What Is a Collar Option?

A collar is an options strategy used by traders to protect themselves against heavy losses. The strategy, also known as a hedge wrapper, involves taking a long position in an underlying stock, buying an out-of-the-money put, and selling an out-of-the-money call.

A collar works by protecting a trader’s existing long stock position by buying a put option, limiting any further losses should the stock price fall below the strike of the put. At the same time, the sale of an out-of-the-money call helps finance the trade, making the cost of protection cheaper than purchasing a put on the underlying shares, with the trade-off that gains will be capped should the stock rise above the strike of the call.

What is the maximum profit on a collar option?

The maximum profit on a collar is when the stock price rallies up to the call’s strike price. Above that level, gains are constant since the long stock position is offset by the short call.

What is maximum loss on a collar option?

The maximum loss on a collar option trade is when the stock price declines to the put’s strike price. Below that level, losses are limited since the long stock position is offset by the long put.

What is breakeven on a collar option?

The breakeven on a collar strategy at expiration is the current stock price minus the net credit received or the current stock price plus the net debit paid.

InvestGen Archives

Jan

2025

Options Collar: How the Strategy Works and Examples

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

A collar is an options strategy used by traders to try to protect themselves against heavy losses. The strategy, also known as a hedge wrapper, is a risk-management options strategy that involves taking a long position in an underlying stock, buying an out-of-the-money (OTM) put, and selling an OTM call.

With an option collar, you’re buying a protective put and a covered call at the same time on a stock that you already own or have long exposure to. Although options collars are designed with the aim to protect against losses, they may also limit any potential gains. Investors need to consider a collar’s break-even point, maximum risk of loss, and maximum potential profit.

Key Points

• Options collar strategy involves buying a protective put and selling a covered call to limit losses and gains on a stock.

• The strategy is used to protect unrealized gains while allowing some upside potential.

• Maximum profit and loss depend on whether the trade is executed at a net credit or debit.

• Time decay and volatility have specific impacts on the strategy, affecting option prices and potential outcomes.

• Collar options are effective for managing risk and protecting assets without selling stock positions.

What Is an Options Collar?

An options collar is designed to manage risk by buying a put option and selling a covered call option at the same time for the same underlying stock. Investors may use this options trading strategy when they want to potentially limit losses on a stock they own, even if it means putting a limit on potential gains.

Typically, the stock price will be between the two strike prices: the high price on the covered call, and the low price on the put option. An options trader uses a collar when they are bullish on the underlying stock but want to be protected against the potential risk of large losses.

A collar is also a useful option strategy when the goal is to protect unrealized gains on a stock.

How Options Collars Work

With a collar option strategy, a trader aims to protect their long stock position by buying a put option, limiting any further losses should the stock price fall below the put’s strike price. Traders also sell an out-of-the-money call option for more than the stock’s current price. This caps potential gains, but it may also help reduce the cost of protection when compared to the premium of a standalone put on the underlying shares. This comes with the trade-off of capped gains, however: any increase in value beyond the strike price will not be realized.Buying a put gives the trader the right (but not the obligation) to sell the stock at the put’s strike price. Selling the call requires the writer to sell the stock at the call’s strike price, if it is assigned. In the meantime, the trader remains long on the shares of the underlying stock.

A trader constructs a collar through their brokerage when they think there could be near-term weakness in the stock but do not want to sell their position.

Maximum Profit

The short call position in a collar option strategy caps upside, limiting the maximum potential profit. The maximum profit depends on whether or not the investor establishes the options trade at a net debit (upfront expense) or a net credit (upfront income).

• Net debit: Maximum profit = Call strike price – Stock purchase price – Net premium paid

• Net credit: Maximum profit = Call strike price – Stock purchase price + Net premium received

At a high level, the trader makes the most money when the stock price is at or above the call’s strike at expiration.

Maximum Loss

The protective put limits losses in the event the underlying share price falls below the put’s strike. This is calculated in one of two ways:

• Net debit: Maximum loss = Stock purchase price – Put strike price – Net debit paid

• Net credit: Maximum loss = Put strike price – Stock purchase price + Net premium received

Break-even Points

Once established, a collar option has two possible break even points – again, depending on whether the trade was executed at a net credit or debit.

• Net debit: Break-even point = Stock purchase price + Net premium paid

• Net credit: Break-even point = Stock purchase price + Net premium collected

Pros and Cons of Collars

Pros	Cons
Limits losses from a falling share price	Limits gains from a rising share price
Allows for some upside exposure	Exposes the trader to risk within the range of the collar
Cheaper than only buying puts	Can be a complicated strategy for new traders
Ownership of the stock retained	Early assignment risk may disrupt the strategy’s effectiveness

Options Collar Examples

Suppose a trader is long shares of XYZ stock that currently trades at $100. The trader is concerned about limited near-term upside and wants to avoid the risk of a significant decline in share price. A collar strategy might help with these concerns.

The trader sells a covered call at the $110 strike price, receives a $5 premium, and also buys a protective put at the $90 strike price of $4. The net credit is $1 and the trader has not paid any commissions.

With these two options trades, the trader has capped their upside at the call’s strike price and the downside at the put’s strike. The breakeven point is $99 (the current stock price, minus the net credit from the premium).

Let’s say the stock rallies to the call’s strike by expiration. In this case, the trader realizes value on the long stock position, keeps the $5 call premium, and lets the put expire worthless. The gain is $11 (the stock price’s gain plus the option’s net credit received.

If the stock price drops to $80, the trader loses $20 on the stock position, keeps the $5 call premium, and $6 gain on the $90 strike long put. Thus, the net loss is $9. The trader benefitted from the collar as opposed to just owning the stock, which went down $20. The payoff diagram below shows how losses are limited in our trade scenario, but gains are also capped at the $110 mark.

