Mar
04
2025
Bollinger Bands Explained

Bollinger Bands Explained

By | Growing Wealth, invest, Investing | Comments Off on Bollinger Bands Explained

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.

Bollinger Bands are a popular technical analysis tool that helps traders assess price trends and market volatility. By measuring how far a security’s price moves above or below its average, Bollinger Bands provide insights into whether the price is relatively high or low compared to recent trading activity, indicating whether the security is overbought or oversold.

These bands can be applied to various assets, including options and stocks, making them versatile for different trading strategies. Although Bollinger Bands are often used to spot potential opportunities, they often work best when combined with other indicators to confirm trends and reduce the risk of false signals.

Key Points

•   Bollinger Bands are technical analysis tools that measure a security’s price relative to its moving average and volatility.

•   The bands consist of three lines: a simple moving average and two standard deviation lines.

•   Bollinger Bands help identify overbought or oversold conditions and potential price reversals.

•   This tool is more effective when used with other indicators like RSI and MACD.

•   Bollinger Bands can be useful for day trading but are not predictive on their own.

What Are Bollinger Bands?

Bollinger Bands are a popular tool used in the technical analysis of securities. They are a set of three bands that measure a security’s relative price in comparison to its moving average and recent price volatility.

The center line is typically the 20-day simple moving average (SMA) of a security’s price, plus plotted lines two standard deviations away from the SMA. The bands are plotted positively and negatively from the SMA, which is what measures the volatility of a security, and the trader can adjust them based on their particular use case. These bands expand during periods of volatility and contract during periods of lower volatility, visually demonstrating market conditions.

Bollinger Bands were created to help investors understand whether a security is currently oversold or overbought, which may help determine whether it is likely to increase or decrease in value over time. When the upper band is close to the SMA, traders may see this as an overbought security. When the lower band is close to the SMA, they may consider the security to be oversold.

The bands, and a set of 22 rules about using them for trading, were developed in the 1980s by John Bollinger, a well-known technical trader.

How Do Bollinger Bands Work?

Bollinger Bands are plotted using two parameters: period and standard deviation.

Period is found by calculating the simple moving average of the security a trader is interested in. The calculation generally uses a 20-day SMA, an average of a security’s closing prices over a 20-day period — or roughly a month of trading days.

The first data point on the graph would be the average of the first 20 days being tracked. The second data point would be the next 20 days, and so on.

That line shows the SMA over time, and the Bollinger Bands are then placed above and below it by calculating the standard deviation of the security’s price along each data point. The standard deviation measures how much a security’s price deviates from its average, reflecting price volatility against its SMA, representing price volatility.

The standard deviation is calculated by first finding the square root of the variance, which is the average of the squared differences of the mean. The standard deviation is typically multiplied by two to create the bands, but traders can adjust this multiplier based on their strategy. The resulting value is then added and subtracted from each SMA data point to form the upper and lower Bollinger Bands.

Key Things to Know About Bollinger Bands

Bollinger Bands adjust dynamically to market conditions, expanding and contracting based on volatility. Here are a few things to keep in mind when using them:

•   When volatility is low, the bands get closer together. This contraction reflects a lower volatility period, which may precede future price movements.

•   When volatility is high, the bands get farther apart. This indicates that an existing price trend could be coming to a close in the future.

•   Generally the security’s price movements stay within the two bands. And once they touch one band they start moving towards the other band. But the price can also bounce off the band multiple times or it can cross over the band. If the price touches one band and crosses the SMA, traders may watch to see if it moves toward the opposite band.

When the price crosses to the outside of the bands, this is a strong indicator of a trend in that direction.

Formula for Bollinger Bands

Below is the formula to plot Bollinger Bands:

BOLU=MA(TP,n)+m∗σ[TP,n]

BOLD=MA(TP,n)−m∗σ[TP,n]

where:

BOLU=Upper Bollinger Band

BOLD=Lower Bollinger Band

MA=Moving average

TP (typical price)=(High+Low+Close)÷3

n = Number of days in smoothing period (typically 20)

m = Number of standard deviations (typically 2)

σ[TP,n]=Standard Deviation over last n periods of TP

Recommended: 7 Technical Indicators of Stock Trading
​

How Do You Read Bollinger Bands?

