Mar
23
2023
Conservative Investing Explained
Conservative investing describes a strategy that avoids risky investments. Blue chip stocks and other established investments are considered conservative.
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Student Loan Consolidation and Refinancing
Mar
22
2023
Explaining the Different Types of Asset Classes
If you’re new to investing, you might ask, “What is an asset class?” Here’s an explainer—plus learn how this can help you diversify your portfolio.
Read moreMar
22
2023
What Is a Money Market Account and How Does it Work?
Money market accounts can offer higher interest rates than a traditional checking account but may come with high minimum balances and fees.
Read moreMar
21
2023
What Is a Swaption? Guide to Understanding Swap Options
A swaption, also known as a swap option, is an option contract that grants the owner the right but not the obligation to enter into a swap contract with specified terms. The swap contracts tend to be interest rate swaps, but can be other types of swaps as well.
With swaptions, one party can exchange a currency of the same value, an interest rate, or the liability of repaying a loan. Read on for how they work, the different types, pros and cons, and more.
How Swaptions Work
As mentioned above, a swaption is an option on a swap rate. Like other types of options contracts, the buyer pays a premium to enter into the swaption, and beyond that they are not obligated to act on the contract.
Although Swaptions are a type of option, they are more similar to a swap than to an option. Similarities to swaps include:
• They are traded over-the-counter instead of on centralized exchanges.
• They are customizable and offer a lot of flexibility since they are not standardized exchange products.
When two parties want to enter into a swap option agreement, they decide on the terms of the contract, such as the the premium, the expiration date, the notional amount, the swap’s legs (fixed vs. float), the benchmark for the floating leg, and the frequency of adjustment for the variable leg.
Recommended: Options Trading 101 Guide
Who Often Uses Swaptions
Swaptions are typically used by institutional investors instead of retail investors, although some private banks offer them to their clients. Large corporations, investment banks, commercial banks, and hedge funds use them for various purposes. It takes a lot of work and experience to create a portfolio of swaptions, so they generally aren’t used by individuals or small firms.
They are often used to hedge against macroeconomic risks such as interest rate risk or securities risks. If an institution thinks interest rates might change, they can enter into an agreement to protect against that. Financial institutions can also use them to change their interest payoff terms.
They tend to be used to hedge specific financings, but they can also be used to hedge a broader change in future interest rates. This can be useful if an institution holds a lot of debt maturities for the year and doesn’t want to risk losses.
The way swaptions are generally set up, their strikes are a strike above the current 10 year swap rate. Therefore the borrower takes on risk between the current rate and the higher rate, but not more than that.
Swaptions can be purchased in most major currencies, such as the U.S. Dollar, Euro, and British Pound.
Recommended: Popular Options Trading Terminology to Know
What Are the Different Types of Swaptions?
There are different types of swap options that each have different types of ‘legs’ in the predetermined swap contract they represent. The two types of options are payer and receiver.
Payer Swaption
If a buyer enters into a payer swaption, they are purchasing the right but not the obligation to enter into a future swap contract. When exercised, the buyer would become the fixed-rate (non-changing) payer and receive the floating rate (variable) payments.
Fixed interest rates don’t change with the market, they stay the same through the duration of a loan. Floating rates change based on a reference rate, the most common one being LIBOR. LIBOR is an average of interest rates that are collected from some of the top banks in London.
Receiver Swaption
In a receiver swaption contract, the swap holder has the option to pay the floating rate and receive the fixed rate.
When Can a Swaption Be Exercised?
There are also swaptions that have different terms of execution. The three most common are:
American
American swaptions can be exercised on any date prior to and including the expiration date.
European
European options can only be exercised on the expiration date, making them less flexible.
Bermudan
Bermudan swaptions have several specific dates when they can be exercised prior to the expiration date.
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.
Swaption Example
A borrower wants to purchase rate protection on their current floating rate debt maturities totalling $50 million. They decide that they would like to purchase the right, but not the obligation, to pay a fixed rate on their debts for ten years.
For this right, they are willing to take on the risk of 10 year interest rates up to 3.8%, but no higher than that.
The borrower enters into an agreement with a settlement date in the current year, for a notional amount of $50 million, with a 10 year term and a strike of 3.8%. The premium they must pay to enter in this contract is $400,000.
Including the premium, the rate is actually hedged higher than 3.8%, but for the sake of this example we will call the strike 3.8%.
