Junk bonds are a type of corporate bond that carry a higher degree of risk and generally have lower credit ratings. Bond issuers are more likely to default, making junk bonds speculative investments.

invest Archives | Page 118 of 180

Aug

2023

What Are Junk Bonds?

By Rebecca Lake | Growing Wealth, invest, Investing | Comments Off

Junk bonds are a type of corporate bond that carry a higher degree of risk and generally have lower credit ratings. The bond issuers are more likely to default, making junk bonds speculative investments.

So why would investors buy a junk bond? For one simple reason: They have the potential to produce bigger returns compared to other bond options.

Junk bonds aren’t necessarily right for every investor, because they are so risky. Understanding how junk bonds work can help you decide if they belong in your investment portfolio.

How Do Junk Bonds Work?

Bonds are a form of debt. When a corporation or government entity issues a bond, they’re doing so for the purposes of raising capital. Investors buy the bonds, providing the capital, and in return, they expect to get paid that money back along with interest.

There’s an implied agreement between the investor and the bond issuer that the latter will make interest payments on time, but in addition, bonds can be secured or unsecured. Treasury bonds, for example, are unsecured bonds that are backed by the full faith and credit of the U.S. government.

Junk bonds, also referred to as high-yield bonds, represent a category of bonds that fall below investment-grade. In simple terms, this means there’s a greater risk that the bond issuer could default or fail to follow through on their promise to repay investors. Whether a bond is considered to be investment-grade or not depends on its credit ratings.

Credit Ratings and Junk Bonds

Bond credit ratings are issued by a number of organizations. These agencies determine which bonds are considered to be investment-grade and which are non-investment grade or speculative-grade.

In the United States, the majority of bond credit ratings are issued by three agencies, on an ABCD scale:

• Moody’s Investors Services

• Standard & Poor’s Global Ratings

• Fitch Ratings

Bonds with a rating of BBB or higher (Baa on the Moody’s scale) are categorized as investment-grade. This means that in the eyes of the rating agency, default risk is low or in other words, investors are reasonably likely to get their money back from the bond issuer.

When bonds fall below the BBB rating range (Ba for Moody’s), they’re considered to be junk bonds. The further the rating drops, the riskier and more speculative the bond becomes. Here’s how junk bond credit ratings compare.

	Moody’s	S&P Ratings	Fitch Ratings
High Risk	Ba or B	BB or B	BB or B
Highest Risk	Caa, Ca or C	CCC, CC or C	CCC
In Default	C	D	DDD, DD or D

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Why Do Investors Like Junk Bonds?

The riskier an investment is, the more potential it has to deliver higher returns. That lies at the heart of why some investors might prefer junk bonds over investment-grade bonds. Junk bonds can have varying maturities like other types of bonds. Typically, these are longer term bonds, with maturities lasting in the five- to 10-year range.

Investing in junk bonds could yield returns on the same level as stocks but with less volatility. That’s because you’re getting the promise of a fixed interest payment, rather than depending on which way the market swings on any given day to determine returns. If the bond issuer undergoes a financial turnaround and its credit rating improves, that can reduce the level of risk associated with its bonds.

Junk bonds can be attractive to investors in low interest rate environments as well. That’s because unlike other bonds, they’re less sensitive to interest-rate movements. Bond issuers may be highly motivated to raise capital so they can offer higher rates to attract investors. Investor risk may also be reduced when the economy is growing, since that can be conducive to improvements in the financial health of bond issuers.

Recommended: How Do Corporate Bonds Work?

Examples of Junk Bonds

Companies that issue junk bonds tend to be newer companies or established ones that may be struggling financially following bankruptcy. For instance, one company that has junk bond ratings in 2023 is Coinbase (NASDAQ:COIN), a cryptocurrency exchange. Because of the speculative and high-risk nature of crypto trading, the company has a junk bond rating. In early 2023, Coinbase’s junk bonds were downgraded even further by Moody’s and Standard & Poor’s Global Ratings.

Advantages and Disadvantages of Junk Bonds

Investing in junk bonds has both pros and cons, just like other investments.