Bollinger Bands help traders understand whether a security’s price is relatively high or low so that they might make trades based on trends. Bollinger Bands can indicate uptrends and downtrends as well as possible upcoming price reversals.

Trends with Bollinger Bands can vary based on the asset and trading strategy, lasting anywhere from minutes to years. Traders should understand how to set up the bands based on their timeline. Here are some patterns and indicators traders might want to learn.

Uptrends

Traders can use Bollinger Bands to see whether there is a bullish trend in a security’s market price. If the center line hits the upper band multiple times, this may suggest an uptrend. If the price hits the upper band, decreases but stays above the center line, then hits the upper band again, that is a strong indicator of an uptrend. If the price then hits the lower band, it may indicate a reversal or a loss of strength in the uptrend.

Downtrends

The lower band can indicate a downtrend or an upcoming reversal towards an uptrend. If the price hits the lower band continuously and stays below the center line, this indicates a downtrend. Traders typically avoid making trades during downtrends, but if there is an indicator of a reversal, they might choose to buy.

The Squeeze

When the bands are close together, this is known as a squeeze. The squeeze happens when the security has low volatility, but it indicates that the security will probably have increased volatility in the future. Traders look for high volatility periods to find trading opportunities, so the squeeze reflects decreased volatility and often precedes periods of higher volatility, though it does not predict price direction.

Traders typically like to exit trades during periods of lower volatility, so they look for far-apart bands as a clue that volatility may soon decrease. The squeeze is not used as a trading signal, and doesn’t show whether a security will increase or decrease in value. However, it may help traders figure out the potential timing of upcoming trades.

Breakouts

The SMA line doesn’t always stay between the Bollinger Bands — it can also move above or below the bands. Around 90% of price changes do happen between the bands, so if the price has a breakout above or below the bands it’s a significant event. Breakouts can signal significant price movement outside the bands, however, but they are not reliable predictors of future trends on their own.

Bollinger Band Trading Strategies

Financial analyst Arthur Merrill identified a set of 16 trend patterns, including M patterns and W patterns, that traders can use to recognize potential price reversals. Here are two key patterns.

M Top

The M top pattern indicates that the security price may decrease to a new low. It forms an M pattern at the upper band, where the price nearly hits or hits the upper band but doesn’t cross over it, then decreases to below the low in the center of the M pattern.

W Bottoms

W patterns can be used to identify W bottoms, which is when the second low is lower than the first low but neither low goes below the lower band. If the security rises above the high in the center of the W, this is an indicator that the price will likely reach a new high.

Recommended: How to Analyze Stocks: 4 Ways

Combining Bollinger Bands With Other Indicators

John Bollinger recommended that traders use Bollinger Bands in conjunction with other non-correlated indicators, such as the relative strength indicator (RSI) and the Stochastic Oscillator, in order to gain a comprehensive understanding of the security being assessed.

Although Bollinger Bands help traders understand price volatility and can show opportunities for upcoming trades, they aren’t strong indicators of potential upcoming price movements.

Drawbacks of Bollinger Bands

There are a number of caveats to consider with Bollinger Bands. In particular, they are best used with other stock indicators, to form a fuller picture.

•   They show old security price data with equal importance to new data, so data that is outdated may be counted with too much importance.

•   They are more of a reactive indicator than a predictive indicator, so they show current market conditions and can indicate trends, but are not strong indicators of what will happen to a security’s price in the future.

•   The standard settings of 20-day SMA and two standard deviations is an arbitrary measurement that doesn’t convey relevant information for every security and trading situation, so it’s important that traders understand how to adjust the band calculations for their particular situation.

Using Bollinger Bands for Crypto Trading

Bollinger Bands have become a popular tool for crypto traders to track volatility and trends. They can be used for trading crypto in a similar way to stocks, but some traders choose to use a 28 or 30 SMA instead of 20, to better represent a month of trading days, since the crypto markets are open 24/7.