Collar Payoff Diagram

Factors That Impact an Options Collar

There are three main factors that can impact the outcome of a collar.

Impact of Price Changes

A collar keeps a trader’s long-term bullish stance while seeking to protect unrealized profits from a short-term decline in share price. If the underlying stock price rises, the collar provides some exposure to upside gains, capped at the short call’s strike. The real value of a collar comes if the stock price drops through the long put strike: the collar protects the trader from further losses.

Another way to look at the impact of price changes is to view it from a perspective of time. A collar can help a trader with a short-term bearish outlook but a bullish long term view. Collars have a positive Delta.

Impact of Volatility Changes

Changes in volatility have a relatively smaller impact on a collar options strategy versus other options trades. This is because the trader has simultaneous long and short option positions. The collar trade usually has a near-zero vega, a calculation that measures an option’s sensitivity to the underlying asset’s volatility.

Recommended: What Are the Greeks in Options Trading?

Impact of Time

With a collar options trade, the effect of time decay depends on how close the stock price is to the option strike prices. Time decay demonstrates the loss in value that an option has as it nears expiration.

Time decay benefits the trader when the underlying stock’s price approaches the short call’s strike price. The option’s extrinsic value decreases as it approaches expiration, which can reduce the potential of assignment.

On the flip side, time decay may work against the trader if the stock price nears the long put’s strike, as the put’s extrinsic value gradually decreases approaching expiration. However, if the stock price stabilizes near the strike price, the option retains intrinsic value, which offsets the impact of time decay, unless the put expires worthless.

When the stock price is about equally between the two strikes, time decay is neutral since both option prices erode at approximately the same rate. So, while the short put value drops, the long call offsets those gains from time decay.

Reasons to Consider Using a Collar Option Strategy

A collar is an effective strategy when an investor expects a stock to trade sideways or down over a period. A trader might also use it when they expect a stock to go up over time and do not want to sell their shares, but they do want to protect unrealized gains – perhaps for tax reasons. A collar option trade is less bearish than buying puts outright, but it may still offer a hedge against large losses. Also, selling the upside call helps finance the protective position.

Limiting Risk

A collar option strategy limits risk beyond the protective put’s strike. Even if a stock price goes to zero, the trader’s loss maxes out at the protective put’s strike.

Protecting an Asset

Another way to protect your stock position is to implement a protective put. With a protective put, a trader buys a put in addition to their long position in the underlying stock. This trade would be more expensive than a collar, since there is no sale of a call option to offset the cost of buying the put, but retains the unlimited upside of the underlying stock position.

The Takeaway

An options collar is a strategy in options trading whereby a trader protects an unrealized gain on a stock at a reduced cost while still allowing some upside equity participation. This strategy is commonly used by traders engaging in online investing to manage risk. Traders might implement a collar for tax purposes or to limit the overall risk in their portfolio.

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

Are options collars bearish or bullish?

An options collar strategy is neither strictly bearish nor bullish. It is typically a neutral-to-slightly-bullish strategy because it provides downside protection through the put option while allowing limited upside potential via the call option. This makes it a common option for investors who are cautiously optimistic but want to hedge against significant downside risk.

What is the benefit of an options collar strategy

An options collar strategy offers downside protection by way of a put option while reducing costs by selling a call option. It also allows investors to retain ownership of the underlying stock. This strategy could help mitigate risk and potentially create more portfolio stability.

What is the opposite of an options collar?

The opposite of an options collar strategy can be considered one of several moves: a naked position, which is an options contract with no offsetting position, or an unhedged long or short stock position, which means holding a financial asset without risk management strategies in place (e.g., other options or futures contracts) to protect against downward price movements.

What is the risk of an options collar?

Options collars come with several potential downsides. There is limited upside potential due to the sale of the out-of-the-money call option, limited risk reduction since a collar does not protect against losses entirely, and early assignment risk, which occurs when the call option buyer exercises their right to purchase the stock before the option’s expiration, potentially disrupting the strategy.

Photo credit: iStock/gorodenkoff

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.

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

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.

¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

SOIN-Q424-043

Jan

2025

Trading Futures vs. Options: Key Differences to Know

Futures vs Options: What Is the Difference?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Futures and options are both derivative contracts that enable an investor to buy or sell an investment for a certain price by a certain date. Although they share similarities, they work quite differently and pose different risks for investors.

With an options contract, the holder has the option (but not the obligation) to buy an underlying asset, such as stock in a business, for a specified price by a specific date. A futures contract requires the holder to buy the asset on the agreed-upon date (unless the position is closed out before then).

The underlying asset for a futures contract is often a physical asset, such as commodities like grain or copper, but you can also trade futures on stocks or an equity index, such as the S&P 500. The underlying asset for an options contract can be a financial asset like a stock or bond, or it could be a futures contract.

Key Points

• Futures contracts make obligations about trading an underlying asset at a set price and date.

• Options give the buyer the right, not the obligation, to trade the underlying asset.

• Futures are riskier due to high leverage and daily mark-to-market adjustments.

• Options buyers risk only the premium paid, while futures leverage amplifies gains and losses.

• Both futures and options are used by hedgers and speculators for different purposes.

Main Differences Between Futures and Options

Although futures and options are similar, as they are both derivative contracts tied to an underlying asset, they differ significantly in terms of risk, obligations, and the ways in which they are executed.

How Futures Work

Futures contracts are a type of derivative in which buyers and sellers are obligated to trade a specific asset on a certain future date, unless the asset holder closes their position prior to the contract’s expiration.