On the advantages side, investors have potential to earn higher yields from junk bonds than other types of bonds. There’s less volatility to contend with compared to stocks, and fixed interest payments could provide a steady source of income. Depending on the credit rating of the bond issuer, it’s possible that a junk bond could actually be less risky compared to a stock.

On the other hand, junk bond investing is speculative, so an investor has to be willing to accept the possibility of losses — specifically, default risk and the likelihood of the bond issuer missing an interest payment. In the worst-case scenario, the company could go bankrupt, meaning an investor may not get their initial investment back, much less the interest. One also has to consider the time component, since junk bonds are not designed to be held for the shorter term.

Junk Bond Advantages	Junk Bond Disadvantages
Investors could earn interest rates above what investment-grade bonds are paying.	Default risk is typically higher with junk bonds vs. investment-grade bonds.
Compared to stocks, junk bonds are less susceptible to volatility and may be less risky overall.	If the bond issuer goes bankrupt, the investment could end up being a total loss.
Fixed interest payments may provide a consistent stream of income for investors.	They’re not suited to short-term investing given the duration of junk bonds and pricing fluctuations.

How to Invest in Junk Bonds

If you’re considering investing in junk bonds, opening a brokerage account is a good place to start. If you already have an investment account, you can move on to purchasing junk bonds. There are a few different ways you can do this:

• Purchase individual junk bonds, if your brokerage offers them.

• Buy a junk bond mutual fund.

• Invest in a junk bond exchange-traded fund (ETF).

Buying individual junk bonds can be risky, as it concentrates investment dollars in a single security. Higher minimum investments may limit the number of junk bonds an investor is able to purchase.

Investing in junk bond funds or ETFs instead may make it easier to spread out your investment dollars while spreading out risk. Junk bond funds and ETFs can offer exposure to a basket of junk securities which can help with diversification and risk management.

When comparing junk bond funds or ETFs, consider the underlying credit ratings for each security that’s represented. This can tell you whether the fund mostly holds high risk, higher risk or in default bond offerings. Also consider the expense ratios involved and the maturity terms so you’re choosing a fund that fits both your budget and timeline for investing.

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

Are Junk Bonds a Good Investment?

Should you buy junk bonds? The answer depends largely on your personal risk tolerance. Junk bonds may be a good investment for investors who are comfortable taking more risk for a shot at higher returns. On the other hand, you may choose to steer clear of them if you’re looking for fixed-income investments that are on the safer side.

What’s important to consider before investing is the entire makeup of your portfolio as a whole and your financial goals. If you’re interested in junk bonds, think about how much of your portfolio you’re comfortable dedicating to them and how that could affect your overall risk profile.

The Takeaway

Investing in bonds can add a fixed-income element to an investor’s portfolio, which may be helpful for diversification. Alongside stocks, bonds may help you devise a more well-rounded investment strategy as you work toward your financial goals.

Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

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Photo credit: iStock/fizkes

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

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

Aug

2023

What Is Asset Management?

By Pam O’Brien | Financial Independence, invest, Investing, Terminology | Comments Off

Asset managers help manage their clients’ money. They typically manage an individual’s or institution’s investment portfolio, with the objective of building or maintaining wealth. Asset managers usually work to deliver investment returns that help clients achieve their financial goals while aiming to mitigate risk.

These professionals are typically fiduciaries, an industry designation which means they must put their clients’ best interests ahead of their own.

Understanding how asset management works, the pros and cons, and the costs involved, can help you decide whether this service is right for you.

What Is Asset Management: The Basics

Asset management is a financial service offered by licensed individuals or companies. The aim of asset management is to build or maintain a client’s wealth, typically through portfolio management. Although asset management is commonly available to high-net-worth individuals, some financial advisors may serve a wider population.

Asset managers choose what investments to buy, sell, or avoid. And they make recommendations based on what they think will help their client’s portfolio grow safely. Asset managers are trained to consider their investment choices in light of a client’s long-term goals or plan and manage potential investment risk factors as well as tax consequences.

In addition to trading traditional and alternative securities, such as stocks, bonds, real estate, and private equity, some asset managers may also offer services not usually available to private investors, such as first access to initial public offerings (IPOs).