The Takeaway

Bollinger Bands are a useful tool for technical analysis in options trading, which measure the relative high or low of a security’s price in relation to previous trades over, typically, the past 20 trading days.

Options traders may use Bollinger Bands to help inform their strategies, whether they’re trying to benefit from stock movements or manage risk.

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

What do Bollinger Bands tell you?


Bollinger Bands show how a security’s price moves over time, and whether it’s relatively high or low compared to its recent average. They also help gauge volatility: when the bands are far apart, the price is more volatile. When they’re close together, it’s less volatile.

Are Bollinger Bands good for day trading?


Yes, Bollinger Bands can be helpful for day trading because they show short-term price trends and volatility, helping traders spot potential opportunities for quick trades.

How reliable are Bollinger Bands?


Bollinger Bands are useful for identifying trends and volatility, but they’re not foolproof. They work best when combined with other indicators to confirm signals and reduce false predictions.

What indicator pairs well with Bollinger Bands?


The Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) pair well with Bollinger Bands to confirm trends and spot potential reversals.

Photo credit: iStock/blackCAT

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

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

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

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

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

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

¹Claw Promotion: Probability 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.

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Mar
04
2025
What Is a Naked Call Options Strategy?

What Is a Naked Call Options Strategy?

By | Growing Wealth, invest, Investing | Comments Off on What Is a Naked Call Options Strategy?

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.

A naked call, or uncovered call, is generally considered a high-risk option strategy. Naked calls are when an investor sells or writes call options for an underlying security they don’t own. The seller is anticipating that the underlying stock price will not increase before the call’s expiration date, which may require them to purchase shares that are higher than the market price to close the position.

It is almost always safer for traders to sell calls on a stock they already own — known as a “covered call” position — than those they don’t. This way, if the stock price increases sharply, the trader’s net position is hedged. Naked calls, on the other hand, may be considered speculative trades. You keep the premium if the underlying asset is at or in the money at expiration, but you also face the potential of seeing unlimited losses if the option to buy is exercised.

Key Points

•   Naked call options involve selling calls without owning the underlying asset, aiming to profit from time decay.

•   This strategy carries high risk, with potential for unlimited losses if stock prices rise sharply.

•   Covered calls, using owned assets, are a less risky alternative to naked calls.

•   Exiting a trade can be done by buying back options or shares to close the position.

•   Risk management and liquidity are essential to handle adverse price movements and margin requirements.

Understanding Naked Calls

When a trader sells or writes a call option, they are selling someone else the right to purchase shares in the underlying asset at the strike price. In exchange, they receive the option premium. While this immediately creates income for the option seller, it also opens them up to the risk that they will need to deliver shares in the underlying stock, should the option buyer decide to exercise.

For this reason, it is generally much less risky to use a “covered call strategy” and sell an option on an underlying asset that you own. In the case of stocks, a single option generally represents 100 shares, so the trader would want to own 100 shares for each option sold.

Trading naked calls, on the other hand, is among the more speculative options strategies. The term “naked” refers to a trade in which the option writer does not own the underlying asset. This is a neutral to bearish strategy in that the seller is betting the underlying stock price will not materially increase before the call option’s expiration date.

In both the naked and the covered scenarios, the option seller gets to collect the premium as income. However, selling a naked call requires a much lower capital commitment, since the seller is not also buying or owning the corresponding number of shares in the underlying stock. While this increases the potential return profile of the strategy, it opens the seller up to potentially unlimited losses on the downside.

How Do Naked Calls Work?

The maximum profit potential on a naked call is equal to the premium for the option, but potential losses are limitless. In a scenario where the stock price has gone well above the strike price, and the buyer of the option chooses to exercise, the seller would need to purchase shares at the market price and sell them at the lower strike price.

Hypothetically, a stock price has no upper limit, so these losses could become great. When writing a naked call, the “breakeven price” is the strike price plus the premium collected; a profit may be achieved when the stock price is below the breakeven price.

