invest Archives

Jul

2025

The Effects of Deadweight Loss

By Matthew Zeitlin | invest, Investing, Terminology | Comments Off

Table of Contents

What Is Deadweight Loss?
Common Causes of Deadweight Loss
How to Calculate Deadweight Loss
Why Investors Should Care About Deadweight Loss
FAQ

Deadweight loss is a macroeconomic term that refers to the total value of lost trades, caused by a mismatch between supply and demand. Deadweight loss can be the result of taxation, price restrictions, the impact of monopolies, and other factors.

Deadweight loss isn’t limited to a single company, but rather describes the impacts on the overall economy of certain policies, which can trickle down and have an effect on the markets.

Key Points

• Deadweight loss refers to the value of all the trades or transactions that did not occur owing to a market inefficiency.

• These inefficiencies are the result of a market distortion, or mismatch, such as what occurs when a tax or minimum wage is imposed.

• These factors can impact production costs and pricing, which can cause a disequilibrium in both supply and demand, leading to deadweight loss.

• Deadweight loss generally plays out in terms of larger societal and/or economic trends, and as such can impact markets as well.

What Is Deadweight Loss?

Deadweight loss refers to inefficiencies created by a misallocation or inefficient allocation of resources, and is an important economic concept. Deadweight loss is often due to government interventions such as price floors or ceilings, or inefficiencies within a tax system that effectively reduce trades or transactions by interfering with supply and demand equilibrium.

To understand more fully, it can be helpful to think about how government interventions can impact the equilibrium between supply and demand.

First: Calculate Surplus

In order to know how to calculate deadweight loss, we must first be able to calculate surplus.

Typically, a business will only sell something if they can do so at a price that’s greater than what they paid for it themselves, and a consumer will only buy something if it’s at or less than the price they want to pay for it — the same principle as generating a stock profit.

Scenario A — The Equilibrium: Let’s imagine Store X sells comic books for $10 each. The store buys the comic books from the wholesaler for $5 and sells them for $10, pocketing $5 of “producer surplus.”

Before the Store X opened, consumers traveled to another store to buy comic books for $15. This $5 difference between the price they were willing to pay and the newly available price is the “consumer surplus”.

In this case, let’s say Store X is able to sell 1,000 comic books, that means the combined producer and consumer surplus is $10,000.

Breakdown:

• P₁ = Producer’s Cost of a Comic Book = $5

• P₂ = Producer’s Price to Sell a Comic Book = $10

• P₃ = Price the Consumer Pays = $10

• P₄ = Price the Consumer Is Willing to Pay = $15

• Units Sold = 1,000

• Producer Surplus = (P₂ – P₁) * Units Sold = ($10 – $5) * 1,000 = $5,000

• Consumer Surplus = (P₄ – P₃) * Units Sold = ($15 – $10) * 1,000 = $5,000

• Total Surplus 1 = Producer Surplus + Consumer Surplus = $5,000 + $5,000 = $10,000

In this theoretical example, there is no deadweight loss because supply and demand are in balance. That would change if another factor entered the picture that caused a market distortion that caused a loss in the number of purchases. Deadweight loss being the value of the trades or transactions that did not occur, owing to a market inefficiency.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Common Causes of Deadweight Loss

There can be several causes of deadweight loss, but some of the most common are government-mandated changes to markets. Examples include price floors, such as a minimum wage, which can create some inefficiencies in the labor market (there may be workers who would be willing to work for less than minimum wage).

Price ceilings, also can create deadweight loss — an example could be rent control. Finally, taxes can create deadweight loss, too.

How to Calculate Deadweight Loss

To properly calculate deadweight loss, you need to be able to represent the supply and demand of the goods being sold graphically in order to determine prices. According to the laws of supply and demand, the higher a price goes, the fewer of that item will get sold; and vice versa.

Example of Deadweight Loss

Let’s go back to our comic book example and imagine that the town’s government imposes a $2 tax on comic books.

Scenario B — The Impact of Taxes

What happens to the price of comic books and the surplus generated by the sales of comic books? Theoretically, Store X could simply bump up prices $2 and sell 1,000 comic books for $12 each, maintaining a $5 producer surplus on each comic book sold, with $2 going to the government, and consumer surplus of $3.

In this case the combined consumer and producer surplus is lower — $5 × 1,000 + $3 × 1,000 = $8,000. So there’s a missing $2,000 of what economics call “gains from trade.” But, the government is collecting $2,000, so the money does not disappear from the economy.

In other words, the government is collecting $2,000, with which it can buy things, hire people, and literally send money to people via economic stimulus measures. Thus, the tax revenue does not disappear from the economy.

But in reality, if Store X were to increase the price to $12, thus passing on the tax to customers, they may not be able to sell enough comic books to maintain the revenue needed to keep the store open.

If they lower the price to $11, splitting the cost of the tax between the store and consumers, it’s likely fewer consumers would buy comic books: let’s say Store X would now sell 600 comic books instead of 1,000.

The combined consumer and producer surplus is $4,800 ($4 × 600 + 600 × $4) with $1,200 of tax collected (600 × $2) meaning there’s a total of $6,000 of consumer surplus, producer surplus, and government revenue. In this case the deadweight loss is $4,000.