A futures contract consists of a long side and a short side, where the short side is obligated to make delivery of the underlying asset, and the long side is obligated to take it (unless the contract is terminated before the delivery date).

Both options and futures typically employ some form of financial leverage or margin, amplifying gains and losses, increasing potential risk of loss.

How Options Work

Options trading consists of buying and selling derivatives contracts that give the holder the right, but not the obligation, to buy or sell an asset at a specified price (the strike price) by the contract’s expiration date.

• The options buyer (or holder) may buy or sell a certain asset, like shares of stock, at a certain price by the expiration of the contract. Buyers pay a premium for each option contract; this represents the cost of acquiring the option.

• The options seller (or writer), who is on the opposite side of the trade, has the obligation to buy or sell the underlying asset at the strike price, if the options holder exercises their contract.

There are only two types of options: puts and calls. Standard equity options contracts are for 100 shares of the underlying security.

💡 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.

The Role of Risk

Trading options come with certain risks. The buyer of an option could lose the premium they paid to enter the contract. The seller of an option is at risk of being required to purchase or sell an asset if the buyer on the other side of their contract exercises the option.

Futures can be riskier than options due to the high degree of leverage they offer. A trader might be able to buy or sell a futures contract putting up only 10% of the actual value, known as margin. This leverage magnifies price changes, meaning even small movements can result in substantial profit or loss.

With futures, the value of the contract is marked-to-market daily, meaning each trading day money may be transferred between the buyer and seller’s accounts depending on how the market moved. An option buyer is not required to post margin since they paid the premium upfront.

The Role of Value

Futures pricing is relatively straightforward. The price of a futures contract should approximately track with the current market price of the underlying asset, plus any associated costs (like storage or financing) until maturity.

Option pricings, on the other hand, is generally based on the Black-Scholes model. This is a complicated formula that requires a number of inputs. Changes in several factors other than the price of the underlying asset, including the level of volatility, time to expiration, and the prevailing market interest rate can impact the value of the option.

Holding constant the price of the underlying asset, futures maintain their value over time, whereas options lose value over time, also known as time decay. The closer the expiration date gets, the lower the value of the option gets. Some traders use this as an options trading strategy. They sell options contracts, anticipating that time decay will eat away at their value over time, expire worthless, and allow them to keep the premium collected upfront.

Options come with limited downside, since the maximum loss is the premium. Futures, however, can fall below zero: the contract’s value is tied to the underlying asset’s price, meaning traders may have to pay more than the contract’s original value.

Here are some of the key differences between futures and options:

Futures	Options
Buyer is obliged to take possession of the underlying asset, or make a trade to close out the contract. Seller is obligated to deliver the asset or take action to close the position.	Buyer has the right, but not the obligation, to buy or sell a certain asset at a specific price, while the seller has the obligation to fulfill the option contract if exercised.
Futures typically involve taking much larger positions, which can involve more risk.	Options may be less risky for buyers because they are not obliged to acquire the asset.
No up-front cost to the buyer, other than commissions.	Buyers pay a premium for the options contract.
Price can fall below $0.	Price can never fall below $0.

Understanding Futures

Futures contracts are similar to options in that they set a specific price and date for the trade of an underlying asset. Unlike options, that give the holder the right to buy or sell, futures investors are obligated to buy at a certain date and price.

Among the most common types of futures are those for commodities, with which speculators can attempt to benefit from changes in the market without actually buying or selling the physical commodities themselves. Commodity futures may include agricultural products (wheat, soybeans), energy (oil), and metals (gold, silver).

There are also futures on major stock market indices, such as the S&P 500, government bonds, and currencies.

Rather than paying a premium to enter a futures contract, the buyer pays a percentage of the market value, called an initial margin.

Recommended: Margin Account: What It Is and How It Works

Example of a Futures Contract

Let’s say a buyer and seller enter a contract that sets a price per bushel of wheat. During the life of the contract, the market price may move above that price — putting the contract in favor of the buyer — or below the contracted price, putting it in favor of the seller.

If the price of wheat goes higher at expiration, the buyer would make a profit off the difference in price, multiplied by the number of bushels in the contract. The seller would incur a loss equal to the price difference. If the price goes down, however, the seller would profit from the price difference.

Who Trades Futures?

Traders of futures are generally divided into two camps: hedgers and speculators. Hedgers typically have a position in the underlying commodity and use a futures contract to mitigate the risk of future price movements impacting their investment.

An example of this is a farmer, who might sell a futures contract against a crop they produce, to hedge against a fall in prices and lock in the price at which they can sell their crop.

Speculators, on the other hand, accept risk in order to potentially profit from favorable price movements in the underlying asset. These may include institutional investors, such as banks and hedge funds, as well individual investors.

Futures enable speculators to take a position on the price movement of an asset without trading the actual physical product. In fact, much of trading volume in many futures contracts comes from speculators rather than hedgers, and so they provide the bulk of market liquidity.

Understanding Options

Options buyers and sellers may use options if they think an asset’s price will go up (or down), to offset risk elsewhere in their portfolio, or to potentially enhance returns on existing positions. There are many different options-trading strategies.

Example of a Call Option

An investor buys a call option for a stock that expires in six months, paying a premium. The stock is currently trading at just below the option’s strike price.

If the stock price goes up above the strike price within the next six months, the buyer can exercise their call option and purchase the stock at the strike price. If they sell the stock, their profit would be the difference in the price per share, minus the cost of the premium.

The buyer could also choose to sell the option instead of exercising it, which can also result in a profit, minus the cost of the premium.

If the price of the stock is below the strike price at the time of expiration, the contract would expire worthless, and the buyer’s loss would be limited to the premium they paid upfront.