If the strike is lower or the settlement date is farther in the future, this increases the value of the swaption and therefore increases the cost of the premium.
The borrower enters into this agreement to hedge against a large increase in swap rates but without choosing a specific rate they want when the contract expires.
It’s important to note that the swaption isn’t tied to the 10 year Treasury, it’s tied to 10 year swap rates, although their movements tend to be related. Also, swaptions are derivatives, so they aren’t the underlying assets themselves, but contracts derived from rates or assets.
When the settlement date occurs, there are two ways the swaption could turn out.
- If 10 year swap rates are below 3.8%, the option contract expires, the lender keeps the premium and the borrower uses the current swap rate.
- If 10 year swap rates are higher than 3.8%, the borrower exercises the option. In this case the provider of the swaption pays the borrower the difference between the swap rate and 3.8%. The borrower locks in the current swap rate for a swap agreement, and uses the payment they received to buy down the rate on this new swap.
Pros and Cons of Swaptions
There are a few reasons why financial institutions use swaptions, but there can be downsides to them as well. Some of the pros and cons of swap options are:
| Pros | Cons |
|---|---|
| Can be used to hedge against risk when there is a possibility that an interest rate will go up. | Swaptions can have longer durations than other types of options. |
| If the swaption is not exercised, the buyer loses the premium amount they put in. | There is a risk of the other party defaulting on the agreement. |
The Takeaway
Entering into swaption agreements is one type of options trading strategy commonly used by institutional investors. They are usually used to help with restructuring a current financial position, alter a portfolio, hedge options positions on bonds, or adjust payoff profiles.
There are other types of options on the market that retail investors often trade.
If you’re ready to try your hand at options trading, You can set up an online options trading account and trade from the SoFi mobile app or through the web platform.
And if you have any questions, SoFi offers educational resources about options to learn more. SoFi doesn’t charge commissions, and members have access to complimentary financial advice from a professional.
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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Mar
17
2023
Bull Markets, Explained
A bull market occurs when a broad market index rises at least 20% over two months or more. Bull markets signal higher levels of investor confidence and optimism about the future of the market. They are generally a sign of a strong, healthy economy.
The opposite scenario, in which stock prices fall by 20% over an extended period, is known as a bear market.
If you’re investing in the stock market, it’s important to know the nature of bull markets and their potential impact on your returns.
What Is a Bull Market?
When asset prices generally rise over time, the upward trend is known as a bull market. The traditional benchmark for identifying a bull market is an increase of 20% or more in a market index over a two-month period. For example, stock experts might look closely at the Dow Jones Industrial Average (DJIA) or the S&P 500 to determine whether a bull market exists.
Bull markets can imply that the economy is in good shape, with unemployment low and new jobs being created. Investors tend to view a bull market favorably because it suggests that stock prices may continue to rise over the long term. People who buy stocks early in a bull market may benefit later from the investments’ significant price appreciation.
Why Is It Called a Bull Market?
Although there’s no single explanation for how bull and bear markets got their names, people often suggest that the descriptive names are meant to reflect the nature of each animal.
Bulls, for instance, have a reputation for charging or attacking. In a bull market, eager investors may rush in to buy stocks in the hope of capitalizing on future price increases.
Bears, on the other hand, are often seen as being defensive animals that only attack when threatened. In a bear market, it’s common to see investors pull back out of caution and sell off stocks they own or avoid buying new ones. Those behaviors are often driven by fear and uncertainty about the market trending down.
Characteristics of a Bull Market
Identifying when a bull market begins or ends is sometimes challenging, given the nature of stock prices and how rapidly they can move up or down. Generally, there are three indicators that stock experts use to determine whether a bull market exists.
• Stock prices, or prices for a broad market index, have increased by 20% or more over a set period of time, typically two months or longer.
• Investor confidence is high and those buying into the market have an optimistic outlook toward the future.
• Overall economic conditions are largely positive, with low unemployment rates and, ideally, low inflation rates as well.
These three signs usually indicate that the market is on a sustained upswing. Other indications of a bull market can include strong earnings reports and marked increases in investors’ dividends.
What Causes a Bull Market?
Bull markets are usually driven by changing undercurrents in the economy. They tend to reflect the business cycle.