Breakdown:

• P₁ = Producer’s Cost of a Comic Book = $5

• P₂ = Producer’s Price to Sell a Comic Book = $9

• P₃ = Price the Consumer Pays = $11

• P₄ = Price the Consumer Is Willing to Pay = $15

• Units Sold = 600

• Tax = $2/Comic Book

• Producer Surplus = (P₂ – P₁) * Units Sold = ($9 – $5) * 600 = $2,400

• Consumer Surplus = (P₄ – P₃) * Units Sold = ($15 – $11) * 600 = $2,400

• Gains From Trade (Tax) = $2 * 600 = $1,200

• Total Surplus 2 = Producer Surplus + Consumer Surplus + Gains From Trade = $6,000

• Deadweight Loss = Total Surplus₁ – Total Surplus₂ = $10,000 – $6,000 = $4,000

The higher price, created through taxation, has impacted the equilibrium between supply and demand and created a deadweight loss — the number of sales that evaporated due to fewer transactions happening between the comic book seller and the readers.

While this is a rather extreme example of what happens when taxes force up prices, it’s a good way of thinking about how deadweight losses are more than just items getting more expensive. Rather, the deadweight loss formula can illustrate the evaporation of mutually beneficial economic transactions due to different types of taxes and other policies.

A similar impact can occur when a government imposes price floors or ceilings on items.

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Why Investors Should Care About Deadweight Loss

Deadweight loss can affect investors in a number of ways, and it’s important to consider it when looking at different types of investments. One of the most debated issues in economics is the effects that the tax system has on income, investment, and economic growth in the short and long run.

Some argue that income taxes, payroll taxes (the flat taxes on wages that fund Social Security and Medicare) and capital gains taxes work like the comic book tax described above, preventing otherwise beneficial transactions from happening and reducing the economic gains available to all sides. There’s evidence on all sides of this debate, and the effects of tax rates on overall economic growth are, at best, unclear.

As an investor, deadweight loss might matter when it comes to companies or sectors impacted by specific taxes, such as sales taxes or excise taxes on alcohol or cigarettes.

Deadweight loss shows how taxes on specific items can not only reduce profitability by increasing a company’s tax bill, but also affect revenue by reducing overall sales or driving down prices that businesses can charge or receive from buyers. As an investor, this knowledge and insight can be useful when allocating capital between companies, sectors, or types of assets.

The Takeaway

Deadweight loss is the result of economic inefficiencies, and it can affect an investor’s portfolio if it results in slower sales and revenues for businesses. It’s a large economic concept, and may not have a day-to-day direct impact on the stock market. But it’s still good for investors to know the basics of deadweight loss and how it applies to them.

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FAQ

Why does a monopoly cause a deadweight loss?

A monopoly can cause deadweight loss because competitive markets create competition and fairer prices. A monopoly distorts prices, leading to inefficiencies.

Can deadweight loss be a negative value?

No, deadweight loss cannot be a negative value, but it can be zero. Zero deadweight loss would mean that demand is perfectly elastic or supply is perfectly inelastic.

Is deadweight loss market failure?

Deadweight loss is not a market failure, but rather, the societal costs of inefficiencies within a market. Market failures can, however, create deadweight loss.

Photo credit: iStock/akinbostanci

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

SOIN-Q325-025

Jul

2025

Front-Running Explained

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Table of Contents

What Is Front Running?
How Front Running Works
A Front Running Example
Front Running in the Real World
Is Front Running Legal?
Are There Times When Front Running Is OK?
FAQ

Front running is when a broker or other investor obtains information that will impact a stock, and places a trade in advance of the news.

In most cases front running is illegal because the broker is acting on information that’s not available to the public markets, and using it for their own gain.

Front running is somewhat different from insider trading, where an individual investor working at a company is able to place a trade based on proprietary information about that company. Insider trading is also illegal.

There is another definition of front running, however, which involves index funds. This type of front running is not illegal.

Key Points

• Front running involves trading a financial asset based on non-public information in order to profit, which is illegal due to unfair market advantage.

• This practice is different from insider trading, although both involve using non-public information for personal profit, and both are prohibited by regulatory agencies.

• Front running can occur when investors or brokers use this news to anticipate significant trades, allowing them to act before the information is public.

• Real-world cases of front running have led to significant penalties, including multi-million dollar fines and prison sentences for those involved in fraudulent trades.

• While most forms of front running are illegal, index front running, which involves changes to market indexes, is considered legal and commonly practiced.

What Is Front Running?

Front running trading means that an investor buys or sells a security based on advance, non-public knowledge or information that they believe will affect its stock price. Because the information is not widely available, it gives the trader or investor an advantage over other traders and the market at large.

Based on this definition of front running, it’s easy to see how the practice — though illegal — earned its moniker. Investors trading stocks based on privately held information, are literally getting out in front of a price movement.

In addition to stocks, front running may also involve certain derivatives contracts, such as options or futures.

Again, although front running is technically different from insider trading, the two are quite similar in practice, and both are illegal. Front running is forbidden by the Securities and Exchange Commission (SEC). It also runs afoul of the rules set forth by regulatory groups like the Financial Industry Regulatory Authority (FINRA).