Example of a Put Option

Meanwhile, if an investor buys a put option to sell a stock at a set price, and that price falls before the option expires, the investor could earn a profit based on the price difference per share, minus the cost of the premium.
If the price of the stock is above the strike price at expiration, the option is worthless, and the investor loses the premium paid upfront.

Who Trades Options?

Options traders often fall into two categories: buyers and sellers. Buyers purchase options contracts — be they calls or puts — with the hope of making a profit from favorable price movements from the underlying asset. They also want to limit potential loss to the premium they paid for the option. Sellers can potentially profit from the premium they’ve collected when writing the options contract, but they face the risk of having to fulfill the contract if the market moves unfavorably.

The Takeaway

Futures and options are two types of investments for those interested in hedging and speculation. These two types of derivatives contracts operate quite differently, and present different opportunities and risks for investors.

Futures contracts specify an obligation — for the long side to buy, and for the short side to sell — the underlying asset at a specific price on a certain date in the future. Meanwhile, option contracts give the contract holder (or buyer) the right to buy or sell the underlying asset at a specific price, but not the obligation to do so.

Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not offer future derivatives at this time.

FAQ

Are futures more risky than options?

Both options and futures are considered high-risk investments. Futures are considered more risky than options, however, because it’s possible to lose more than your total investment amount.

Which uses more leverage: futures or options?

Typically, futures trading uses more leverage, and that’s part of what makes futures higher risk, and potentially appealing to speculators.

Which is easier to trade: futures or options?

Options strategies can be more complicated, and in some ways futures contracts are more straightforward, but futures trading can be highly speculative and volatile.

Photo credit: iStock/DonnaDiavolo

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.

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.

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.

¹Probability of Member receiving $1,000 is a probability of 0.026%; If you don’t make a selection in 45 days, you’ll no longer qualify for the promo. Customer must fund their account with a minimum of $50.00 to qualify. Probability percentage is subject to decrease. See full terms and conditions.

SOIN-Q424-053

Jan

2025

Short Position vs Long Position, Explained

Short Position vs Long Position: What’s the Difference?

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.

When you own shares of a security, that’s a long position. When you borrow shares in order to sell them, that’s a short position (since you’re literally “short” of the shares).

Going long is considered a bullish strategy, whereas selling short is a bearish strategy because you’re banking on the share price declining. But there are exceptions to these conventions, and ultimately your strategy can depend on the securities being traded.

Key Points

• Long positions in stocks involve buying shares with the expectation of potential price increases, that may come with unlimited upside and limited downside risk.

• Short positions in stocks involve borrowing shares to sell, hoping for price drops, with unlimited risk and interest costs.

• Long options positions can be bullish or bearish, influenced by time decay and volatility.

• Short options positions involve selling contracts, aiming for price drops, with strategies based on market projections.

• Long positions are typically used when bullish, while short positions are typically used for bearish outlooks or hedging.

Long vs. Short Position in Stocks

An investor in a short position aims to benefit from a decline in the price of the asset. When you go short, your goal is to borrow shares at one price, sell them on the open market and then — assuming the price drops — return them to the broker at a lower price so you can keep the profit. Executing a short stock strategy is more complicated than putting on a long trade, and is for experienced traders.

When you go long on an asset, you are bullish on its price. Your potential downside is limited to the total purchase price, and your upside is unlimited. That’s a key difference in a long vs short position, since short positions can feature an unlimited risk of loss (if the price rises instead of dropping), with a capped upside potential (because the price can only drop to zero).

Long Positions and Stocks

To take a long position on shares, you execute a buy order through your brokerage account. This involves purchasing the stock with the expectation that its price will increase over time, allowing you to sell it later at a profit. In essence, a long position represents traditional stock ownership — buying low and selling high.

Short Selling a Stock

Short selling a stock is done by borrowing shares from your stock broker, typically using a margin account, then selling them on the open market. This is known as “sell to open” because you’re opening a short position by selling the shares first.

By using a margin account (a.k.a. leverage), you would owe interest on the amount borrowed, and you face potentially unlimited losses since the stock price could hypothetically rise to infinity. Investors must meet specific criteria in order to trade using margin, given its potential for significant losses as well as gains.

You must close your short position in the future by repurchasing the shares in the market (hopefully at a lower price than that at which you sold them), and then return the shares to the broker, keeping the profit. Remember: you’re paying interest on the money borrowed to open the position, which may influence when you decide to close.

A short squeeze is a danger short sellers face since intense short-covering — a rush to buy stock to cover short positions — leads to a rapidly appreciating share price (when traders rush to buy back stock, causing prices to increase quickly). It can also create opportunities for market participants who anticipate the squeeze, however.

💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.

Long vs. Short Position in Options

Long and short positions also exist in the world of options trading.

Long Position in Options

In options trading, going long means entering a buy-to-open order on either calls or puts. A long options position can be bullish or bearish depending on the type of option traded.

• For example, in a long call position, you hope that the underlying asset price will appreciate so that your call value increases. The maximum potential gain for buying a long call is unlimited, while the maximum loss is limited to the premium paid.

• In a long put position, you want to see the underlying asset price drop below the strike price, since buying a put offers the holder the right, but not the obligation, to sell a security at a specified price within a specified time frame. The maximum potential gain for buying a long put is the difference between the strike price and the asset price, minus the premium paid, while the maximum loss is the premium paid.

Investors may employ options strategies designed to seek returns from volatility, though these also tend to be higher risk. These strategies for options trading rely on the expectation that a stock price may become more erratic, thus making the options potentially more valuable.

A long straddle strategy, for example, is one of several strategies that bets on higher volatility by taking bullish and bearish positions of different financial values, anticipating upside or downside while still hedging against one or the other. These strategies may under perform if volatility decreases or remains stable. In that case, the maximum potential loss is limited to the total premiums paid for both options.