They may also offer their clients other services like bundled insurance policies or estate planning, legacy planning, giving strategies, and more.

To make managing and monitoring their accounts easier, clients may consolidate all of their accounts — including checking, savings, money market, and investment accounts — into one asset management account. These accounts provide one monthly statement to help clients keep track of their financial activities and may provide other benefits such as automatic periodic investment.

Asset management accounts are relatively new: The government first allowed them less than 25 years ago. In 1999, the Gramm-Leach-Bliley Act overrode the Glass-Steagall Act of 1933, which banned firms from offering banking and securities services at the same time. The Gramm-Leach-Bliley Act permitted financial services firms to offer brokerage and banking services, and asset management accounts were born.

💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

What Is an Asset Manager?

“Asset manager” is a term in the financial industry that refers to professionals or companies that manage clients’ wealth. Asset managers may also be referred to as investment advisors, financial advisors, or wealth managers.

Generally speaking, what distinguishes an asset manager from, say, a stock broker or brokerage house is that they are legally Registered Investment Advisors (RIAs). An RIA differs from a broker, and potentially from some financial advisors, in that she or he is a fiduciary, and an asset management company is considered a fiduciary firm. That means they can execute investment trades on their clients’ behalf, and they are legally obligated to put their clients’ interests first.

An asset manager must take a two-pronged approach to managing their clients’ assets. They have to consider ways to grow the portfolio and continue to build the client’s wealth. At the same time, they have to manage risk in order to limit potential losses.

Obviously, this is the aim of many investors as well. But most investors aren’t trained in the technicalities of choosing investments, maintaining (or adjusting) a portfolio’s asset allocation, and analyzing how certain strategies may or may not support their goals. For this reason, working with a professional asset manager makes sense for a number of people.

Hiring an asset manager means trusting a professional to execute your financial mandate. These mandates may include instructions on your goals and priorities, what benchmarks may be used to measure success, and what types of investments should be prioritized or avoided. For example, an environmental organization might avoid stocks or funds that include petroleum companies, or an individual concerned about corporate responsibility might target funds that prioritize good corporate governance.

How Much Does an Asset Manager Cost?

Investors should pay special attention to how an asset manager gets paid, as their compensation structures can be complicated.

Before hiring an asset manager, an investor should feel comfortable asking for a copy of their fee structure. Individual Advisory Representatives (IAR), which most asset managers are, are required by the Securities and Exchange Commission (SEC) to file a Form ADV that includes information such as the manager’s investment style and assets they manage, among other things.

Here’s how asset managers may be paid.

Fee based on a percentage of assets

Many asset managers charge an annual fee based on a percentage of the value of an account. These fees may vary depending on the size of the portfolio. For example, larger portfolios may be charged lower fees than smaller portfolios. Or, some asset managers may offer tiered-fee systems that assign different costs to different asset levels. For example, managers may charge one fee for portfolios up to $250,000 and a slightly smaller fee for $250,000 to $1 million, and so on.

Commission-based fees

Asset managers may also earn commissions on other products or services they offer, such as insurance policies. Or they may do a combined fee structure. It’s a good idea to ask an asset manager if they accept commissions for any products they might sell, even if they also charge an annual fee.

Flat fees

Other asset management firms are fee-only, meaning they don’t collect commissions on specific products, and only make money from the management fees they charge their clients. A fee structure like this may make investors feel more confident that their asset manager is choosing investments and products that are appropriate for them and their goals, rather than choosing products because they carry higher commissions.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

The Importance of Asset Managers

Of course all investors are seeking the best ways to manage their portfolios. They hope to employ the right strategies that may help achieve their goals, build wealth, and avoid risk when possible. In some cases, individuals can accomplish these aims on their own, but in other cases it’s beneficial to have an asset manager who is trained in these skills.

An asset manager can:

• Help identify investments that align with an investor’s financial goals

• Build a portfolio and set up an asset allocation that suits an investor’s risk tolerance and risk capacity

• Manage the portfolio over time, adjusting to their clients’ changing priorities

• Be responsive to market conditions

• Adhere to fiduciary standards and responsibilities in putting their clients’ best interests ahead of their own.