Investing in naked calls comes with significant risk and requires discipline and a firm grasp of common options trading strategies.

Writing a Naked Call

Although there are significant risks to naked calls, the process of writing them can be straightforward. An individual enters an order to trade a call option; but instead of buying, they enter a sell-to-open order. Once sold, the trader hopes the underlying stock moves sideways or declines in value.

So long as the shares remain below the strike price at expiration, the naked call writer will keep the premium (or credit) collected. However, if the company that issued the shares releases unexpected good news, or the shares simply have positive price momentum, the stock price can go upward and expose the naked call writer to potentially significant losses should the buyer exercise the call option.

There are dozens of options on stocks and exchange-traded funds (ETFs) with differing expiration dates and strike prices. For this reason, a trader must take a directional position on the underlying stock price while also accounting for the impact of time decay leading up to expiration. Keeping a close eye on implied volatility is important, too.

Closing Out a Naked Call

When the trader wants to exit the trade, they create a buy-to-close order on their short calls. Alternatively, a trader can buy shares of the underlying asset to offset the short call position.

Finally, user-friendly options trading is here.*

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*Check out the OCC Options Disclosure Document.

Naked Call Example

Let’s say a trader wants to sell a naked call option on shares of a stock. Let’s also assume the stock trades at $100 per share.

For our example, we’ll assume the trader sells a call option at the $110 strike price expiring three months from today. This option comes with a premium of $5 per share, which they receive for selling their options. This call option would be considered “out of the money” since the strike price is above the underlying stock’s current price.

Thus, the option only has extrinsic value (also known as time value). This naked call example seeks to benefit from the option’s time decay, also known as theta. At initiation, the trader sells to open the trade, and then collects the $5 premium per share.

As the option nears its expiration date, time value diminishes, and the option price may decrease if the stock price does not significantly rise. If the stock price ends below the strike price by expiration, the option could expire worthless, allowing the trader to retain the full premium as profit.

Conversely, if the stock price increases significantly — say from $50 to $60 — the traders who sold the call at a $52 strike price could face a loss of at least $8 per share ($60 market price minus the $52 strike price, less any premium received). If multiple contracts are sold, the losses can add up quickly.

For example, if the stock price rises during the contract period, the trader who sold the call option may face increasing losses as the stock moves further above the strike price.

Using Naked Calls

In general, naked calls are best suited for experienced traders who have a risk management strategy in place already.

Naked calls may appeal to traders seeking speculative opportunities, since they may profit if the underlying stock price remains stable or declines. The strategy comes with the risk of potentially unlimited losses and other considerations, such as liquidity concerns and the potential need for a margin account or leverage.

The challenge of trading naked calls is the need for sufficient liquidity to manage adverse price movements. If the underlying stock experiences unexpected positive momentum, its price may rise sharply, leading to substantial losses for the trader. This risk is compounded when a trader does not have adequate funds to cover the margin requirements associated with the position.

This strategy may require you to open a margin account with a broker so you can tap into their liquidity if necessary. Brokers typically enforce strict margin requirements for naked calls to mitigate this risk, which can result in margin calls if the account value drops too low.

Naked call strategies are most appropriate for seasoned traders who thoroughly understand options mechanics, as well as the factors that influence price movements (volatility, time decay, and underlying stock performance). These traders should implement stringent risk controls, such as predefined exit strategies and position sizing, to limit exposure.

Risks and Rewards

The potential for unlimited losses makes naked call writing a risky strategy. The reward is straightforward — keeping the premium received at the onset of the trade. Here are the pros and cons of naked call option trading:

Pros

 Cons
Potential profits from a flat or declining stock price Unlimited loss potential
Can allow time decay (theta) to work in your favor Reward is limited to the premium collected
May generate income May result in a margin call when the underlying asset appreciates

Naked Call Alternatives

One common alternative to naked calls is known as “covered call writing.” This strategy includes owning the underlying stock while selling calls against it. This can be a more risk-averse alternative to naked calls, but the trader must still have enough cash to purchase the necessary shares (unless they are using margin trading).