If a trader has inside knowledge about a particular stock, and makes trades or changes their position based on that knowledge in order to profit based on their expectations derived from that knowledge, that’s generally considered a way of cheating the markets.

How Front Running Works

The definition of front running is pretty straightforward, and there are two main ways front running — also called tailgating — can occur.

• A broker or trader investing online or through a traditional brokerage gets wind of a large upcoming trade from one of their institutional clients, and the size of the trade is sure to influence the price.

• A broker or trader learns about a specific analyst report about a given security that’s likely going to impact the price.

In either case, the trader gains access to price-relevant information that’s not yet available to the public markets, and they are well aware that the upcoming trade will substantially impact the price of the asset. So before they place the trade, they might either buy, sell, or short the asset — depending on the nature of the information at hand — and make a profit as a result.

A Front Running Example

Say there’s a day trader working for a brokerage firm, and they manage a number of clients’ portfolios. One of the broker’s clients calls up and asks them to sell 200,000 shares of Company A. The broker knows that this is a big order — big enough to affect Company A’s stock price immediately.

With the knowledge that the upcoming trade will likely cause the stock price to fall, the broker decides to sell some of his own shares of Company A before he places his client’s trade.

The broker makes the sale, then executes the client’s order (blurring the lines of the traditional payment for order flow). Company A’s stock price falls — and the broker has essentially avoided taking a loss in his own portfolio.

He may use the profit to invest in other assets, or buy the newly discounted shares of Company A, potentially increasing his long-term profits essentially by averaging down stocks.

The trader would’ve broken the law in this scenario, breached his fiduciary duties to his client, and also acted unethically.

Recommended: Understanding the Risks of Day Trading

Front Running in the Real World

There are many real-world examples of front running that have led to securities fraud, wire fraud, or other charges.

In 2022, for example, the SEC charged an employee of a large financial institution and an outside associate, of executing a multi-year scheme worth some $47 million in fraudulent front-running profits.

In this case, the employee took advantage of proprietary information about upcoming company trades, which he conveyed to an accomplice outside the firm. Based on the ill-gotten information, this outside trader opened and closed positions ahead of the bigger company trades, and shared the profits.

The company employee was sentenced to 70 months in prison, three years of supervised release, and both traders had to forfeit some $38 million.

Is Front Running Legal?

No. In almost all cases, front running is illegal. Front running is a type of fraud that involves using information that’s not available to the public solely for personal gain.

Are There Times When Front Running Is OK?

Yes, actually. Index front running is not illegal, and is actually fairly common among active investors.

As many investors are aware, index funds track market indexes like the S&P 500 or Dow Jones Industrial Average. These funds are designed to mirror the performance of a market index. And since equity market indexes are essentially large portfolio stocks, they change quite often. Companies are frequently swapped in and out of the S&P 500 index, for instance.

When that happens, the change in an index’s constituents is generally announced to the public, before the swap actually takes place. If a company is being added to the S&P 500, that’s probably considered good news, and can make investors feel more confident in that company’s potential.

Conversely, if a company is being dropped from an index, it may be a sign that things aren’t going so well.

That gives some traders an opening to take advantageous positions. Let’s say that an announcement is made that Firm X is being added to the Dow Jones Industrial Average, taking the place of another company. That’s big news for Firm X, and means that Firm X’s stock price could go up.

Traders, if they have the right tools, may be able to quickly buy up Firm X shares the next day, and potentially, make a profit if things shake out as expected (although there’s no guarantee they will).

How is this different from regular front running? Because the information was available to the public — there was no secret, insider knowledge that helped traders gain an edge.

The Takeaway

Front-running is the illegal practice of taking non-public information that is likely to impact the price of a certain asset, then placing a trade ahead of that information becoming public in order to profit. Front running is similar to insider trading, although the latter generally involves an individual investor who profits from internal company information.

Fortunately, there are plenty of investing opportunities that don’t involve resorting to fraudulent activity like front running.

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

FAQ

Why is front-running illegal?

Front running is illegal for a few reasons. First, it’s a form of cheating the market, by using non-public information for personal gain. Second, in the case of institutional front running, it’s a violation of a broker’s fiduciary duty to a client.

How can I identify if my trades have been affected by front running?

Unfortunately, owing to the non-public nature of the information that typically leads to front-running, it’s very difficult for individual investors to determine whether or not their own trades have been impacted by a front-running event. Financial institutions have more tools at their disposal to detect incidents of front running.

Are there any technological solutions or tools available to detect and prevent front running?

Yes. With so many traders using remote terminals to place trades since the pandemic, trade surveillance technology and trade reconstruction tools are more important than ever. Fortunately, financial institutions have the resources to employ these tools, and other types of algorithms, to monitor the timing of different trades in order to identify front runners and front running.

Photo credit: iStock/Drazen_

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

S&P 500 Index: The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
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.

