InvestHH Archives | Page 5 of 19

Feb

2025

The Black-Scholes Model, Explained

By Brian Nibley | Financial Independence, Growing Wealth, invest, Investing | Comments Off

Table of Contents

What Is the Black-Scholes Model?
The History of the Black-Scholes Model
What Does the Black-Scholes Model Tell?
The Black-Scholes Formula
Why Is the Black-Scholes Model Important?
How Accurate Is the Black-Scholes Model?

The Black-Scholes option pricing model is a mathematical formula used to calculate the theoretical price of an option. It’s a commonly-used formula for determining the price of contracts, and as such, can be useful for investors in the options market to know and have in their pocket for use.

But there are some important things to know about it, such as the fact that the model only applies to European options, and more.

Key Points

• The Black-Scholes model is a mathematical formula used to calculate the theoretical price of an option.

• It is commonly used for pricing options contracts and helps investors determine the value of options they’re considering trading.

• The model takes into account factors like the option’s strike price, time until expiration, underlying stock price, interest rates, and volatility.

• The Black-Scholes model was created by Myron Scholes and Fischer Black in 1973 and is also known as the Black-Scholes-Merton model.

• While the model has some assumptions and limitations, it is considered an important tool for European options traders.

What Is the Black-Scholes Model?

As mentioned, the Black-Scholes model is one of the most commonly used formulas for pricing options contracts. The model, also known as the Black-Scholes formula, allows investors to determine the value of options they’re considering trading.

The formula takes into account several important factors affecting options in an attempt to arrive at a fair market price for the derivative. The Black-Scholes options pricing model only applies to European options.

💡 Quick Tip: How do you decide if a certain trading platform or app is right for you? Ideally, the investment platform you choose offers the features that you need for your investment goals or strategy, e.g., an easy-to-use interface, data analysis, educational tools.

The History of the Black-Scholes Model

The Black-Scholes model gets its name from Myron Scholes and Fischer Black, who created the model in 1973. The model is sometimes called the Black-Scholes-Merton model, as Robert Merton also contributed to the model’s development. These three men were professors at the Massachusetts Institute of Technology (MIT) and University of Chicago.

The model functions as a differential equation that requires five inputs:

• The option’s strike price

• The amount of time until the option expires

• The price of its underlying stock

• Interest rates

• Volatility

Modern computing power has made it easier to use this formula and made it more popular among those interested in stock options trading.

The model only works for European options, since American options allow contract holders to exercise at any time between the time of purchase and the expiration date. By contrast, European options come at cheaper prices and only allow the owner to exercise the option on the expiration date. So, while European options only offer a single opportunity to earn profits, American options offer multiple opportunities.

What Does the Black-Scholes Model Tell?

The main goal of the Black-Scholes Formula is to determine the chances that an option will expire in the money. To this end, the model goes deeper than simply looking at the fact that a call option will increase when its underlying stock price rises and incorporates the impact of stock volatility.

The model looks at several variables, each of which impact the value of that option. Greater volatility, for example, could increase the odds the options will wind up being in the money before its expiration. The more time the investor has to exercise the option also increases the likelihood of it winding up in the money and lowers the present value of the exercise price. Interest rates also influence the price of the option, as higher rates make the option more expensive by decreasing the present value of the exercise price.

The Black-Scholes Formula

The Black-Scholes formula expresses the value of a call option by taking the current stock prices multiplied by a probability factor (D1) and subtracting the discounted exercise payment times a second probability factor (D2).

Explaining in exact detail what D1 and D2 represent can be difficult because the original research papers by Black and Scholes didn’t explain or interpret D1 and D2, and neither did the papers published by Merton. Entire research papers have been written on the subject of D1 and D2 alone.

💡 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.

Why Is the Black-Scholes Model Important?

The Black-Scholes option pricing model is so important that it once won the Nobel Prize in economics. Some even claim that this model is among the most important ideas in financial history.

Some traders consider the Black-Scholes Model one of the best methods for figuring out fair prices of European call options. Since its creation, many scholars have elaborated on and improved this formula. In this sense, Black and Scholes made a significant contribution to the academic world when it comes to math and finance.

Some claim that the Black-Scholes model has made a significant contribution to the efficiency of the options and stock markets. While designed for European options, the Black-Scholes Model can still help investors understand how an option’s price might react to its underlying stock price movements and improve their overall options trading strategies.

This allows investors to optimize their portfolios by hedging accordingly, making the overall markets more efficient. However, others assert that the model has increased volatility in the markets, as more investors constantly try to fine tune their trades according to the formula.

How Accurate Is the Black-Scholes Model?

Some studies have shown the Black-Scholes model to be highly predictive of options prices. This doesn’t mean the formula has no flaws, though.

The model tends to undervalue calls that are deeply in the money and overvalue calls that are deeply out of the money.

That means the model might assign an artificially low value to options that are much higher than the price of their underlying stock, while it may overvalue options that are far beneath the stock’s current value. Options that deal with stocks yielding a high dividend also tend to get mispriced by the model.

Assumptions of the Black-Scholes Model

There are also a few assumptions made by the model that can lead to less-than-perfect predictions. Some of these include:

• The assumption that volatility and the risk- free rate within a stock remain constant

• The assumption that stock prices are stable and large price swings don’t happen

• The assumption that a stock doesn’t pay dividends until after an option expires

Recommended: How Do Dividends Work?