Given the multitude of uncertainties investors can face over a lifetime, it may be wise for some investors to consider working with an asset manager.

The Takeaway

Though asset managers are known by many names (including wealth advisor, financial advisor, RIA), they are typically professionals or firms that work with individuals or institutions to manage their money. An asset manager is entrusted with choosing the investments that can help their clients build wealth, while at the same time mitigating risk factors that might lead to losses.

Typically, an asset manager is an RIA — or registered investment advisor — which not only means they’ve met certain industry standards, but they are also considered a fiduciary: They are legally obliged to put their clients’ best interests above their own.

So should you work with an asset manager? Although many asset managers work with high-net-worth individuals (or larger organizations such as corporations and universities), it’s possible to get guidance and portfolio management skills at a range of asset levels. But whether you work with an asset manager or not, you can still start saving and investing to help reach your goals and build financial security.

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

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

Aug

2023

How to Cash in a Bond

By Pam O’Brien | Growing Wealth, invest, Investing | Comments Off

When you were younger, you may have received savings bonds from your grandparents or a relative. Now that you’re older, the bonds have matured, and you’re finally ready to redeem them to pay for an expense or reinvest the money. However, you may be uncertain about how cashing savings bonds works and what their value is.

Find out about how to cash in a bond and how much bonds are worth.

What Are Savings Bonds?

Savings bonds are long-term, low-risk investments that are a debt instrument of the United States government. Created during World War II, they initially allowed citizens to help fund the U.S. government during the war, and were formerly called Series E War Savings Bonds. (Nowadays, there are different types of bonds, as outlined below.) Since these bonds are guaranteed by the U.S. government, they are generally considered among the safest investments out there.

How Do I Cash In a Savings Bond?

Once you’re ready to redeem a savings-bond, you have two options. If it’s an older paper savings bond, financial institutions, like a bank, can often cash them out. If the bank will not redeem these bonds, they should be able to point the owner towards an institution that can. It can be helpful to call the bank first to make sure it’s able to cash the full amount of a bond’s worth.

Since the interest earned on savings bonds are subject to federal taxes (but not local state taxes), bond owners can either pay taxes every year they have the bond or wait until it’s redeemed and pay all the tax due at the end. After a bond is cashed out, an IRS Form 1099-INT is issued that shows the owner’s taxable gain.

It’s also possible to cash savings bonds through Treasury Retail Securities Services. Bond owners just need to complete FS Form 1522, with a certified signature, and mail the bonds and form to Treasury Retail Securities Services, PO Box 9150, Minneapolis, MN 55480-9150.

Another option is to convert older savings bonds into electronic bonds. Go to TreasuryDirect.gov and link a bank account to cash the existing bonds out. If you have electronic bonds, you can cash them in at the Treasury Direct website. Typically, once redeemed, the bond amount is sent to an owner’s bank account within a few days.

If you have questions about the bond redemption process, you can contact Treasury Direct by filling out an email form on the website, or call them at 844-284-2676.

How To Calculate the Value of Your Savings Bonds

Before figuring out how to redeem savings bonds, many recipients first want to calculate their bonds’ present value. Fortunately, TreasuryDirect.gov helps bond owners to do just that.

On this government website, a bond recipient or purchaser can see how much their bonds are now worth by inputting the current date, indicating whether the bond is Series E, Series EE, or Series I, and noting the issue date and serial number. The site will store this information, so users can view it again at a later time.

It’s worth noting here a few things that the Treasury savings bond calculator cannot do, including:

• verifying whether not a user actually owns the bonds

• guaranteeing that a bond is eligible for redemption

• confirming that the serial number is valid

• creating a savings bond based on the information provided

Anyone who’s been issued an electronic savings bond can go to TreasuryDirect.gov and click the “Current Holdings” tab to see how much their bonds are worth.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

When To Cash a Savings Bond

When a Series EE bond arrives at maturity (after 20 years), the bond owner can redeem the principal on it or let it collect more interest for 10 years beyond the maturity date. To redeem, an owner must hold the bond for at least a year. It’s helpful to remember that if a savings bond is redeemed within five years of the purchase date, a three-month interest penalty must be paid.