SOIN-Q325-027

Jul

2025

A Guide to Delta-Neutral Trading Strategies

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

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Table of Contents

What Is Delta?
What Does Delta Neutral Mean?
How Does Delta Neutral Function?
Profiting From Delta-Neutral Trading
Pros and Cons of Delta Neutral Positions
Delta-Neutral Straddle
FAQ

The typical options buyer generally seeks to profit from directional price moves in an underlying asset. However, there are some traders who aim to profit from other characteristics of options, such as volatility or time decay, by using strategies like delta-neutral positioning.

To pursue these trading strategies, investors may seek to minimize the effect of price changes and create portfolios that are more sensitive to other factors. A delta-neutral strategy does this by combining positions with offsetting deltas in order to create a net delta of zero overall.

Key Points

• Delta-neutral strategies aim to balance positive and negative deltas, achieving a net delta of zero.

• These strategies can generate profits from changes in implied volatility and time decay.

• Delta-neutral positions require regular adjustments to maintain neutrality.

• A delta-neutral straddle involves purchasing both at-the-money calls and puts.

• Delta-neutral trading minimizes exposure to short-term price fluctuations while holding longer-term positions.

What Is Delta?

Delta is one of the Option Greeks and measures how much an option will change in price, given a $1 change in the price of the underlying asset. By convention, the delta of a long position in the underlying asset is always 1, while a short position has a delta of -1.

What Does Delta Neutral Mean?

Delta neutral means that a position’s value is intended to remain stable when there are small market price changes. By holding a combination of assets and options, or combinations of various call and put options, a trader can create a portfolio with an overall delta of approximately zero.

Traders use delta-neutral strategies to reduce sensitivity to price changes while aiming to benefit from shifts in implied volatility, the time decay of options, or to hedge against existing positions.

How Does Delta Neutral Function?

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

Basic Mechanics

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

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

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

Deep in-the-money long call options tend to have a delta near 1. Deep out-of-the-money long call options will have a delta near 0. At-the-money long call options typically have a delta near 0.5.

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

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

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

The investor must also be aware that any delta-neutral portfolio will only retain its neutrality for a short period of time and over a narrow range of asset prices. Therefore, a portfolio must be constantly adjusted to maintain delta neutrality.

An Example of Delta-Neutral in Use

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

The goal of a delta-neutral strategy is to use a combination of calls and puts to bring the portfolio’s net delta close to 0. One possibility is to purchase at-the-money put options that have a delta of -0.5. Two of these put option contracts (each with a delta of -0.5 a share) have a total delta of approximately -100 (-0.5 multiplied x 100 shares x 2 contracts). Recall that an options contract represents 100 shares of stock.

Here, the $100 strike acts as a temporary balance point for delta neutrality. As the underlying price moves away from $100, the delta of the portfolio will shift, and may require rebalancing to maintain neutrality. This shift happens because delta itself changes as the underlying asset changes — a second-order effect known as gamma.

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

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

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

Portfolio delta = stock position delta + long put position delta

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

The net position may offer downside risk reduction by being long put options while still having exposure to upside from the long stock position. Of course, using protective puts involves premium costs that may reduce overall returns.

A diagram might help illustrate how delta-neutral positioning works.

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

Profiting From Delta-Neutral Trading

It is possible to profit from changes other than price movements in the underlying stock. For example, an options trader can use delta-neutral strategies to seek gains from declining or rising volatility. Vega is the Options Greek that measures the sensitivity of an option’s price to changes in volatility.

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

Shorting Vega

Shorting vega is a more advanced options trading strategy, used to express a bearish view on implied volatility.

You might consider shorting volatility after a period of extreme movement in the market or a single stock. The key is to short vega when implied volatility is still high and there is an expectation it may decline.

When implied volatility is high, you pay a significant premium to be long options. You may seek to capitalize on elevated premiums by selling options while still being delta neutral. The risk is that implied volatility levels continue to increase further, which can lead to losses on a short vega play. Note: delta neutrality degrades due to gamma as prices move.

Waiting for Collapse in Volatility

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

Pros and Cons of Delta Neutral Positions

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

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Pros:

• Potential to profit from variables other than the price movement of the underlying asset

• Traders hold stock for the long run while seeking to limit the impact of near-term declines

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Cons:

• Requires frequent trades, which may increase costs, to maintain a delta near 0

• Deltas are constantly changing, which can result in over- or under-hedging

Delta-Neutral Straddle

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

For example, if XYZ stock trades at $100, and it’s at-the-money call has a delta of 0.5 and it’s at-the-money put has a delta of -0.5, a trader might buy both options to establish a neutral position and then sell them if implied volatility increases. With this delta-neutral long straddle strategy, your delta is effectively 0 but you are long volatility.

A delta-neutral short straddle is an options trade that aims to benefit from limited price movement and a decline in implied volatility. The short straddle, as the inverse of the long straddle, may be used when implied volatility is expected to decrease.

Other options trading strategies that may benefit from volatility and time decay include calendar spreads, diagonal spreads, iron butterflies, and iron condors, among others.

The Takeaway

Building and maintaining a delta-neutral portfolio can be a challenging task, but the potential to benefit from time decay and volatility shifts may make it worthwhile.

Delta-neutral trading can also help reduce exposure to short-term declines while allowing investors to hold stock for the long-term.