Such assumptions are necessary, even if they may negatively impact results. Relying on assumptions like these make the task possible, as only so many variables can reasonably be calculated.

Over the years, math scholars have elaborated on the work of Black and Scholes and made efforts to compensate for some of the gaps created by the original assumptions.

This leads to another flaw of the Black-Scholes model, unlike other inputs in the model, volatility must be an estimate rather than an objective fact. Interest rates and the amount of time left until the option expires are concrete numbers, while volatility has no direct numerical value.

The best a financial analyst can do is calculate an estimation of volatility by using something like the formula for variance. Variance is a measurement of the variability of an asset, or how much prices change from time to time. One common measurement of volatility is the standard deviation, which is equivalent to the square root of variance.

Test your understanding of what you just read.

The Takeaway

The Black-Scholes option-pricing model is among the most influential mathematical formulas in modern financial history, and it may be the most accurate way to determine the value of a European call option. It’s a complicated formula that has some drawbacks that traders must understand, but it’s a useful tool for European options traders.

Given the Black-Scholes model’s complexity, it’s likely that many investors will never use it. That doesn’t mean it isn’t important to know or understand, of course, but many investors may not get much practical use out of it unless they delve deeper into the world of options trading.

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

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/akinbostanci

SoFi Invest®

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

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

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

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN0623051

Feb

2025

What Is the MOASS?

By Brian O'Connell | Growing Wealth, invest, Investing | Comments Off

Table of Contents

Short Squeeze Basics
How the MOASS Works
GameStop: The Prime Example of MOASS
MOASS Trading Tips
MOASS Tip: Have a Plan to Sell Quickly

“MOASS,” or, the “Mother of All Short Squeezes,” was largely unknown to investors prior to 2021. But a saga involving so-called “meme stocks,” most notably GameStop stock, changed that, and MOASS entered the investing lexicon. In short, that specific scenario, bringing the Mother of All Short Squeezes, as a strategy, to investors’ attention, involved a rag-tag band of day traders taking on the hedge fund giants, with a short-sale “squeeze” that greatly impacted some of those giants.

Meme stocks, including GameStop and AMC Theatres, saw further short squeeze action in mid-May 2024, too. But the episode in 2021 shined a light on investors, short-sales, trading squeeze strategies, and digital trading on a massive scale, all of which fell under the MOASS umbrella.

Key Points

• MOASS stands for “Mother of All Short Squeezes,” a phenomenon where stock prices skyrocket due to mass buying.

• It gained prominence with the GameStop stock saga, where day traders challenged large hedge funds.

• The strategy involves a high volume of purchases to drive up stock prices, countering short sellers.

• Effective execution of MOASS can lead to significant profits for traders who initiate the squeeze.

• The approach carries high risks, especially for those who join late or cannot sell off at peak prices.

Short Squeeze Basics

A short squeeze is an orchestrated effort to drive up shares of a stock that’s being heavily shorted. MOASS, meaning the Mother of All Short Squeezes, as noted, is a trading strategy in which a high volume of buyers drive up shares of stocks that were being “shorted” by other investors.

A short squeeze trading strategy needs two components to work — a short seller or, more preferably, several short sellers on one side and a group of disciplined contrarian investors who unroll a short squeeze and buy shares of the stock being shorted.

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

How the MOASS Works

In order to understand how a short squeeze — or a massive short squeeze — works, you first need to understand short selling.

Short sellers aim to profit from the fall in a stock’s price. They do so by borrowing and selling shares of a stock that they believe will decline in value. Then, when the stock price falls, a short seller buys the stock at the reduced price, returns the shares, and pockets the profit.

If the short seller makes the right call, meaning the price does fall, they earn the difference between the price when they entered the short position and the lower stock price at which they bought to cover.

If the short seller makes the wrong call, and the price goes up, the investor must buy the stock at a price higher than when they entered the short position, thereby losing money — and negating any potential for a profit.

As short sellers wind up leaving their short positions when they execute a buy order on the stock, those “short-squeeze” buy positions get noticed by other day traders, who also jump in to purchase the stock. That, in turn, drives the stock’s price even higher, since there are fewer shares of the stocks available to purchase.

Short-sellers, highly alarmed by the rising share price, also issue buy orders on the stock to exit the short sale strategy and reduce their investment risk, which completes the cycle and puts the short squeeze in full effect. This can result in the short sales losing money and the MOASS day traders making a profit on the rising stock price.

Recommended: Understanding Low Float Stocks

GameStop: The Prime Example of MOASS

Perhaps the best example of MOASS in action is the GameStop saga in early 2021. At the time, several hedge fund firms had “shorted” GameStop stock, which essentially meant betting the share price of the stock would decline. That didn’t happen with GameStop shares. Some context is important to understand, too, as many retail stocks, like GameStop, had been heavily affected by the pandemic at the time.

But GameStop shares bucked the trend.

A group of day traders hanging out on a Reddit investing forum called “Wallstreetbets” banded together and started buying up shares of GameStop stock. The gambit worked, with GameStop shares skyrocketing from $19 per share to around $350 per share. The retail investors had successfully “squeezed” the short sellers, causing several hedge funds to lose hundreds of millions of dollars on their short positions on GameStop.