When looking into how to cash in a Series I savings bond, the same penalty of three months’ interest is applied when the bond is redeemed less than five years from its purchase date.

As mentioned, Series E bonds purchased between 1941 to 1980 no longer earn interest. However, it’s still possible to cash out or redeem savings bonds from these years. To cash in Series HH bonds, the bonds must be mailed to Treasury Retail Security Services along with a completed FS Form 1522 and a certified signature.

Finding Lost or Stolen Savings Bonds

Sometimes owners lose printed bonds that were given to them as children. In that case, if an owner no longer possesses the physical copy of the bond, they can go to TreasuryDirect.gov and fill out an FS Form 1048 , which is a “Claim for Lost, Stolen, or Destroyed United States Savings Bonds.” All that’s needed is the issue date, face-value amount, bond number, the owner’s Social Security number (or the purchaser’s Social Security number), and names and addresses noted on the bonds.

On the Treasury site, it’s also possible to designate whether bonds were lost, stolen, or destroyed (and even attach any remaining pieces of the bond along with the form). By listing a bank account and routing number here, the Treasury can deposit the bond’s value into an owner’s account when they’re ready to redeem. It’s key to remember that the form must be certified with a bond owner’s signature. Once completed, the form can be sent to Treasury Retail Securities Services, P.O. Box 9150, Minneapolis, MN 55480-9150.

Since savings bonds earn interest over time, many recipients opt not to redeem their bonds before that initial five-year mark has passed. Bond owners could wait until the bond reaches maturity or, perhaps, check out a savings-bond calculator to determine how much value might accrue on their still maturing bonds. If a bond owner is pleased with its current value, they might then look into how to redeem the savings bonds for cash.

How Do You Buy Savings Bonds?

You can buy electronic Series EE and Series I bonds savings bonds from Treasury Direct. Simply go to the website and set up an account. Then fill out the form, including the amount you want to purchase in bonds, and use your credit card or debit card to buy the bonds. The electronic bonds will be kept in your account at Treasury Direct.

If you prefer paper bonds, you can only purchase paper Series I bonds. You’ll need to use your IRS tax refund to purchase them. When you file your taxes, fill out IRS form 8888 to indicate how much of your refund should go to I bonds.

Investing Your Savings Bonds With SoFi

Many bond owners opt to reinvest money earned on their savings bonds once the bonds are redeemed. If they don’t need the cash right away, the gains on a bond could go towards another type of investment, where that money might continue to grow. All you need is an investment account to reinvest the money earned on your bonds.

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

FAQ

Do banks cash savings bonds?

You can cash paper savings bonds at many banks. Not every bank cashes paper bonds, however, so you may want to call the bank first and inquire. If you have electronic savings bonds you cash them in online at TreasuryDirect.gov. Simply log into your account to cash in your electronic bonds.

What is the best way to cash in savings bonds?

If you have electronic savings bonds, the best way to cash them in is at TreasuryDirect.gov. Just log into your online account to complete the transaction. The money can be transferred via direct deposit to your savings or checking account.

How long should you wait to cash in a savings bond?

If possible, it’s best to wait until a bond reaches maturity before cashing it in to take full advantage of the interest that accrues over time. However, if you want to cash in a bond before then, try to wait at least five years before redeeming it so you won’t lose any accrued interest. If you cash in a bond before the five-year mark, you will lose three months’ worth of interest.

Finally, it’s important to know that you have to wait at least 12 months from the time of purchase before cashing in most savings bonds.

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

Aug

2023

Buy to Open vs Buy to Close

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

Buy to Open and Buy to Close are options orders used by traders. A trader buys to open using calls or puts with the goal of closing the position at a profit after the options price increases.

Investors use a “buy to open” order to initiate a new options contract, betting that the option price will go up. On the other hand, traders who want to exit an existing options contract, thinking the option price will go down, use a “buy to close” order.

What Is Buy to Open?

“Buy to open” is an order type used in options trading, similar to going long on a stock. Generally, you think the price is going to go up, which is a bullish position. That said, in options trading, you can buy to open a call or a put, and buying a put is taking a bearish position. Either way, to buy to open is to enter a new options position.