Short Selling Options

You can sell short options by writing (a.k.a. selling) contracts. The goal is the same as when selling shares short: you are expecting the option price to drop. Unlike shorting shares, which always reflects a bearish expectation, shorting options can involve either a bearish or bullish outlook, depending on whether you short calls or puts. An options seller enters a sell-to-open order to initiate a short sale.

You can take a bearish or bullish strategy depending on the options used. Whether you short call vs put options makes a difference: If you short call options, you are bearish on the underlying security. Shorting puts is considered a bullish strategy.

With options, you can short implied volatility and benefit from the passage of time. Entering a short position on calls and puts is done in the hope of seeing the option premium decline in value — that can come from changes in the underlying asset’s price, but it can also come from a decline in implied volatility and as expiration approaches.These are plays on two of the options Greeks: vega and theta.

Examples of Long Positions

Long positions come in different forms: going long on a stock – where you purchase shares outright, and going long on calls and puts – where you anticipate fluctuation on the price an investor pays to purchase the stock.

Going Long on a Stock

When you go long on shares of stock, you actually own shares in the company. Typically, you would go long on shares if you believe the price will rise, and would look to eventually sell them to potentially realize a gain. Here, you have unlimited upside potential (if the price continues to rise), and the downside is limited to what you paid for the shares ($1,000).

Going long on options, however, works a bit differently.

Going Long on Calls and Puts

Consider this example of going long on a call option. Say, for example, that you believe stock XYZ is poised to increase in value. You can purchase a call option on XYZ with an expiration date of three months, and wait to see if the stock increases within the contract window. If it does, you can exercise the option and purchase the stock at the agreed-upon strike price, with the likelihood of making a profit. If the price doesn’t move or declines, your option expires worthless, and you would lose the premium per share that you paid for the option.

Let’s say on the other hand that you believe stock XYZ’s will decline in a few months. You may then wish to go long on a put option. You would buy a put option for XYZ with an expiration date of three months. If the stock price falls below the strike price before the expiration date, you can exercise the option to sell the stock at its lower price, likely generating a profit (minus the premium). If you believe the stock price will stay flat or rise, your option would expire and be rendered useless – and you would only be out the premium you paid.

Examples of Short Positions

Like long positions, short positions come in various forms as well. Shorting a stock is when you borrow shares in order to sell them and (hopefully) repurchase them at a lower price, while shorting an option is when you sell an option contract with the expectation that the underlying stock will rise to a certain price.

Shorting a Stock

If you wanted to short shares of XYZ, currently selling at $10 per share, this is a bearish strategy as you’re essentially betting on a price decline.

Let’s say you want to short stock XYZ. You would borrow shares from a stock broker and sell them on the open market. If the price falls, you buy back the shares at a lower price and return them to the broker, thus pocketing the difference as profit. Bear in mind that if the stock price rises, instead of falling, your losses are theoretically unlimited. This makes shorting stocks potentially riskier.

Going Short on an Option

If you think that stock XYZ is overvalued, and that its price will remain flat or decline, you might sell a call option with an expiration date of three months. Should the stock price stay below the strike price by the contract’s expiration, the option will expire worthless, and you’ll keep the premium paid by the buyer. If the stock price rises above the strike price, however, the buyer may exercise their right to purchase the stock at the strike price. This would leave you responsible for delivering the shares, which could result in losses.

If you believe stock XYZ is undervalued and its price will rise, you might sell a put option with the same three-month expiration. Should the stock price stay above the strike price, the option will expire worthless and you keep the premium. But if the price falls below the strike price, the buyer may exercise their right to sell the stock to you, and you’d be obligated to buy it, potentially incurring losses if the market price of the stock drops.

Comparing Long Positions vs Short Positions

Although long and short positions have different aims, these strategies do share some similarities.

Similarities

Both exposures require a market outlook or a prediction of which direction a single asset price will go.
If you’re bullish on a stock, you could consider going long by buying shares directly or buying call options. Both may profit from a rising stock price. Alternatively, if you’re bearish, you may opt to short the stock or sell call options. Both depend on a view of a share, or of the markets in general.

Differences

Short vs. long positions have several differences, and the ease with which you execute the trade is among them. For example, when taking a short position you’ll typically be required to pay interest to a broker. With a long position, you do not usually pay interest.

Additionally, long positions have unlimited gains and capped losses, whereas short positions have unlimited losses and capped gains.

Similarities in a Long Position vs. Short Position	Differences in a Long Position vs. Short Position
You can go long or short on an underlying stock via calls and puts.	Taking a long position on shares is bullish, while going short is bearish.
Both long and short positions offer exposure to the market or individual assets.	Short positions can have potential losses that are unlimited with capped upside — that is the opposite of some long positions.
Both rely on predicting price movements within a specific timeframe.	Long positions require paying the upfront cost in full; short positions often require having a margin account.

💡 Quick Tip: If you’re an experienced investor and bullish about a stock, buying call options (rather than the stock itself) can allow you to take the same position, with less cash outlay. It is possible to lose money trading options, if the price moves against you.

Pros and Cons of Short Positions

When considering a short position, it can be helpful to look at both the pros and cons.

Pros of Short Positions	Cons of Short Positions
You benefit when the share price drops.	You owe interest on the amount borrowed.
You can short shares and options.	There’s unlimited risk in selling shares short.
Shorting can be a bearish or bullish play.	There are limited gains since the stock can only drop to zero, and a risk of complete loss if the share price continues to rise.

Pros and Cons of Long Positions

Likewise, when considering a long position, assessing the benefits and drawbacks can be helpful.