If the short squeeze works, the share price will continue to rise and the short investors, many of whom have fixed deadlines built into their short sales positions, will have to sell their shares and cut their losses, thereby driving the stock price even higher. That rewards the short squeeze investor, who profits from the rising share price, especially as other buyers enter the fray and drive the share price up even higher.

Once victory was declared with the GameStop short squeeze, the Reddit traders turned their attention to other so-called meme stocks where short selling activity was particularly high. That group included AMC Entertainment Holdings, Koss Corporation, and Blackberry, which all saw share volumes rise after the MOASS traders entered the fray.

Thus, a series of short squeezes that target more and more short sellers is really what MOASS is all about: squeezing enough short-sellers to achieve critical mass in the trading markets, and making huge profits in the process.

Also, as mentioned, a similar situation played out in May 2024, when certain stocks (including GameStop and AMC Theatres) were at the center of another short squeeze, though smaller in scale than the 2021 events.

Recommended: Pros and Cons of Momentum Trading

MOASS Trading Tips

Investors who want to participate in the next short squeeze effort should be careful. So-called “meme” stock trading can be fraught with risk, especially if you’re left holding the bag after other short-squeezers sell out of their positions before you do.

Take these risk considerations with you before participating in a mass short squeeze play.

Consider Minimal Purchases to Limit Losses

While the adrenaline level can be high when participating in a short squeeze trading event, tamp down emotions by limiting the amount of money you invest in a GameStop-type situation. As the old gambling adage says, never risk money you can’t afford to lose. That goes double when chasing the thrill of a MOASS scenario.

Should You Expect to Lose Money?

There’s a significant chance that you’ll lose money at some point with a short squeeze play.

Nothing is guaranteed in the stock market and that’s especially the case as short-sellers have learned their lesson after meme-stock related events in recent years, and grow more cautious about their investing habits. MOASS trading patterns can be something of a roller coaster ride for investors, and the odds that your ride will dip along the way are high. That can translate into days or even weeks of your short-squeeze buying strategy where your investment returns are written in red ink.

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

MOASS Tip: Have a Plan to Sell Quickly

Short squeeze investing isn’t exactly an orderly process and you need to put your interest first ahead of other MOASS investors. Why? Because volatility can be high and prices can swing at a moment’s notice when trading MOASS-themed stocks. Additionally, nobody really has any idea how high a price can go with a short squeeze in play, and nobody really knows if a stock will rise higher at all.

That’s why it’s a good idea to have a fixed “sell price” in mind when engaging in a short squeeze situation — a stop loss order to automatically sell the stock at a specific price can be a good idea in this scenario.

If you buy a targeted MOASS stock at $50 and it goes to $70, there’s no way of knowing if the stock will go any higher — it might and it might not. Worse, the price could slide back to $30 when buyers lose interest in the stock.

Having a good investment exit strategy in a short squeeze scenario, can help minimize investment losses and capitalize on a stock increase when and if it happens.

Test your understanding of what you just read.

The Takeaway

“MOASS” means the “Mother of All Short Squeezes,” and perhaps the best example of it in action involved so-called “meme stocks” in 2021. Short squeeze trading strategies can bring a great deal of portfolio-shaking volatility to the investment table, and there are plenty of heavily shorted stocks that could be the next MOASS, but it’s impossible to know which one could trigger a squeeze.

That means MOASS may not be the best strategy for long-term investors or those with an aversion to risk. A short squeeze takes a significant amount of discipline, patience, and attention on the part of the investors, with continual risk in play until the squeeze is played out.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

Photo credit: iStock/PeopleImages

SoFi Invest®

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

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

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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.

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN-Q224-1885888-V1

Feb

2025

Calculating an Investment’s Payback Period

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

Key Points

• The payback period is the estimated amount of time it will take to recoup an investment or to break even. Generally, the longer the payback period, the higher the risk.

• To calculate the payback period you divide the Initial Investment by Annual Cash Flow.

• Equity firms may calculate the payback period for potential investment in startups and other companies to ensure capital recoupment and understand risk-reward ratios.

• Downsides of using the payback period include that it does take into account the time value of money or other ways an investment might bring value.

What Is the Payback Period?

The payback period is the amount of time it will take to recoup the initial cost of an investment, or to reach its break-even point. Considering the ups and down of various market factors — e.g. the crypto winter or the impact of higher-than-usual interest rates — being able to gauge the payback period is one of the most important calculations for investors when planning investments and returns.

The payback period can help investors decide between different investments that may have a lot of similarities, as they’ll often want to choose the one that will pay back in the shortest amount of time. The longer money remains locked up in an investment without earning a return, the more time an investor must wait until they can access that cash again, and the more risk there is of losing the initial investment capital.

How to Calculate the Payback Period

The payback period is calculated by dividing the cost of the investment by the annual cash flow until the cumulative cash flow is positive, which is the payback year. Payback period is generally expressed in years.

Prior to calculating the payback period of a particular investment, one might consider what their maximum payback period would be to move forward with the investment. This will help give them some parameters to work with when making investment decisions. If the calculated payback period is less than the desired period, this may be a safer investment.

There are two easy basis payback period formulas:

Payback Period Formula (Averaging Method)

Payback Period = Initial Investment / Yearly Cash Flow

Using the averaging method, the initial amount of the investment is divided by annualized cash flows an investment is projected to generate. This works well if cash flows are predictable or expected to be consistent over time, but otherwise this method may not be very accurate.