Buying to open is one way to open an options position. The other is selling to open. When buying to open, the trader uses either calls or puts and bets that the option will increase in value – that could be a bullish or bearish wager depending on the option type used. Buying to open sometimes creates a new option contract in the market, so it can increase open interest.

A trader pays a premium when buying to open. The premium paid, also called a debit, is withdrawn from the trader’s account just as the value of a stock would be when buying shares.

Example of Buy to Open

If a trader has a bullish outlook on XYZ stock they might use a buy to open options strategy. To do that, they’d purchase shares or buy call options. The trader must log in to their brokerage account then go to the order screen. When trading options, the trader has the choice of buying to open or selling to open.

Buying to open can use either calls or puts, and it may create a new options contract in the market Buying to open calls is a bullish bet while buying to open puts is a bearish wager.

Let’s assume the trader is bullish and buys 10 call contracts on XYZ stock with an expiration date of January 2025 at a $100 strike price. The order type is “buy to open” and the trader also enters the option’s symbol along with the number of contracts to purchase. Here is what it might look like:

• Underlying stock: XYZ

• Action: Buy to Open

• Contract quantity: 10

• Expiration date: January 2025

• Strike: $100

• Call/Put: Call

• Order type: Market

A trader may use a buy to open options contract as a stand-alone trade or to hedge existing stock or options positions.

Profits can be large with buying to open. Going long calls features unlimited upside potential while buying to open puts has a maximum profit when the underlying stock goes all the way to zero. Buying to open options carries the risk that the options will expire worthless, however.

What Does Buy to Close Mean?

Buying to close options exit an existing short options position and can reduce the number of contracts in the market. Buying to close is an offsetting trade that covers a short options position. A buy to close order occurs after a trader writes an option.

Writing options involves collecting the option premium – otherwise known as the net credit – while a buy to close order debits an account. The trader hopes to profit by keeping as much premium as possible between writing the option and buying to close. The process is similar to shorting a stock and then covering.

Example of Buy to Close

Suppose a trader performed an opening position by writing puts on XYZ stock with a current share price of $100. The trader believed the underlying stock price would remain flat or rise, so they put on a neutral to bullish strategy by selling one options contract.

A trader might also sell options when they believe implied volatility will drop. The puts with a strike of $100, expiring in one month, brought in a credit of $5.

The day before expiration, XYZ stock trades near the unchanged mark relative to where it was a month ago; shares are $101. The put contract’s value has dropped sharply since the strike price is below the stock price and because there is so little time left until the delivery date. The trader profits by buying to close at $1 the day before expiration.

The trader sold to open at $5, then bought to close at $1, making a $4 profit.

Differences Between Buy to Open vs Buy to Close

There are important differences between a buy to open vs. buy to close order. Having a firm grasp of the concepts and order type characteristics is important before you begin trading.

Buy to Open	Buy to Close
Creates a new options contract	Closes an existing options contract
Establishes a long options position	Covers an existing short options position
Has high reward potential	Seeks to take advantage of time decay
Can be used with calls or puts	Can be used with calls or puts

Understanding Buy to Open and Buy to Close

Let’s dive deeper into the techniques and trading strategies for options when executing buy to open vs. buy to closer orders.

Buy to Open

Either calls or puts may be used when constructing a buy to open order. With calls, a trader usually has a bullish outlook on the direction of the underlying stock. Sometimes, however, the trader might be betting on movements in other variables such as volatility or time decay.

Buying to open later-dated calls while selling to open near-term calls, also known as a calendar spread, is a strategy used to benefit from time decay and higher implied volatility. Buying to open can be a stand-alone trade or part of a bigger, more complex strategy.

Buy to Open Put

Buying to open a put options contract is a bearish strategy when done in isolation. A trader commonly uses a protective put strategy when they are long the underlying stock. In that case, buying to open a put is simply designed to protect gains or limit further losses in the underlying stock. This is also known as a hedge.

A speculative trade using puts is when a trader buys to open puts with no other existing position. The trader executes this trade when they believe the stock price will decline. Increases in implied volatility also benefit the holder of puts after a buy to open order is executed.