SoFi’s options trading platform offers qualified investors the flexibility to pursue income generation, manage risk, and use advanced trading strategies. Investors may buy put and call options or sell covered calls and cash-secured puts to speculate on the price movements of stocks, all through a simple, intuitive interface.

With SoFi Invest® online options trading, there are no contract fees and no commissions. Plus, SoFi offers educational support — including in-app coaching resources, real-time pricing, and other tools to help you make informed decisions, based on your tolerance for risk.

Explore SoFi’s user-friendly options trading platform.

FAQ

How do you make money with a delta-neutral strategy?

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

What is a delta-neutral strike?

A delta-neutral strike refers to the price at which a portfolio is precisely balanced. In practice, this is an approximation rather than an exact level. As the underlying asset price moves, delta may shift away from zero; it will take additional hedging trades to get back to delta neutral.

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

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

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

Photo credit: iStock/Delmaine Donson

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

SOIN-Q225-074

Jul

2025

Option Assignment: Defined and Explained

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

Table of Contents

What Is Option Assignment?
How Does Option Assignment Work?
Option Assignment and Multi-Leg Strategies
What Does Assignment Mean for Individual Investors?
FAQ

Option assignment occurs when the buyer of an options contract chooses to exercise their puts or calls. That means they wish to trade the underlying security at the strike price set in the contract, which the options contract seller is obligated to fulfill.

While relatively few options contracts are ever exercised, options writers should be mindful of assignment risk. Options assignment requires writers to buy or sell the underlying security at the strike price.

As with all options trading, it’s important to know and understand all of the key risks. American-style options can be exercised at any time before and on the date of expiration, which means sellers might be faced with option assignment whenever they hold a short position. Option assignment is also more likely as expiration nears.

Key Points

• Option assignment occurs when a contract buyer exercises their right to buy or sell the underlying asset, and the seller is required to fulfill the contract.

• American-style options may be assigned at any point before or at expiration.

• European-style options may only be exercised and assigned on the expiration date.

• Only sellers of options face assignment risk, including in multi-leg strategies with short positions.

• The Options Clearing Corporation randomly allocates assignments to brokers, who then pass the assignment on to accounts that are holding the contract.

What Is Option Assignment?

Writers (or sellers) of option contracts assume the obligation to buy or sell shares if the option is exercised by the buyer, satisfying the terms of the options contract. Buyers (or) holders of options contracts purchase the right to exercise these options under the terms of the options contract.

Option assignment is the process of matching an exercised option with a seller who is obligated to fulfill the contract. In options trading, a seller must fulfill the contract terms if the buyer exercises the option. The seller does this by either purchasing or selling a specific number of shares of the underlying stock from or to the buyer.

The option contract buyer, also called a holder, has the right but not the obligation to buy (in the case of a call option) or sell (in the case of a put) a predetermined number of shares of the underlying asset at a strike price. It is only when the option contract holder elects to exercise, that option assignment happens. The individual shorting the option (i.e., the seller of the option) must then abide by the contract’s provisions.

How Does Option Assignment Work?

Option assignment is when the seller must complete the terms outlined in an options contract after the call or put contract owner chooses to exercise their option and submits an exercise notice. By selling an option, the seller grants the buyer the right to buy or sell a standardized number of shares at a predetermined price in the future. Any option strategy that has a short leg, such as a bull put credit spread, may involve assignment risk.

Call options offer the owner the right, but not the obligation, to buy stock while put options give the holder the right, but not the obligation, to sell shares. The call option seller, on the other hand, would potentially be required to buy stock in order to sell it to the call option owner.

Writers of bond options also face assignment risk.

A Peek Under the Hood

The mechanics of option assignment can seem unclear since there are so many options contracts traded, and it’s hard to determine who is on the other side of your trade.

Options trade through exchanges, and since they are standardized contracts, the exchange is essentially the counterparty to an option trader until an option is exercised. The entity in charge of facilitating exercises and assignments in the U.S. is the Options Clearing Corporation (OCC). Option assignment rules are followed, and the OCC ensures a fair process.

An options assignment begins when an option holder notifies their broker, who then submits an exercise notice to the OCC. The OCC randomly allocates this assignment to brokerage firms that have clients who are short that contract using a lottery-style process. The brokerage firms then use their own rules and processes to allocate the assignment to a specific client, though many use a similar random allocation method.

The two parties to the assignment are not required to be the same two parties that entered into the original options contract because options are fungible and centrally cleared.

Can You Know If a Position Will Be Assigned?

According to the Options Industry Council (OIC), it’s hard to know when you, as the seller, will be assigned, as it can happen any time up to expiration for American-style options. Many index options, or index futures options, are European-style however.

It may be helpful to know that just 7% of option holders exercise their right, and that percentage has not budged much over the years, according to the OIC.

Can You Do Anything If a Position Is Assigned?

You must meet your option assignment duties once you are assigned. What’s nice, though, is that many brokers handle the process automatically for you. Traders should be prepared to see their account balances fluctuate when an assignment happens. When trading futures options, you might also see a cost of carry with the underlying futures contracts.

Finally, user-friendly options trading is here.^*

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

*Check out the OCC Options Disclosure Document.