Example of Payback Period

If a company makes an investment of $1,000,000 in new equipment which is expected to generate $250,000 in revenue per year, the calculation would be:

$1,000,000 / $250,000 = 4-year payback period

If they have another option to invest $1,000,000 into equipment which they expect to generate $280,000 in revenue per year, the calculation would be:

$1,000,000 / $280,000 = 3.57-year payback period

Since the second option has a shorter payback period, this may be a better choice for the company.

Payback Formula (Subtraction Method)

Payback Period = the last year with negative cash flow + (Amount of cash flow at the end of that year / Cash flow during the year after that year)

Using the subtraction method, one starts by subtracting individual annual cash flows from the initial investment amount, and then does the division. This method works better if cash flows vary from year to year.

Example of Payback Period Using the Subtraction Method

A company is considering making a $550,000 investment in new equipment. The expected cash flows are as follows:

Year 1 = $75,000
Year 2 = $140,000
Year 3 = $200,000
Year 4 = $110,000
Year 5 = $60,000

Calculation:

Year 0 : -$550,000
Year 1 : -$550,000 + $75,000 = -$475,000
Year 2 : -$475,000 + $140,000 = -$335,000
Year 3 : -$335,000 + $200,000 = -$135,000
Year 4 : -$135,000 + $110,000 = -$25,000
Year 5 : -$25,000 + $60,000 = $35,000

Year 4 is the last year with negative cash flow, so the payback period equation is:

4 + ($25,000 / $60,000) = 4.42

So the payback period is 4.42 years.

Other factors

Investors might also choose to add depreciation and taxes into the equation, to account for any lost value of an investment over time.

Benefits of Using the Payback Period

The payback period is simple to understand and calculate. It can provide individuals and companies with valuable insights into potential investments, and help them decide which option provides the best return on investment (ROI). It also helps with assessing the risk of different investments. Advantages include:

• Easily understandable

• Simple to calculate

• Tool for risk assessment

• Helps with comparing and choosing investment options

• Provides insights for financial planning

• Other calculations, such as net present value and internal rate of return, don’t

• look at the amount of time it takes to recoup an investment

Downsides of Using the Payback Period

Although the payback period can be a useful calculation for individuals and companies considering and comparing investments, it has some downsides. The calculation only looks at the time period up until the initial investment will be recouped. It doesn’t consider the earnings the investment will bring in after that, which may either be higher or lower, and could determine whether it makes sense as a long-term investment.

If earnings will continue to increase, a longer payback period might be acceptable. If earnings might decrease after a certain number of years, the investment may not be a good idea even if it breaks even quickly. On the other hand, an investment with a short lifespan could need replacement shortly after its payback period, making it a potentially poor investment.

The payback period doesn’t take into consideration other ways an investment might bring value, such as partnerships or brand awareness. This can result in investors overlooking the long-term benefits of the investment since they’re too focused on short-term ROI.

The payback period equation also doesn’t take into account the effects an investment might have on the rest of the company’s operations. For instance, new equipment might require a significant amount of expensive power, or might not be able to run as often as it would need to in order to reach the payback goal.

Another limitation of the payback period is that it doesn’t take the time value of money (TVM) into account. The time value of money is the idea that cash will be worth more in the future than it is worth today, due to the amount of interest that it can generate. Not only does this apply to the initial capital put into an investment, but it’s also important because as an investment generates returns, that cash can then be reinvested into something else that earns interest or income. This is another reason that a shorter payback period makes for a more attractive investment.

When Would You Use The Payback Period?

The payback period can apply to personal investments such as solar panels or property maintenance, or investments in equipment or other assets that a company might consider acquiring. Often an investment that requires a large amount of capital upfront generates steady or increasing returns over time, although there is also some risk that the returns won’t turn out as hoped or predicted.

Calculating payback periods is especially important for startup companies with limited capital that want to be sure they can recoup their money without going out of business. Companies also use the payback period to select between different investment opportunities or to help them understand the risk-reward ratio of a given investment.

Knowing the payback period is helpful if there’s a risk of a project ending in the future. For example, if a company might lose a lease or a contract, the sooner they can recoup any investments they’re making into their business the less risk they have of losing that capital.

Any particular project or investment can have a short or long payback period. A short period means the investment breaks even or gets paid back in a relatively short amount of time by the cash flow generated by the investment, whereas a long period means the investment takes longer to recoup. How investors understand that period will depend on their time horizon.

Test your understanding of what you just read.

The Takeaway

You can use the payback period in your own life when making large purchase decisions and consider their opportunity cost. Understanding the way that companies calculate their payback period is also helpful to determine their financial viability and whether it makes sense for you to invest in them as part of your portfolio.

Whether you’re new to investing or already have a portfolio started, there are many tools available to help you be successful. One great online investing tool is SoFi Invest® online brokerage platform. The investing platform lets you research and track your favorite stocks and ETFs. You can easily buy and sell with just a few clicks on your phone, and view your portfolio on one simple dashboard.

You can choose from either active or automated investing. With active investing, you can hand select each individual stock or ETF you wish to add to your portfolio. Using automated investing, you can choose from groups of pre-selected stocks. There are additional tools in the app to set personal financial goals and add all your banking and investment accounts so you can see all of your information in one place.