Pros of Long Positions	Cons of Long Positions
You can own shares and potentially benefit when the stock rises and may also profit from puts when the underlying asset drops in value.	You face potential losses on a long stock position and on call options when the share price drops.
You can take a long position on calls or puts.	You must fully pay for the asset upfront, or finance through a margin account.
There’s unlimited potential upside with calls and shares of stock.	A long options position may be hurt from time decay (loss of value near expiration date).

The Takeaway

Buying shares and selling short are two different strategies to potentially profit from changes in an asset’s price. By going long, you can purchase a security with the goal of seeing it rise in value. Selling short is a bearish strategy in which you borrow an asset, sell it to other traders, then buy it back — hopefully at a lower price — so you can return it profitably to the broker.

Shorting options can also be a bullish strategy, depending on whether you’re shorting call or put options. Shorting calls is considered bearish, while shorting puts reflects a more bullish sentiment since you profit if the asset’s price rises or remains stable.

Explore SoFi’s user-friendly options trading platform.

FAQ

Are short positions riskier than long positions?

Yes, short positions can be riskier than long positions. That goes for selling shares of a stock short and when you write options. Speculators often face more risk with their short positions while hedgers might have another position that offsets potential losses from the short sale.

What makes short positions risky?

You face unlimited potential losses when you are in a short position with stocks and call options. Selling shares short involves borrowing stock, selling it out to the market, then buying it back. There’s a chance that the price at which you buy it back will be much higher than what you initially sold it at.

How long can you hold a short position?

You can hold a short position indefinitely. The major variable to consider is how long the broker allows you to short the stock. The broker must be able to lend shares in order for you to short a stock. There are times when shares cannot be borrowed and when borrowing interest rates turn very high. As the trader, you must also continue to meet margin requirements when selling short.

Photo credit: iStock/Charday Penn

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

SOIN-Q424-042

Dec

2024

Bid and Ask Price: Definition, Example, How It Works

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Bid and ask are commonly used investing terms, and they refer to the best potential price at which a security on the market could be bought or sold for at any given time. In other words, the best price that buyers and sellers would potentially be willing to buy (the “bid” price) or sell (the “ask” or offer price) the asset.

It’s important for traders to understand the bid vs. ask price of a security, as well as the difference between the two, which is known as the bid-ask spread. The market price is a historical price: the price of the last trade that occurred with the security. The bid and ask prices, on the other hand, show what buyers and sellers would be willing to trade the security for now.

Key Points

• The bid price is the highest price a buyer is willing to pay for a security, reflecting market demand.

• The ask price is the lowest price a seller is willing to accept, representing market supply.

• The bid-ask spread, the difference between bid and ask prices, serves as a transaction cost and indicates market liquidity.

• Narrow bid-ask spreads suggest high liquidity and trading volume, while wider spreads indicate lower liquidity.

• Investors use the bid-ask spread to assess market sentiment and risk, with narrower spreads indicating lower risk.

What Are Bid and Ask?

If you’re new to online investing or investing in stocks, you’re probably wondering about bid vs. ask prices. Bid and ask prices show the current market supply and demand for the security. The bid price represents demand for a security; the ask price represents supply.

When an asset has high liquidity — i.e. the market has a high trading volume not dominated by selling — the bid and ask prices will be fairly close. In other words the bid-ask spread, or the difference between the bid and ask prices, will be narrow in a highly liquid market. When there’s a greater gap between demand and supply, the spread will be wider.

That’s why the bid-ask spread is often considered a gauge of liquidity.

Bid Price

The bid price is the best potential price that retail investors would be willing to pay to buy a security.

So if a trader wants to sell a security, they would want to know how much they’d be able to sell it for. They can find out the best price they could get for the security by looking at the current bid price in the market, which would show the highest potential amount they could get for it.

Ask Price

Conversely, ask price is the lowest price investors are willing to sell a security for at any given time. If a trader wants to buy a security, they want to get the lowest possible price, so they look at the ask price to find out what that is.

Bid and Ask Price Examples

Let’s imagine that an investor wants to buy Stock X at the quoted price of $75, so they plan to buy 10 shares for $750. But they end up paying $752. That’s not an error, but rather because the ask price (the selling price) is $75.20.

The current price of $75 per share is the last traded price. But prices can change quickly, and in this case the ask price was 20 cents higher. The bid or buyer’s price is almost always lower than the ask price.

Investors can use limit orders to set specific parameters around the price at which they’re willing to buy or sell a security. This can give investors some control, so they’re not simply paying the current price, which may or may not be advantageous.

Evaluating the bid-ask spread can be part of an investor’s due diligence when trying to gauge rates of return for different securities.

What the Bid-Ask Spread Signals

How far apart the ask price and bid price are can give you a sense of how the market views a particular security’s worth.

If the bid price and ask price are fairly close together, that suggests that buyers and sellers are more or less in agreement on what a security is worth. On the other hand, if there’s a wider spread between the bid and ask price, that might signal that buyers and sellers don’t necessarily agree on a security’s value.

How Are Bid and Ask Prices Determined?

Essentially it’s the supply and demand of the market that sets the bid and ask prices. And many factors can play into supply vs. demand. Because of this, investors who are interested in active investing can use the difference in price between the bid and the ask of a security to gauge what the market thinks the security is worth.

Investors and market-makers can place buy or sell orders at a price they set. These orders will be fulfilled if someone is willing to sell or buy the security at that bid or ask price. Those order placements determine the bid and ask price.

What’s the Difference Between Bid and Ask Prices?

In any market, from stocks to real estate to lemonade stands, there is almost always a difference between what someone is willing to pay for an item versus what someone wants to sell it for.