What Happens After a Position Is Assigned?

A writer facing an options assignment will be notified through their brokerage firm after the OCC allocates the exercise notice.

A seller of call options must deliver shares at the strike price and in return receives cash equal to the strike price multiplied by the number of shares specified in the contract. If the seller wrote covered calls — and therefore owns the shares in their account — their brokerage can simply transfer the shares from one account to the other, and the seller will receive the strike price for each sold share, regardless of the stock’s current market price.

If the seller sold naked calls, they will be required to buy shares on the open market to provide them to the options holder, but will still receive the strike price per share, regardless of market price. If the seller has pursued a combination options strategy, it might be possible to exercise another option to satisfy the terms of the assigned option. Whether this is feasible depends on the structure and margin requirements of the remaining position.

For someone short puts facing option assignment, they are obligated to buy shares at the exercise price from the holder of the option. If the put seller pursued a cash-secured put strategy, they will have the cash in their account to make the purchase of shares at the strike price upon assignment. If the seller does not have the cash, they will have to deposit sufficient funds or sell account assets to fund the obligatory assignment purchase.

Option Assignment Example

It helps to run through an options assignment example to grasp how the process works.

Let’s say you were bearish or neutral on the price of XYZ stock over the coming 30 days and expected high implied volatility for call options on that stock. After analyzing the option Greeks, you decide to sell $100 strike call options while the shares trade at $95. The option premium you collect is $10.

After three weeks, the stock has jumped to $105, and the short calls are worth $6. You are alerted that you now face a call option assignment. To meet the requirements of option assignment, you must deliver shares to the individual who exercised the call option. You can buy shares in the market or, if you own shares and wrote a covered call, your shares might be called away.

For puts, the purchaser of the option sells (or “puts”) shares to the writer, who is required to purchase the shares at the strike price.

Option Assignment and Multi-Leg Strategies

Some of the more complex options trading strategies, like those involving many legs, may involve increased exposure to option assignment risks. If just one leg of a broader trade is assigned, the writer must act to preserve the strategy’s intended risk profile. That might involve closing the entire strategy or modifying the other legs to manage risk.

Once an option seller’s position is assigned, the trader must meet the contract’s terms to buy or sell shares of the underlying security, regardless of what other legs remain open or are part of a multi-leg strategy.

What Does Assignment Mean for Individual Investors?

Options assignment is just another risk to be mindful of when selling puts and calls as part of an options strategy or standalone trade. While there are plenty of upshots to writing options, such as collecting premium, assignment risk remains a key consideration. It’s important that you check with your brokerage firm to understand their option assignment process and cut-off times. Some firms might have significant costs while others may waive fees for option assignment.

The Takeaway

Option assignment happens to writers of contracts when the owner of puts or calls elects to exercise their right. Options sellers are then required to purchase or deliver shares at the strike price to the individual exercising. Option assignment is facilitated by the OCC, which uses a lottery-style process to randomly select member brokerage firms with short positions, which in turn identify sellers for assignment.

Option sellers face assignment risk, but traders can help avoid the risk by holding long option positions rather than short ones.

Explore SoFi’s user-friendly options trading platform.

FAQ

How is option assignment determined?

Option assignment is determined by the OCC, which randomly assigns firms that have accounts short options. This only happens once an options contract holder chooses to exercise their option. While a small portion of options contracts are exercised, traders should understand the risks, particularly as expiration nears, as that is when assignments may become more likely.

Are options assigned before or after expiration?

American-style options can be exercised, and thus assigned, any time before and on the expiration date. European-style options, however, can only be exercised at expiration. Be sure to know the style of options contract you are selling so that you know your option assignment risk.

What are option assignment fees and how much are they?

Options assignment fees vary by brokerage. These days, trading commissions to fulfill obligations from being short an options contract are generally reasonable. There could be a base options trading fee plus a per contract charge, but some brokers may waive assignment fees entirely.

Photo credit: iStock/nortonrsx

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.

SOIN-Q225-022

Jul

2025

Cost of Carry, Explained and Defined

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

Table of Contents

What Is Cost of Carry?
How Cost of Carry Works
Examples of Cost of Carry
Cash and Carry Arbitrage
Cost of Carry and Net Return
FAQ

Cost of carry refers to the ongoing expenses tied to holding an investment, such as interest payments, storage fees, or missed potential gains from using the money elsewhere. These costs may impact the total return that an investor earns on a position. These costs can vary by asset type and financing method, but they often influence pricing and profit potential.

This guide breaks down how cost of carry works in futures and options trading, how to calculate it, and why it matters when assessing potential returns.

Key Points

• Cost of carry refers to the ongoing costs associated with holding an investment, such as interest, storage, or insurance.

• These carrying costs can reduce the net return of an investment if not properly accounted for.

• In options trading, cost of carry may include margin interest, opportunity costs, and missed dividends.

• The cost of carry in futures helps explain the difference between spot and futures prices.

• Cash-and-carry arbitrage strategies attempt to profit when futures prices exceed spot price plus carrying costs.

What Is Cost of Carry?

Cost of carry refers to the ongoing expenses associated with holding a given investment. Transaction costs, which are incurred upon the purchase or sale of the asset, are typically not considered a carrying cost.