If you have any questions or need help getting started, SoFi has a team of professional financial advisors available to help you reach your personal financial goals.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

You may also be interested in:

Rate of Return (RoR): Formula and Calculation Examples

NPV Formula: How to Calculate Net Present Value

Discounted Cash Flow (DCF) Explained

Photo credit: iStock/MicroStockHub
SoFi Invest®

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

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

SoFi Relay offers users the ability to connect both SoFi accounts and external accounts using Plaid, Inc.’s service. When you use the service to connect an account, you authorize SoFi to obtain account information from any external accounts as set forth in SoFi’s Terms of Use. Based on your consent SoFi will also automatically provide some financial data received from the credit bureau for your visibility, without the need of you connecting additional accounts. SoFi assumes no responsibility for the timeliness, accuracy, deletion, non-delivery or failure to store any user data, loss of user data, communications, or personalization settings. You shall confirm the accuracy of Plaid data through sources independent of SoFi. The credit score is a VantageScore® based on TransUnion® (the “Processing Agent”) data.

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN20232

Feb

2025

How to Calculate Expected Rate of Return

By Inyoung Hwang | Growing Wealth, invest, Investing | No Comments

When investing, you often want to know how much money an investment is likely to earn you. That’s where the expected rate of return comes in; expected rate of return is calculated using the probabilities of investment returns for various potential outcomes. Investors can utilize the expected return formula to help project future returns.

Though it’s impossible to predict the future, having some idea of what to expect can be critical in setting expectations for a good return on investment.

Key Points

• The expected rate of return is the profit or loss an investor expects from an investment based on historical rates of return and the probability of different outcomes.

• The formula for calculating the expected rate of return involves multiplying the potential returns by their probabilities and summing them.

• Historical data can be used to estimate the probability of different returns, but past performance is not a guarantee of future results.

• The expected rate of return does not consider the risk involved in an investment and should be used in conjunction with other factors when making investment decisions.

What Is the Expected Rate of Return?

The expected rate of return — also known as expected return — is the profit or loss an investor expects from an investment, given historical rates of return and the probability of certain returns under different scenarios. The expected return formula projects potential future returns.

Expected return is a speculative financial metric investors can use to determine where to invest their money. By calculating the expected rate of return on an investment, investors get an idea of how that investment may perform in the future.

This financial concept can be useful when there is a robust pool of historical data on the returns of a particular investment. Investors can use the historical data to determine the probability that an investment will perform similarly in the future.

However, it’s important to remember that past performance is far from a guarantee of future performance. Investors should be careful not to rely on expected returns alone when making investment decisions.

💡 Quick Tip: When you’re actively investing in stocks, it’s important to ask what types of fees you might have to pay. For example, brokers may charge a flat fee for trading stocks, or require some commission for every trade. Taking the time to manage investment costs can be beneficial over the long term.

How To Calculate Expected Return

To calculate the expected rate of return on a stock or other security, you need to think about the different scenarios in which the asset could see a gain or loss. For each scenario, multiply that amount of gain or loss (return) by its probability. Finally, add up the numbers you get from each scenario.

The formula for expected rate of return looks like this:

Expected Return = (R1 * P1) + (R2 * P2) + … + (Rn * Pn)

In this formula, R is the rate of return in a given scenario, P is the probability of that return, and n is the number of scenarios an investor may consider.

For example, say there is a 40% chance an investment will see a 20% return, a 50% chance that the investment will return 10%, and a 10% chance the investment will decline 10%. (Note: all the probabilities must add up to 100%)

The expected return on this investment would be calculated using the formula above:

Expected Return = (40% x 20%) + (50% x 10%) + (10% x -10%)

Expected Return = 8% + 5% – 1%

Expected Return = 12%

What Is Rate of Return?

The expected rate of return mentioned above looks at an investment’s potential profit and loss. In contrast, the rate of return looks at the past performance of an asset.

A rate of return is the percentage change in value of an investment from its initial cost. When calculating the rate of return, you look at the net gain or loss in an investment over a particular time period. The simple rate of return is also known as the return on investment (ROI).

How to Calculate Rate of Return

The formula to calculate the rate of return is:

Rate of return = [(Current value − Initial value) ÷ Initial Value ] × 100

Let’s say you own a share that started at $100 in value and rose to $110 in value. Now, you want to find its rate of return.

In our example, the calculation would be [($110 – $100) ÷ $100] x 100 = 10

A rate of return is typically expressed as a percentage of the investment’s initial cost. So, if you were to sell your share, this investment would have a 10% rate of return.

Different Ways to Calculate Expected Rate of Return

How to Calculate Expected Return Using Historical Data

To calculate the expected return of a single investment using historical data, you’ll want to take an average rate of returns in certain years to determine the probability of those returns. Here’s an example of what that would look like:

Annual Returns of a Share of Company XYZ
Year	Return
2011	16%
2012	22%
2013	1%
2014	-4%
2015	8%
2016	-11%
2017	31%
2018	7%
2019	13%
2020	22%

For Company XYZ, the stock generated a 21% average rate of return in five of the ten years (2011, 2012, 2017, 2019, and 2020), a 5% average return in three of the years (2013, 2015, 2018), and a -8% average return in two of the years (2014 and 2016).

Using this data, you may assume there is a 50% probability that the stock will have a 21% rate of return, a 30% probability of a 5% return, and a 20% probability of a -8% return.