Buy to Close

A buy to close order completes a short options trade. It can reduce open interest in the options market whereas buying to open can increase open interest. The trader profits when buying back the option at less than the purchase price.

Buying to close occurs after writing an option. When writing (or selling) an option, the trader seeks to take advantage of time decay. That can be a high-risk strategy when done in isolation – without some other hedging position, there could be major losses. Writing calls has unlimited risk while writing puts has risk as the stock can fall all the way to zero (making puts quite valuable).

Shorting Against the Box

Shorting against the box is a strategy in which a trader has both a long and a short position on the same asset. This strategy allows a trader to maintain a position, such as being long a stock.

Tax reasons often drive the desire to layer on a bearish options position with an existing bullish equity position. Selling highly appreciated shares can trigger a large tax bill, so a tax-savings play that also reduces risk is to simply buy to open puts.

Not all brokerage firms allow this type of transaction, however. Also, when done incorrectly or if tax rules change, the IRS could determine that the strategy was effectively a sale of the stock that requires capital gains payments.

Using Buy to Open or Buy to Close

A trader must decide if they want to go long or short options using puts or calls. Buying to open generally seeks to profit from large changes in the underlying stock while selling to open often looks to take advantage of time decay. Traders often place a buy to close order after a sell to open order executes, but they might also wait with the goal of the options expiring worthless.

Another consideration is the risk of a margin call. After writing options contracts, it’s possible that the trader might have to buy to close at a steep loss or even be forced to sell by the broker. The broker could also demand more cash or other assets be deposited to satisfy a margin call.

The Takeaway

Buy to open is a term that describes when an options trader establishes a long position. Buy to close is when a short options position is closed. Understanding the difference between buy to open vs. buy to close is essential to successful options trading. These option orders allow traders to put on positions to fit a number of bullish or bearish viewpoints on a security.

Thinking about investing in options? SoFi’s options trading platform has an intuitive and approachable design that gives investors the ability to trade options either on the mobile app or web platform. Also, they can learn more by accessing the associated library of educational content on options.

Pay low fees when you start options trading with SoFi.

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

Aug

2023

What Is a Nominated Advisor (NOMAD) in an IPO?

By Paulina Likos | Growing Wealth, invest, Investing, Terminology | Comments Off

A nominated advisor (NOMAD) is a type of corporate advisor, such as a boutique finance firm, investment bank, or accounting firm, which helps international companies get listed on a branch of the London Stock Exchange (LSE).

NOMADs have to be approved by the LSE, and they assist smaller, riskier companies gain access to public capital through an initial public offering or IPO on the Alternative Investment Market, or AIM, which is less stringent compared to larger exchanges.

The NOMAD determines whether the company can be listed on AIM, even if the company will not IPO. If the company ends up pursuing an IPO, the NOMAD advises the company through the AIM IPO process and afterward. Here’s how the process works.

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Nominated Advisor (NOMAD), Explained

NOMADs or Nominated Advisors determine whether a company should be admitted on LSE’s AIM. These are typically small- or mid-cap companies that are seeking aggressive growth and want to be listed on a public exchange. Thousands of companies have gone public, thanks to the more flexible listing requirements of AIM. But these companies are also required to work with a NOMAD that will guide it through this process and continue to be a resource once the company is admitted.

A NOMAD focuses on specific sectors in which they are an expert in, and they provide the company with continuous guidance on all the AIM rules. Assuming the company goes public via an IPO and gets listed on AIM, the NOMAD makes sure the company remains compliant with AIM standards, is up-to-date with AIM’s regulatory changes, and provides the company strategic advice depending on the market cycle.

Some NOMAD responsibilities include: providing financial planning advice, determining whether the company is eligible to be listed on AIM, preparing the company to be listed on the public exchange, and acting as the company regulator during its time on the AIM.

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How Do Nominated Advisors Work?

The Alternative Investment Market (AIM) is a sub-market of the LSE. It is a network that’s designed to allow certain companies that may not be ready for a larger exchange to gain access to the markets and thus reach their full potential.

In order for a company to gain entry into this market, a NOMAD needs to facilitate the process.