Cost of carry can come in a variety of different forms — here are a few types of carrying costs that you’ll want to be aware of:

• Storage costs, if you are investing in the futures market for physical goods

• Interest paid on loans used for an investment

• Interest charged in margin accounts when borrowing to invest in stocks or options

• Costs to insure or transport physical goods

• The opportunity cost of investments

Most, if not all, investments have carrying costs, and many buyers factor these into their decisions. Even if a particular investment doesn’t have obvious carrying costs, there is always the opportunity cost of making one options trade over the other.

How Cost of Carry Works

The way that cost of carry works depends on the type of investment you are considering. If you are investing in the futures markets for tangible goods like coffee, oil, gold, or wheat, you may incur carrying costs related to storage, insurance, or delivery. For example, if you buy a commodity like crude oil, you must pay the costs for transporting, insuring and storing that oil until you sell it.

To accurately calculate net trading returns, you must include those carrying costs.

In a purely financial transaction like buying stock or trading options, there can still be carrying costs involved. You may have to pay interest if you are borrowing money with a margin account. You may also incur what are called opportunity costs. Opportunity costs refer to potential unrealized returns.

If you are holding $10,000 in your stock account waiting for an option assignment, you may be forgoing potential returns on other potential investments.

Which Markets Are Impacted by Cost of Carry?

Cost of carry is a factor in a variety of different types of investments. Options trading has carrying costs, including interest incurred through margin accounts and opportunity costs associated with capital allocation.

Investing in commodities may require a cost of storing, insuring, or transporting your goods. You should be aware that most types of investments also have opportunity costs.

Cost-of-Carry Calculation

The simplest cost-of-carry calculation just includes all of your carrying costs as a factor when you analyze the profitability of a particular investment. So, if

• P = Purchase price of an investment

• S = Sale price of the same investment

• C = carrying costs while holding the investment

The net return of this investment could be expressed as Profit = S – P – C. This formula highlights how holding costs directly influence potential gains.

Futures Cost of Carry

The futures market has two different prices for each type of commodity. The spot price refers to the price for immediate delivery (i.e., on the spot). A futures price is the price for goods at some specified time in the future.

Because most futures contracts incur carrying costs, the futures price is usually (but not always) higher than the spot price. This situation is called contango. When the futures price is lower than the spot price, often due to high demand or limited supply, it’s known as backwardation. (Contago and backwardation are key terms in commodity futures markets.)

Options Cost of Carry

When trading options the costs of carry fall into a few categories:

• Interest costs – Some investors borrow money to purchase options, i.e., a loan from a friend, a bank loan, or a brokerage margin account.

Whatever the source of the money, the interest paid on borrowed funds is a carrying cost.

• Opportunity costs – You’ve chosen to invest in options. But where else could you have invested that money? Because most alternative investments carry risk, as does investing in options, it’s difficult to make an apples-to-apples comparison.

Risk-free investing rates are typically used to assess opportunity cost. “Risk-free” is often approximated using the yield on short-term U.S. Treasury bills, such as the three-month T-bil. In the past, 30-year bonds were the standard, but 10-year returns and even the return on short-term Treasury notes may also be used.

• Forgoing Dividends – One of the disadvantages of owning options compared to owning stock, is that you are not eligible for dividends as an option holder. The market may price expected dividends into the option premium but, as interest rates can fluctuate over time, so can dividend rates.

Models like Black-Scholes and binomial option pricing incorporate cost of carry through adjustments to interest rates and dividends.

💡 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.

Examples of Cost of Carry

Here is an example of cost of carry and how it might affect an investment in purchasing company XYZ commodity.

Say you buy a contract for 1,000 barrels of XYZ commodity at $80/barrel. Six months later, the price of the commodity has gone up to $90/unit, and you sell. At first glance, it may appear to yield a $10,000 profit, but that excludes the cost of carrying the oil.

If it cost you $3,000 to store and insure those units for the six months that you owned them, those carrying costs must be subtracted from your profit. You also are liable for delivering the commodity, which might cost another $1,000. Considering the cost to carry, your actual profit was only $6,000. While these costs may be easier to understand with physical goods like commodities, most types of investments have carrying costs.

Cash and Carry Arbitrage

Like crypto arbitrage, there sometimes exists a type of arbitrage called cash-and-carry arbitrage. In cash-and-carry arbitrage, an investor will purchase a position in a stock or commodity and simultaneously sell a futures contract for the same stock or commodity.

If the futures price is higher than the combined amount of the stock price plus carrying costs, it may be possible to achieve a limited arbitrage gain through cash and carry arbitrage. However, execution delays, financing charges, or delivery constraints may reduce or eliminate gains.

Cost of Carry and Net Return

As discussed already, the cost of carry can reduce the net return on investment. When determining your total profit and the return on investment (ROI), you need to account for any and all costs that you incur as part of the investment.

These might include transaction costs, like commissions, interest payment, and storage costs. Subtract these costs from gross profit to calculate the net return of your investment.

Can You Do Anything About Cost of Carry?