The expected return on a share of Company XYZ would then be calculated as follows:

Expected return = (50% x 21%) + (30% x 5%) + (20% x -8%)

Expected return = 10% + 2% – 2%

Expected return = 10%

Based on the historical data, the expected rate of return for this investment would be 10%.

However, when using historical data to determine expected returns, you may want to consider if you are using all of the data available or only data from a select period. The sample size of the historical data could skew the results of the expected rate of return on the investment.

💡 Quick Tip: The best stock trading app? That’s a personal preference, of course. Generally speaking, though, a great app is one with an intuitive interface and powerful features to help make trades quickly and easily.

How to Calculate Expected Return Based on Probable Returns

When using probable rates of return, you’ll need the data point of the expected probability of an outcome in a given scenario. This probability can be calculated, or you can make assumptions for the probability of a return. Remember, the probability column must add up to 100%. Here’s an example of how this would look.

Expected Rate of Return for a Stock of Company ABC
Scenario	Return	Probability	Outcome (Return * Probability)
1	14%	30%	4.2%
2	2%	10%	0.2%
3	22%	30%	6.6%
4	-18%	10%	-1.8%
5	-21%	10%	-2.1%
Total		100%	7.1%

Using the expected return formula above, in this hypothetical example, the expected rate of return is 7.1%.

Calculate Expected Rate of Return on a Stock in Excel

Follow these steps to calculate a stock’s expected rate of return in Excel (or another spreadsheet software):

1. In the first row, enter column labels:

• A1: Investment

• B1: Gain A

• C1: Probability of Gain A

• D1: Gain B

• E1: Probability of Gain B

• F1: Expected Rate of Return

2. In the second row, enter your investment name in B2, followed by its potential gains and the probability of each gain in columns C2 – E2

• Note that the probabilities in C2 and E2 must add up to 100%

3. In F2, enter the formula = (B2*C2)+(D2*E2)

4. Press enter, and your expected rate of return should now be in F2

If you’re working with more than two probabilities, extend your columns to include Gain C, Probability of Gain C, Gain D, Probability of Gain D, etc.

If there’s a possibility for loss, that would be negative gain, represented as a negative number in cells B2 or D2.

Limitations of the Expected Rate of Return Formula

Historical data can be a good place to start in understanding how an investment behaves. That said, investors may want to be leery of extrapolating past returns for the future. Historical data is a guide; it’s not necessarily predictive.

Another limitation to the expected returns formula is that it does not consider the risk involved by investing in a particular stock or other asset class. The risk involved in an investment is not represented by its expected rate of return.

In this historical return example above, 10% is the expected rate of return. What that number doesn’t reveal is the risk taken in order to achieve that rate of return. The investment experienced negative returns in the years 2014 and 2016. The variability of returns is often called volatility.

Standard Deviation

To understand the volatility of an investment, you may consider looking at its standard deviation. Standard deviation measures volatility by calculating a dataset’s dispersion (values’ range) relative to its mean. The larger the standard deviation, the larger the range of returns.

Consider two different investments: Investment A has an average annual return of 10%, and Investment B has an average annual return of 6%. But when you look at the year-by-year performance, you’ll notice that Investment A experienced significantly more volatility. There are years when returns are much higher and lower than with Investment B.

Year	Annual Return of Investment A	Annual Return of Investment B
2011	16%	8%
2012	22%	4%
2013	1%	3%
2014	-6%	0%
2015	8%	6%
2016	-11%	-2%
2017	31%	9%
2018	7%	5%
2019	13%	15%
2020	22%	14%
Average Annual Return	10%	6%
Standard Deviation	13%	5%

Investment A has a standard deviation of 13%, while Investment B has a standard deviation of 5%. Although Investment A has a higher rate of return, there is more risk. Investment B has a lower rate of return, but there is less risk. Investment B is not nearly as volatile as Investment A.

Recommended: A Guide to Historical Volatility

Systematic and Unsystematic Risk

All investments are subject to pressures in the market. These pressures, or sources of risk, can come from systematic and unsystematic risks. Systematic risk affects an entire investment type. Investors may struggle to reduce the risk through diversification within that asset class.

Because of systematic risk, you may consider building an investment strategy that includes different asset types. For example, a sweeping stock market crash could affect all or most stocks and is, therefore, a systematic risk. However, if your portfolio includes different types of bonds, commodities, and real estate, you may limit the impact of the equities crash.

In the stock market, unsystematic risk is specific to one company, country, or industry. For example, technology companies will face different risks than healthcare and energy companies. This type of risk can be mitigated with portfolio diversification, the process of purchasing different types of investments.

Expected Rate of Return vs Required Rate of Return

Expected return is just one financial metric that investors can use to make investment decisions. Similarly, investors may use the required rate of return (RRR) to determine the amount of money an investment needs to generate to be worth it for the investor. The required rate of return incorporates the risk of an investment.

What Is the Dividend Discount Model?

Investors may use the dividend discount model to determine an investment’s required rate of return. The dividend discount model can be used for stocks with high dividends and steady growth. Investors use a stock’s price, dividend payment per share, and projected dividend growth rate to calculate the required rate of return.

The formula for the required rate of return using the dividend discount model is:

RRR = (Expected dividend payment / Share price) + Projected dividend growth rate

So, if you have a stock paying $2 in dividends per year and is worth $20 and the dividends are growing at 5% a year, you have a required rate of return of:

RRR = ($2 / $20) + 0.5

RRR = .10 + .05

RRR = .15, or 15%

What is the Capital Asset Pricing Model?