A buyer may want to buy a house for $300,000, but the seller is selling it for $325,000. An investor may want to buy a stock for $100, but the sell or ask price is $105.

That difference in price is called the spread, and when the spread is narrow it’s a lot easier to close the sale. When the spread is wider, there is a bigger gap between what the buyer thinks an item is worth vs. what the seller thinks it’s worth.

What Does It Mean When Bid and Ask Are Close?

A narrow spread, i.e. when the bid and ask price are close, means traders will be able to buy and sell the security at roughly the same price. This generally means there is a high trading volume for the security, with a lot of people willing to buy and sell because of high demand.

If demand increases for the security, the bid and ask prices will move higher, and vice versa. If there is a surge in demand, but not enough supply, that might drive the bid price up. Conversely, if supply outpaces demand, the bid price of a security could fall In either case, the spread would likely get wider when the bid or the ask prices outweighs the other.

The Bid-Ask Spread

The bid-ask spread is the gap between the two prices: the bid or buyer’s price and the ask or offer price. There are different factors that can affect a stock’s spread, including:

• Liquidity. A measure of how easily a stock or security can be bought and sold or converted to cash. The more liquid an investment is, the closer the bid and ask price may be, since the market is in agreement about what the security is worth.

• Trading volume. This means how many shares of a stock or security are traded on a given day. As with liquidity, the more trading volume a security has, the closer together the bid and ask price are likely to be.

• Volatility. A way of gauging how rapidly a stock’s price moves up or down. When there are wider swings in a stock’s price, i.e. more volatility, the bid-ask price spread can also be wider as market makers attempt to profit from the price changes.

Who Benefits From the Bid-Ask Spread?

The difference in price between the bid and the ask is where brokers and market makers make their profit.

But traders can also benefit from the bid-ask spread, if they use limit orders to get the best possible price on a desired trade, as opposed to using market orders.

How the Bid-Ask Spread Is Used

When you understand how bid-ask spread works, you can use that to invest strategically and manage the potential for risk. This means different things whether you are planning to buy, sell, or hold a stock.

If you’re selling stocks, that means getting the best bid price; when you’re buying, it means paying the best ask price. Essentially, the goal is the same as with any other investing strategy: to buy low and sell high.

Bid-Ask Spread Impact on Trading Profits

Naturally, the bid-ask spread impacts trading profits, and in fact can act almost as a hidden cost.

For example, if an investor places a market order on a stock with a bid price of $90 and an ask price of $91, they’ll get the stock at $91 per share. If the price of the stock rises 5%, so the bid price is now $94.50 and the ask price is $95.55 and the bid-ask spread is $1.05.

If the investor decides to sell the shares they bought at $91 through a market order, they will receive $94.50 per share. So their profit is $3.50 per share, even though the stock price rose by $4.55. The $1.05 gap in profit reflects the $1.05 bid-ask spread on this stock.

Wide vs Narrow Bid-Ask Spread

What is the difference between wide and narrow bid-ask spreads, and what is the significance of each? Here’s a rundown.

Narrow Bid-Ask Spreads

The bid-ask spread, often just called the spread, is tighter when a security has more liquidity, i.e. there’s higher trading volume for that stock. When you think of big companies, industry leaders, constituents of different indexes like the Dow Jones or the S&P 500, those companies may have higher volume and narrower spreads.

Wider Bid-Ask Spreads

Conversely, smaller companies or those that aren’t in demand tend to have wider spreads, reflecting a lower level of market interest. These trades tend to be more expensive, as investors must contend with lower liquidity.

Impact of the Bid-Ask Spread

The narrower the bid-ask spread, the more favorable it is for traders. If an investor wants to buy 100 shares of Stock A at $60, but shares are being offered at $60.25, that 25 cent spread may not seem like much. It would add up to $25 (100 x 0.25). But if that trader wanted to buy 500 shares or more, the cost of the spread is about $125.

The Takeaway

Bid and ask prices help traders know exactly how much they may buy and sell securities for. The bid price is the highest price a buyer is willing to pay for a security. The ask price is the lowest price a seller is willing to accept. The difference between them is the bid-ask spread, or “spread.” The spread ends up being a transaction cost, as market makers pocket the cost of the spread.

Since the bid price and the ask price are essentially a function of supply and demand in the market, investors can consider the bid-ask spread as a gauge of risk. The narrower the spread, the more aligned buyers and sellers are on the value of a certain security, and thus there’s higher volume and more liquidity — and lower risk to the investor that the stock or security might lose value (although it could, as there are no guarantees).

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹

FAQ

Do I buy a stock at the bid or ask price?

You buy a stock at the ask price, that’s the lowest price the seller is willing to offer.

Is the last price the same as the market price?

The last price is the last traded price for a security, or the last price at which it closed. The market price is the best current price.

Is it better if your bid is higher than the asking price?

The bid price is typically lower than the seller’s price or ask price, so it would be unusual if the bid was higher than the ask. If a bid price is higher than the ask, a trade would occur, but it would put the buyer at risk of a potential loss.

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

SOIN-Q424-021

Dec

2024

What Is a Shareholder Activist?

By Michael Flannelly | Growing Wealth, invest, Investing | Comments Off

A shareholder activist may be a hedge fund, institutional investor, or wealthy individual who uses an ownership stake in a company to influence corporate decision-making. Shareholder activists, sometimes called activist investors, typically seek to change how a company is run to improve its financial performance. However, they may also have other objectives, such as increasing transparency or promoting social responsibility.

Activist shareholders can impact the way a company is managed, thus affecting its stock price. As such, you may benefit from understanding shareholder activism and how these investors may impact the stocks in your portfolio.