The business cycle experiences periods of expansion, followed by periods of contraction. Real gross domestic product is a commonly used metric for determining which of four phases the economy is in.
• Expansion. During the expansion period, the economy is growing and domestic production is up. There may be a bull market for stocks during this period.
• Peak. A peak occurs when the economy exhausts its ability to grow. At this stage, the bull market typically hits its highest levels before entering the next phase.
• Contraction. During the contraction period, the economy shrinks. Companies may cut back on spending or hiring to save money and stocks may enter bear market territory.
• Trough. The trough is the lowest point in the business cycle. It’s followed by the beginning of the next expansion phase, which can open the door to a new bull market.
The business cycle also influences when bear markets occur. In addition, there are times when a bull or bear market is triggered by something other than the business cycle. For example, in early 2020 there was a short-lived bear market caused by uncertainty over the emerging COVID-19 pandemic.
Example of a Bull Market
The bull market that began in 2009 following the shock of the financial crisis is the longest on record, lasting until the bear market that occurred in early 2020.
Several factors contributed to the sustained length of the bull market, including strategic moves to manage monetary policy on the part of the Federal Reserve, and tax breaks delivered by the 2017 Tax Cuts and Jobs Act.
Many stockholders benefited from steady dividend payouts, and the real estate market also delivered a strong performance during that time.
Bull Market vs Bear Market
Bull markets and bear markets are opposites in terms of how participants behave and what the outcomes can mean for investors. Bull markets typically involve upward movement of stock prices while bear markets indicate a downturn.
In a bull market, investors tend to take a positive view of the market. Bear markets, on the other hand, can trigger pessimism, fear, or other negative feelings among investors.
Bull markets are usually marked by thriving economies and high levels of corporate growth. Bear markets point toward a slowing economy and limited growth. In extreme cases, a bear market could suggest that a recession may be on the horizon (although a recession can offer certain opportunities as well).
Investing Tips During a Bull Market
Investing in a bull market isn’t one-size-fits-all, so your personal approach may be different from other investors’. There are, however, a few overall strategies that could help you to maximize gains while taking on a level of risk you’re comfortable with.
Keep Your Goals In Sight
It’s easy to be tempted to follow the crowd when investing in a bull market or a bear market, but it’s important to stay focused on your individual goals, especially if you’re a beginning investor. If you already have a financial plan in place, that plan can act as a guide for how to choose the right asset allocation during a bull market.
Diversify Your Portfolio
Diversification is an important tool for managing risk in a portfolio. When you’re diversified across different asset classes or industries, it helps to limit your exposure to certain kinds of investment risk. If one investment begins to decline in value, your other investments can help to bolster your portfolio.
A higher allocation to stocks may be optimal if stock prices are rising, but you may want to balance those out with less risky investments, like bonds.
If you’re investing in mutual funds or exchange-traded funds (ETFs), consider what assets each one holds to avoid becoming overweighted in one particular industry or sector.
Go Long in Your Positions
Going long simply means adopting a buy-and-hold approach when investing in a bull market. The end goal is to buy stocks at a low price, then sell them later for a higher price to maximize returns. The key is knowing how to identify the impending end of a bull market so that you can sell before prices drop.
The Takeaway
Bull markets, in which asset prices rise and investors feel optimistic, are a natural part of the market cycle. A bull market begins when a market index rises 20% or more over a two-month period, and it can last months or years. Generally, during a bull market, maintaining a diverse portfolio and a clear idea of your goals can help you manage your investments prudently.
If you’re not investing yet, it’s never been easier to get started. With SoFi, you can open an online investment account and start building a portfolio. You can choose between self-directed trading or automated trading as you begin your journey to growing wealth. SoFi doesn’t charge management fees, and investors can choose between stocks, ETFs, and more.
FAQ
Is a bull market a good market?
A bull market usually signifies that the market is strong. A market where stock prices are generally increasing can offer an opportunity to buy and hold stocks — if you can purchase them before prices rise too high.
How long can a bull market last?
Bull markets have no set duration; they can last months or even years. When a bull market occurs, it typically sticks around for a longer period of time than bear markets do.
Should you sell stocks in a bull market?
Selling stocks in a bull market could make sense if you’re able to sell them for substantially more than you paid for them. Essentially, it all comes down to timing and what makes sense for your individual goals and tolerance for risk.
Photo credit: iStock/GOCMEN
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.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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.
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