trading requires a trader to post margin to use leverage.

Can you trade without leverage?

Yes. You can trade securities with cash in your account. This method also avoids paying interest on margin balances. The downside is you will not be able to amplify returns as you would when trading on margin or with leverage.

You can also trade leveraged ETFs without a margin trading account.

What is margin in stock trading?

Margin in stock trading happens when an investor takes out a loan on an investment with the goal of seeing that asset’s price rise. When the investment is sold, the borrowed funds are returned to the lender, but you as the investor keep the profits. The downside is if the security’s price drops, you will see enhanced losses. In either event, you owe the lender interest on borrowed funds.

Photo credit: iStock/DuxX

SoFi Invest®

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

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

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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Feb
22
2022
Guide to Jade Lizards

Guide to Jade Lizards

By | Growing Wealth, invest, Investing | Comments Off on Guide to Jade Lizards

A Jade Lizard is an advanced options strategy that requires taking three different positions. It is a slightly bullish strategy typically used by traders who want to profit from high levels of market volatility.

Traders who use the Jade Lizard strategy must monitor their position and have a plan for exit to avoid the potential for significant losses. The maximum profit for a Jade Lizard strategy is the initial premium received when opening the trade.

What Is a Jade Lizard Option Strategy?

With a Jade Lizard trade, you will enter into three different options positions on the same underlying stock through your brokerage account. The first two positions require selling a call spread, which involves selling a call option at one strike price and buying a call option with the same expiration at a higher strike price. The third and final option position is a put at an even lower strike price.

With a Jade Lizard, these options are usually at out-of-the-money strike prices. The strikes should be selected such that the total premium received from selling the call spread and selling the put option are greater than the width of the call spread. Don’t worry — if it’s not clear what that means, we’ll illustrate in the example that follows.

How Does a Jade Lizard Work?

A Jade Lizard option trade is a neutral to bullish options strategy, which means that you should anticipate the price of your underlying stock to stay the same or go up. With a Jade Lizard options strategy, you are hoping to capture the premium that comes with higher levels of implied volatility, so the ideal environment to execute the trade is one where volatility is elevated.

Setting Up a Jade Lizard

When you set up a Jade Lizard, you should initially be collecting premium from both the call spread and put that you are selling. The key concept of setting up a Jade Lizard is that you want the total amount of premium that you collect initially to be more than the width of your call spread.

As an example, say that stock ABC is trading around $60. You could sell a 58/62/63 Jade Lizard, at these hypothetical prices, on options expiring in 30 days:

•   Sell ABC 62 Call for 1.25

•   Buy ABC 63 Call for 0.90

•   Sell ABC 58 Put for 0.75

Your net credit is $1.10 ($1.25 minus $0.90 plus $0.75), so you collect $110 for each contract that you implement (since one contract typically controls 100 shares of the underlying stock). In our example, you have no risk should the stock move to the upside. To illustrate how, suppose the stock trades above 63 on expiration day. The put option expires worthless, and your maximum loss on the call spread is $100, which is less than the $110 you collected up front. On the other hand, you do have nearly unlimited downside risk if the underlying stock goes to 0. This is the main reason that the Jade Lizard options strategy only makes sense for stocks where you have a neutral to bullish outlook.

Maximum Profit

You will achieve your maximum profit if the options expire with the underlying stock having a price in between the strike price of your put option and the strike price of your lower call option. In our example above, if the stock closes between $58 and $62, then all three options expire worthless and your profit is the $1.10 in initial premium that you collected.

Maximum Loss

In a Jade Lizard strategy, you have nearly unlimited downside exposure, since you are selling a put option. A put option increases in value as the price of the underlying stock goes down. Since you are short the put option, as the stock price goes down you could be on the hook for the difference between the strike price of the put and the price of the underlying stock.

Breakeven Point

The breakeven point for a Jade Lizard on the downside is the difference between the strike price of the put option and the initial premium collected. In our earlier example, we collected $1.10 in net premium, so our breakeven point is $56.90 (the difference between $58.00 and $1.10).

There is also a potential breakeven point to the upside. Ideally with a Jade Lizard, you collect more in initial premium than the width of your call spread. In our example, we collected $1.10 in initial premium and our call spread is only $1 wide (between $62 and $63).

So if the stock closes anywhere above $63 when the options expire, your put will be worthless and your call spread will cost you $1 to close out, or $100 per set of contracts. That will leave you with a profit of $10 per set of contracts.

Exit Strategy

The exit strategy for a Jade Lizard involves purchasing back the options you sold using a buy to close order. When setting up the trade, it’s a good idea to set target profit at which you would buy back the options.

In our example, where we received $1.10 per share, you might look to close out the Jade Lizard when you could buy your options back for around $0.55 per share, 50% of the initial premium you received. The options may decline in value due to movement of the underlying stock, or time decay as the options get closer to their expiration.

Maintaining a Jade Lizard

A Jade Lizard is not a set-it-and-forget-it options strategy. Because of the unlimited downside risk, you’ll want to monitor your position, especially if the price of the underlying stock starts to go down. In that scenario, you may want to close out your position or roll down the strike prices of your short call spread.

Pros and Cons of the Jade Lizard Strategy

Here are some pros and cons of the Jade Lizard strategy:

Pros of the Jade Lizard strategy

 Cons of the Jade Lizard strategy
No risk of losses from upward price movement in the underlying Significant risk of downward price movement in the underlying
Immediate collection of the net premium Profits capped to the amount of premium initially received

Alternatives to Jade Lizards

One alternative to the Jade Lizard strategy is a strategy called the Big Lizard. With a Jade Lizard, you typically sell out-of-the-money options. With a Big Lizard strategy, the options that you sell are at-the-money, meaning that their strike price is close to the price of the underlying stock.

Investing With SoFi

The Jade Lizard strategy is an advanced strategy that options traders use when they have a bullish to neutral outlook on a stock. The strategy’s maximum upside is equal to the premium received when opening the trade, while the downside risk is essentially uncapped.

Learning about different options strategies can be a great way to further understand the stock market and how to invest. From there, you might consider an options trading platform like the one offered by SoFi. This platform has an intuitive and approachable design and allows investors to trade options from the mobile app or web platform. And if you aren’t done learning, there are educational resources about options available to explore.

Trade options with low fees through SoFi.

FAQ

How are Jade Lizards managed?

When opening a Jade Lizard options strategy, you want to make sure to keep an eye on the underlying stock until the options’ expiration date. Since a Jade Lizard comes with no upside risk, you should especially monitor negative moves in the stock price. In that case, you could close out your position or roll your call spread to a lower stock price, earning more premium.

How do reverse Jade Lizards differ from Jade Lizards?

In a reverse Jade Lizard, also known as a twisted sister option, you sell a put spread, being long the put option with the lower stock price. Additionally you sell a call with a higher strike price.

As the name suggests, a reverse Jade Lizard is the opposite of a regular Jade Lizard, and makes sense when you have a neutral to bearish outlook on a stock. You have risk of losses due to downard price movement and unlimited loss potential from upward price movement, due to the short call.

What is the maximum payoff of a Jade Lizard?

The maximum payoff or profit of a Jade Lizard is capped to the total initial premium that you receive when you open the position. This is equal to the amount you get for selling the put and short leg of the spread minus the amount of premium for the long leg of the call spread.

Photo credit: iStock/ipopba

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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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