While cost of carry is difficult to eliminate entirely, investors can reduce its impact by choosing investments in line with their goals and resources. For example, if you do not have access to low-cost financing or storage, you may want to avoid trades that rely heavily on borrowed funds or physical delivery. On the other hand, if your specific situation gives you access to below-market financing or storage costs, you may be able to earn a profit with cash and carry arbitrage.

The Takeaway

The cost of carry isn’t just a theoretical concept: it directly affects net return by adding real, sometimes hidden, costs to holding an investment. Whether due to storage and insurance in futures or margin interest and missed dividends in options trading, these expenses can shift trade-related math. Understanding how carry works helps buyers assess risk, price contracts more effectively, and misjudge a position’s profit potential.

Explore SoFi’s user-friendly options trading platform.

*Risks associated with buying and selling options.

FAQ

How can you calculate cost of carry?

The cost of carry refers to any costs that you incur during the course of your investment. In commodities trading, this generally refers to costs like storage, insurance, or delivery of the commodity. In other types of investments, the cost of carry could include interest charges or the opportunity cost of using your money.

Do bonds have a cost of carry?

Yes, nearly all investments, including bonds, can involve costs associated with holding or financing the position. In the bond market, the cost of carry generally refers to the difference between the face value of the bond plus premiums minus applicable discounts.

How are ordering and carrying costs different?

Ordering costs are the costs that you pay as part of the ordering process. In a stock or option transaction, any broker’s commissions that you pay would be considered ordering costs. While ordering costs are usually incurred only once (at buy and/or sale), carrying costs are the costs that you must pay to hold an investment throughout its duration.

Photo credit: iStock/fizkes

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

SoFi Invest is a trade name used by SoFi Wealth LLC and SoFi Securities LLC offering investment products and services. Robo investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser. Brokerage and self-directed investing products offered through SoFi Securities LLC, Member FINRA/SIPC.

For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.

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

Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.

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

Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.

CRYPTOCURRENCY AND OTHER DIGITAL ASSETS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE

Cryptocurrency and other digital assets are highly speculative, involve significant risk, and may result in the complete loss of value. Cryptocurrency and other digital assets are not deposits, are not insured by the FDIC or SIPC, are not bank guaranteed, and may lose value.

All cryptocurrency transactions, once submitted to the blockchain, are final and irreversible. SoFi is not responsible for any failure or delay in processing a transaction resulting from factors beyond its reasonable control, including blockchain network congestion, protocol or network operations, or incorrect address information. Availability of specific digital assets, features, and services is subject to change and may be limited by applicable law and regulation.

SoFi Crypto products and services are offered by SoFi Bank, N.A., a national bank regulated by the Office of the Comptroller of the Currency. SoFi Bank does not provide investment, tax, or legal advice. Please refer to the SoFi Crypto account agreement for additional terms and conditions.

SOIN-Q225-073

The Effects of Deadweight Loss

What Is Deadweight Loss?

First: Calculate Surplus

Common Causes of Deadweight Loss

How to Calculate Deadweight Loss

Example of Deadweight Loss

Scenario B — The Impact of Taxes

Why Investors Should Care About Deadweight Loss

The Takeaway

FAQ

Why does a monopoly cause a deadweight loss?

Can deadweight loss be a negative value?

Is deadweight loss market failure?

Front-Running Explained

What Is Front Running?

How Front Running Works

A Front Running Example

Front Running in the Real World

Is Front Running Legal?

Are There Times When Front Running Is OK?

The Takeaway

FAQ

Why is front-running illegal?

How can I identify if my trades have been affected by front running?

Are there any technological solutions or tools available to detect and prevent front running?

A Guide to Delta-Neutral Trading Strategies

What Is Delta?

What Does Delta Neutral Mean?

How Does Delta Neutral Function?

Basic Mechanics

An Example of Delta-Neutral in Use

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

Profiting From Delta-Neutral Trading

Shorting Vega

Waiting for Collapse in Volatility

Pros and Cons of Delta Neutral Positions

Pros:

Cons:

Delta-Neutral Straddle

The Takeaway

FAQ

How do you make money with a delta-neutral strategy?

What is a delta-neutral strike?

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

Option Assignment: Defined and Explained

What Is Option Assignment?

How Does Option Assignment Work?

A Peek Under the Hood

Can You Know If a Position Will Be Assigned?

Can You Do Anything If a Position Is Assigned?

Finally, user-friendly options trading is here.*

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

What Happens After a Position Is Assigned?

Option Assignment Example

Option Assignment and Multi-Leg Strategies

What Does Assignment Mean for Individual Investors?

The Takeaway

FAQ

How is option assignment determined?

Are options assigned before or after expiration?

What are option assignment fees and how much are they?

Cost of Carry, Explained and Defined

What Is Cost of Carry?

How Cost of Carry Works

Which Markets Are Impacted by Cost of Carry?

Cost-of-Carry Calculation

Futures Cost of Carry

Options Cost of Carry

Examples of Cost of Carry

Cash and Carry Arbitrage

Cost of Carry and Net Return

Can You Do Anything About Cost of Carry?

The Takeaway

FAQ

How can you calculate cost of carry?

Do bonds have a cost of carry?

How are ordering and carrying costs different?

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