The other way of calculating the required rate of return is using a more complex model known as the capital asset pricing model.

In this model, the required rate of return is equal to the risk-free rate of return, plus what’s known as beta (the stock’s volatility compared to the market), which is then multiplied by the market rate of return minus the risk-free rate. For the risk-free rate, investors usually use the yield of a short-term U.S. Treasury.

The formula is:

RRR = Risk-free rate of return + Beta x (Market rate of return – Risk-free rate of return)

For example, let’s say an investment has a beta of 1.5, the market rate of return is 5%, and a risk-free rate of 1%. Using the formula, the required rate of return would be:

RRR = .01 + 1.5 x (.05 – .01)

RRR = .01 + 1.5 x (.04)

RRR = .01 + .06

RRR = .07, or 7%

Test your understanding of what you just read.

The Takeaway

There’s no way to predict the future performance of an investment or portfolio. However, by looking at historical data and using the expected rate of return formula, investors can get a better sense of an investment’s potential profit or loss.

There’s no guarantee that the actual performance of a stock, fund, or other assets will match the expected return. Nor does expected return consider the risk and volatility of assets. It’s just one factor an investor should consider when deciding on investments and building a portfolio.

For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.

FAQ

How do you find the expected rate of return?

An investment’s expected rate of return is the average rate of return that an investor can expect to receive over the life of the investment. Investors can calculate the expected return by multiplying the potential return of an investment by the chances of it occurring and then totaling the results.

How do you calculate the expected rate of return on a portfolio?

The expected rate of return on a portfolio is the weighted average of the expected rates of return on the individual assets in the portfolio. You first need to calculate the expected return for each investment in a portfolio, then weigh those returns by how much each investment makes up in the portfolio.

What is a good rate of return?

A good rate of return varies from person to person. Some investors may be satisfied with a lower rate of return if its performance is consistent, while others may be more aggressive and aim for a higher rate of return even if it is more volatile. Ultimately, it is up to the individual to decide what is considered a good rate of return.

SoFi Invest®

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

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

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.

Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

SOIN-Q224-1912117-V1

Feb

2025

Guide to Options Spreads: Definition & Types

By Samuel Becker | 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.

Options spreads are trading strategies that involve two or more options designed to manage risk while providing opportunities for profit. Traders using an option spread simultaneously buy multiple options on the same underlying asset with different strike prices, different expiration dates, or both.

Understanding options spreads can help you decide whether these strategies could work for your portfolio, and which one to use in a given situation.

Key Points

• Options spreads are strategies using multiple options to manage risk and enhance profit potential.

• Vertical spreads involve options with the same expiration but different strike prices.

• Horizontal spreads use the same strike prices but different expiration dates, capitalizing on time decay.

• Diagonal spreads combine different strike prices and expiration dates, offering versatile market positioning.

• These strategies can be implemented with calls or puts, tailored to bullish or bearish market outlooks.

Credit and Debit Spreads

The difference between credit and debit spreads in options investing is that, in a credit spread, a trader sells one option (receiving a premium) and buys another (paying a lower premium), with the net result being a credit to their account. Conversely, when they buy an option and sell an option with a lower premium, they pay a net premium to open the position, resulting in a debit to their account.

Recommended: What Investors Should Know About Spread

3 Common Option Spread Strategies

Spread strategies occur when a trader buys and sells multiple call or put options pegged to the same underlying asset or security, but with different strike prices or expiration dates.

There are several types of option spreads. Here’s a look at a few common ones:

1. Vertical Spread Options

A vertical spread is an options strategy in which the options have the same expiration date but different strike prices. There are four types of vertical spread options that investors use depending on whether they are bullish or bearish, and whether the spread is a debit or credit.

Bull Call Spreads

A bull call spread strategy involves buying a call option at a lower strike price and selling another call option at a higher strike price. The call spread options have the same underlying asset and expiration date.

Traders may use this strategy when they expect the price of the underlying asset to increase, but want to limit potential loss by capping both their gains and losses.The trader caps their potential losses to the net premium they paid for the options. Their maximum gain is capped at the differences in strike prices, minus the net premium paid.

For example, a trader buys a call option on a stock at a strike price of $10, for a premium of $2. They then sell a call option with the same expiration date but at a strike price of $12, receiving a premium of $1. Conversely, if the stock price falls below $10 by expiration, the option would expire worthless and the trader’s loss is limited to the $1 premium.

This strategy limits the trader’s maximum loss to the net premium paid for the options. If the stock price rises above the higher strike price, the potential gain is capped at the difference between the strike prices, minus net premium paid. Although this cap limits the upside, it also provides protection against potential losses beyond the premium paid.

Bear Call Spreads

The opposite of a bull call spread, a bear call spread benefits from an underlying asset’s decrease in value.

For example, if a trader using a bear call spread anticipates a stock’s value is going to decrease, they would set up a spread by selling a call option and buying another call option at a higher strike price — the inverse of the bull call spread method. This is a credit spread, meaning the trader maximum gain is limited by the net premium received for the position. Their potential loss is capped at the difference in strike price. For example, a trader sells a call option on a stock at a strike price of $10, and buys another call at a strike price of $12.

Bull Put Spreads

A bull put spread is similar to a bull call spread, but it involves puts rather than calls. Using a bull put spread, a trader anticipates an increase in the underlying asset’s value. In our example, the trader would sell a put option at a strike price of $10, and simultaneously buy another at a lower strike price, which in this example is $8.