Key Points

• Shareholder activists use ownership stakes to influence corporate decisions, aiming to improve financial performance or promote transparency and social responsibility.

• Activists can be hedge funds, institutional investors, or wealthy individuals seeking changes in company management.

• Activist investors may use media and shareholder voting to gain support for their proposals and influence company strategies.

• Goals of activism vary, from improving environmental impact to unlocking shareholder value through strategic changes.

• Activism can lead to stock volatility, but targeted stocks may still be valuable for diversified portfolios if proposed changes are supported.

How Shareholder Activism Works

Shareholder activism is a process in which investors purchase a significant stake in a company to influence the management of the company. When an investor builds up a large enough stake in a company, this usually opens up channels where they may discuss business proposals directly with management.

Activist investors may also use the shareholder voting process to wield influence over a company if they believe it is mismanaged. This more aggressive tactic may allow activist shareholders to nominate their preferred candidates for the board of directors or have a say on a company’s management decisions.

Activist investors typically own a relatively small percentage of shares in a company, perhaps less than 10% of a firm’s outstanding stock, so they may need to convince other shareholders to support their proposals. They often use the media to generate support for their campaigns.

Shareholder activists may also threaten lawsuits if they do not get their way, claiming that the company and its board of directors are not fulfilling their fiduciary duties to shareholders.

Activist investors’ goals can vary. Some investors may want to see companies improve their environmental and social impact, so they will suggest that the company adopt a Corporate Social Responsibility framework. Other investors try to get the company to adopt changes to unlock shareholder value, like selling a part of the company or increasing dividend payouts.

However, shareholder activism can also be a source of conflict between shareholders and management. Some activist investors may prefer the company unlock short-term gains that benefit shareholders, perhaps at the expense of long-term business operations. These investors may exit a position in a company once they unlock the short-term gains with little concern for the company’s future prospects.

Types of Shareholder Activists

There are three primary types of shareholder activists: hedge funds, institutional investors, and individual investors. So, your average investor who may be doing a bit of online investing or building a retirement portfolio likely wouldn’t qualify as a shareholder activist. Each type of shareholder activist has its distinct objectives and strategies.

Hedge Funds

Hedge funds are private investment vehicles usually only available to wealthy individuals who make more than $200,000 annually or have a net worth over $1 million. These funds often take a more aggressive approach to shareholder activism, like public campaigns and proxy battles, to force a company to take specific actions to generate a short-term return on its investment.

Institutional Investors

Institutional investors are typically large pension funds, endowments, and mutual funds that invest in publicly-traded companies for the long term. These investors often use their voting power to influence a company’s strategy or management to improve their investment’s financial performance.

Individual Investors

Though less common than hedge funds and institutional investors, very wealthy individual investors sometimes use their own money to buy shares in a company and then push for change.

Examples of Shareholder Activists

Shareholder activism became a popular strategy in the 1970s and 1980s, when many investors – called “corporate raiders” – used their power to push for changes in a company’s management. Shareholder activism has evolved since this period, but there are still several examples of activist investors

For example, Carl Icahn is one of the most well-known shareholder activists who made a name for himself as a corporate raider in the 1980s. He was involved in hostile takeover bids for companies such as TWA and Texaco during the decade.

Since then, Icahn has been known for taking large stakes in companies and pushing for changes, such as spin-offs, stock buybacks, and management changes. More recently, Icahn spearheaded a push in early 2022 to nominate two new directors to the board of McDonald’s. His goal was to get McDonald’s to change its treatment of pigs. However, his preferred nominees failed to get elected to the board.

Another well known activist investor is Bill Ackman, the founder and CEO of Pershing Square Capital Management, a hedge fund specializing in activist investing. Ackman is known for his high-profile campaigns, including his battle with Herbalife.

In 2012, Ackman shorted the stock of Herbalife, betting the company would collapse. He accused Herbalife of being a pyramid scheme and called for a government investigation. Herbalife denied the allegations, and the stock continued to rise. Ackman eventually closed out his position at a loss.

Other examples of shareholder activists include Greenlight Capital, led by David Einhorn, and Third Point, a hedge fund founded by Dan Loeb.

In 2013, Einhorn took a stake in Apple and pushed for the company to return more cash to shareholders through share repurchases and dividends. Apple eventually heeded his advice and initiated a plan to return $100 billion to shareholders through dividends and buybacks.

In 2011, Loeb’s hedge fund took a stake in Yahoo and pushed for the company to fire its CEO, Scott Thompson. Thompson eventually resigned, and Yahoo appointed Loeb to its board of directors. More recently, in 2022, Loeb took a significant stake in Disney and started a pressure campaign calling on the company to spin-off or sell ESPN. However, he eventually backed off that suggestion.

Is Shareholder Activism Good for Individual Investors?

Depending on the circumstances, a shareholder activist campaign may be good for investors. Some proponents argue that shareholder activism can improve corporate governance, promote ESG investing, and lead to better long-term returns for investors.

Others contend that activist investors are primarily interested in short-term gains and may not always have the best interests of all shareholders in mind. While individual investors may benefit from a stock’s short-term spike after an activist shareholder’s campaign, this rally may not last for investors interested in long-term gains.

The Takeaway

Shareholder activists use their financial power to try to influence the management of publicly traded companies. Because activist investors often leverage the media to promote their goals, individual investors may read about these campaigns and worry about how they could affect their holdings.

Generally, the impact of shareholder activism on investors depends on the specific goals of the activist and the response of the company’s management. If an activist successfully pressures management to make changes that improve the company’s performance, this can increase shareholder value. However, if an activist’s campaign is unsuccessful or the company’s management resists the activist’s demands, this can lead to a decline in the stock price.

Opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.¹

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

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