The NOMAD does research to see if a company is viable to join this part of the stock market, which is a market for small to mid-sized growth companies. If the company fits the AIM listing requirements, the NOMAD will work with the company to apply to the exchange. If the company is admitted successfully, the NOMAD continues to oversee the company, much like a regulator, to make sure the company is adhering to all the AIM rules.

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Qualifications for NOMADs

The NOMAD has to be approved by the London Stock Exchange, and there are certain criteria the advisor must meet in order to hold the title of a NOMAD.

First, a NOMAD is not an individual person, rather it is a firm or company that a company uses to get on the LSE. And according to the AIM rules, the NOMAD has to have practiced in corporate finance for at least two years.

The NOMAD needs to also have experience in facilitating at least three qualified transactions.

Lastly, the NOMAD must employ at least four qualified executives on staff of the firm. To become a NOMAD, the firm needs to complete the Nominated Advisor application form.

Once the NOMAD is appointed for the company, typically a smaller company by market cap, the Nominated Advisor is then responsible for advising and guiding the company on how it can be successfully admitted into AIM. The Nominated Advisor must maintain its eligibility status even after it is approved by the LSE.

The Exchange can conduct interviews with the NOMAD to ensure it maintains understanding of AIM rules for companies seeking admission and maintaining their position in the exchange. This is important to mitigate the potential for risk for investors. IPOs are considered extremely volatile events, and can expose all investors — but particularly inexperienced individual investors — to heavy losses.

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The NOMAD Process

The NOMAD is needed once a company decides it wants to be listed on the AIM. Next, the NOMAD is appointed to assist the company through the application, admissions processes and ongoing guidance while listed on the exchange. After the company is finally listed on the AIM, the NOMAD offers consistent oversight of the company to ensure its listing.

Once admitted to the exchange, if the company the NOMAD oversees does not continue to meet AIM requirements, the NOMAD may choose to resign from their position or report the company, otherwise, the NOMAD could be subject to a fine for not upholding AIM expectations. In such a scenario, the company’s shares would be suspended and eventually de-listed if a NOMAD replacement is not found within a 30-day period.

What Is the Importance of a NOMAD During the IPO Process?

The Alternative Investment Market was launched in 1995, and its success can be partly attributed to the role that NOMADs play. When a company applies to be admitted into AIM, the NOMAD facilitates the process and is integral to the company getting listed on the exchange. The company that wants to be listed in AIM must appoint a NOMAD, a trusted and experienced representative that ideally may lead the company to go public.

This critical process requires the NOMAD to make sure the company is following the AIM’s rules and regulations, which is why the LSE had strict criteria for becoming a NOMAD. The Exchange wants to ensure the company seeking admission to AIM meets the criteria and has the potential to be a long-term success, and to keep the integrity of the market and protect shareholders who may invest in companies listed on the exchange.

The Takeaway

For some smaller, perhaps riskier, companies hoping to gain access to market capital, a NOMAD or nominated advisor, is required to become listed on the Alternative Investment Market (AIM), a submarket of the London Stock Exchange (LSE).

This route may offer an easier path to an initial public offering. The AIM is considered less rigorous in its requirements, compared with some larger exchanges, and they will consider listing small companies seeking aggressive growth as long as those entities are paired with a NOMAD.

The NOMAD is typically a corporate finance advisor that thoroughly reviews the AIM applicant in terms of its business model, track record, executive team, financials, and so forth. Assuming the company satisfies all requirements, the NOMAD agrees to assist the company in its application to the AIM, and to continue to provide oversight afterward.

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FAQ

What is a NOMAD company?

A NOMAD company is a financial entity that has been approved by the London Stock Exchange (LSE) to help eligible companies who are interested in being admitted into Alternative Investment Market (AIM), which is part of the LSE.

What do NOMADs do during an IPO?

As corporate nominated advisors, NOMADs provide advice to a company that wants to go public on AIM. The NOMAD has market sector expertise and does their due diligence to make sure a company meets the eligibility requirements to be listed on the exchange.

What is a NOMAD investment?

NOMADs is integral in the pre-IPO process because they provide guidance for being admitted into the exchange along with ongoing oversight once the company has successfully been accepted into the public exchange.

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

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

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