If the stock price remains above $10, both options expire worthless. The trader retains the full premium received as their maximum gain. If the stock price falls below $8, the trader incurs the maximum loss. This is capped at the difference between the strike prices minus the premium received.

Bear Put Spreads

A bear put spread is the inverse of a bull put spread. In our example, the trader would buy one put option at a $10 strike price, and simultaneously sell another put at a lower strike price, like $8.

The trader cannot lose more than the net premium the trader paid to take the position (as this is a debit spread) or gain more than the difference in strike prices.

2. Horizontal Spreads

Horizontal spreads (also called “calendar spread options”) involve options with the same underlying asset and same strike prices, but with different expiration dates. The main goal of this strategy is to generate income from the effects of time decay or the volatility of the two options.

There are also two main types of horizontal spreads.

Call Horizontal Spreads

A call horizontal spread is a strategy which a trader would employ if they believed that the underlying asset’s price would hold steady. In this case, the trader would buy a call with an expiration date on January 15th, for example, and sell another call with a different expiration date, like January 30th.

The trader can also reverse these positions by selling a call option that expires on January 15th, and another that expires on January 30th. The two positions’ differing expiration dates act as buffers, limiting potential losses (the premium paid) and gains.

Put Horizontal Spreads

Put horizontal spreads similar to call horizontal spreads except that traders use puts instead of calls.

3. Diagonal Spreads

Diagonal spreads incorporate elements from both vertical and horizontal spread strategies. These spreads involve the same option types and underlying asset (the same as before), but with differing strike prices and differing expiration dates.

Diagonal spreads — with different strike prices and expiration dates — allow for a variety of options combinations, and can be used under different market conditions. For example, they can be bearish and bullish, use calls or puts, and use different time horizons (long or short).

Other Options Spreads

While we’ve covered the main types of options spread strategies, there are a few more you may run into.

Butterfly Spread Options

A butterfly spread incorporates multiple strike prices, and can utilize either calls or puts. It also combines a bull and bear spread across four different options.

An example would be a trader buying a call at a certain strike price, selling two more calls at a higher strike price, and then buying another call at yet an even higher strike price—of equal distance, or value, from the two central calls. This results in a cap on losses and gains, and the trader could realize gains depending on the volatility levels of the underlying asset.

Box Spread Options

A box spread option strategy involves a bear put and a bull call with identical strike prices and expiration dates. Under very specific circumstances, traders employ box spreads when they are looking to capitalize on arbitrage opportunities.

The Takeaway

There are several spread strategies for options trading that traders use to limit their losses and position themselves for potential gains based on their projections about the price of a specific asset.

Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.

Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.

Explore SoFi’s user-friendly options trading platform.

🛈 While investors are not able to sell options on SoFi’s options trading platform at this time, they can buy call and put options to try to benefit from stock movements or manage risk.

Photo credit: iStock/damircudic

SoFi Invest®

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

SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
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-Q125-095

What Is the Black-Scholes Model?

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

The History of the Black-Scholes Model

What Does the Black-Scholes Model Tell?

The Black-Scholes Formula

Why Is the Black-Scholes Model Important?

How Accurate Is the Black-Scholes Model?

Assumptions of the Black-Scholes Model

The Takeaway

Short Squeeze Basics

How the MOASS Works

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

GameStop: The Prime Example of MOASS

MOASS Trading Tips

Consider Minimal Purchases to Limit Losses

Should You Expect to Lose Money?

MOASS Tip: Have a Plan to Sell Quickly

The Takeaway

What Is the Payback Period?

How to Calculate the Payback Period

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

Payback Period Formula (Averaging Method)

Example of Payback Period

Payback Formula (Subtraction Method)

Example of Payback Period Using the Subtraction Method

Other factors

Benefits of Using the Payback Period

Downsides of Using the Payback Period

When Would You Use The Payback Period?

The Takeaway

You may also be interested in:

What Is the Expected Rate of Return?

How To Calculate Expected Return

What Is Rate of Return?

How to Calculate Rate of Return

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, alternative investments, IRAs, and more. Get started in just a few minutes.

Different Ways to Calculate Expected Rate of Return

How to Calculate Expected Return Using Historical Data

How to Calculate Expected Return Based on Probable Returns

Calculate Expected Rate of Return on a Stock in Excel

Limitations of the Expected Rate of Return Formula

Standard Deviation

Systematic and Unsystematic Risk

Expected Rate of Return vs Required Rate of Return

What Is the Dividend Discount Model?

What is the Capital Asset Pricing Model?

The Takeaway

FAQ

How do you find the expected rate of return?

How do you calculate the expected rate of return on a portfolio?

What is a good rate of return?

Credit and Debit Spreads

3 Common Option Spread Strategies

1. Vertical Spread Options

Bull Call Spreads

Bear Call Spreads

Bull Put Spreads

Bear Put Spreads

2. Horizontal Spreads

Call Horizontal Spreads

Put Horizontal Spreads

3. Diagonal Spreads

Other Options Spreads

Butterfly Spread Options

Box Spread Options

The Takeaway

JOIN THE COMMUNITY

Student Loan Refinancing

Personal Loans

Online Investments

Other

Student Loan
Refinancing

Personal
Loans

Online
Investments