There are other, more complex options strategies that can help achieve results similar to naked call writing. Covered puts, covered calls, and bear call spreads are common alternatives to naked calls. Experienced options traders have strategies to manage their risk, but even sophisticated traders can become overconfident and make mistakes.

Selling naked puts is another alternative that takes a neutral to bullish outlook on the underlying asset. When selling naked puts, the trader’s loss potential is limited to the strike price (minus the premium collected) since the stock can only go to $0 — however, that loss can be significant.

The Takeaway

A naked call strategy is a high-risk technique in which a trader seeks to profit from a declining or flat stock price. The maximum gain is the premium received while the risk is unlimited potential losses. As with all option trading strategies, traders need to understand the risks and benefits of selling naked calls.

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Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not offer naked options trading at this time.

Photo credit: iStock/twinsterphoto

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.

¹Claw Promotion: Probability 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-Q125-096

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Mar
04
2025
31 Things to Do With a Windfall

Financial Windfall: Definition and Ideas on Use

By | Budgeting & Goals, Growing Wealth, money | Comments Off on Financial Windfall: Definition and Ideas on Use

You just came into a cash windfall. You’re happy about this, but you aren’t exactly sure about what to do with it. Should you spend it? Save it? Invest it?

The answer will depend on the size of the windfall and your current financial situation and goals. Here are some ideas for things you can do with a financial windfall to ensure that you are handling it in the smartest way possible.

Key Points

•   A good way to use a windfall is to pay down high-interest debts, such as credit card balances.

•   It’s also wise to build an emergency fund with at least three to six months of living expenses.

•   Consider putting the funds in a high-yield savings account or investing in stocks or bonds for future growth.

•   You might allocate funds to personal goals like professional development, starting a side business, or home improvements.

•   Another good use for a windfall is donating to a charity for a potential tax deduction and to support causes you care about.

What Is a Financial Windfall

While there’s no one specific definition for a financial windfall, it typically means that you’ve received some unexpected money of a significant amount. For some people, a windfall could be a few hundred dollars; for others, it could be millions.

The key component of a windfall is the element of surprise — you may be surprised by receiving any money at all, the amount of the money, or both. Generally, a windfall isn’t money you’ve factored into your regular income and budget. This can make it a major plus, but it can also lead to some financial challenges, along with some major decisions to make.

Examples of Financial Windfalls

Financial windfalls can come from a variety of sources. Here are some common examples of windfalls:

•   Lottery or prize winnings

•   Employee bonus

•   Tax refund

•   Inheritance or life insurance payout

•   Major successes in investing

•   Profit from selling a property or business

•   Injury or lawsuit settlement

3 Tips to Help You Make the Most of Your Money Windfall

If you are fortunate enough to have a windfall land in your lap, you’ll need to decide if you’re going to spend, save, invest, donate the money, or some combination of the above. The following steps can help you come up with a plan that makes the most of your newfound cash.

•  Get professional advice: Depending on the size and source of your windfall, you might owe taxes on it and it might push you into a different tax bracket. Consulting with an accountant or financial planner can help you identify the implications.

•  Take it slow: While it’s exciting to have cash coming your way, it’s wise to take some time and reflect on how the money would be best spent versus deciding “Dinner’s on me!” for you and your 10 best pals to celebrate. For instance, could your windfall lower or wipe out some debt? Could it be invested? Don’t let the adrenaline rush drive you to make too quick a decision. Take some time to clarify your goals.

•  Think long-term: If you’ve received a sizable sum, it may be tempting to quit your day job to travel or take on a passion project. Again, it could be wise to seek financial counseling before you make that type of leap. What sounds like a major sum may not actually be enough to fully finance your dreams. It’s important to look at the financial implications of a major life change carefully.

Remember That Taxes May Be Due on Your Windfall

Depending on the source of your windfall, it may be subject to income taxes. Tax law regarding windfalls is complicated, however, so it’s a good idea to consult an accountant or other tax professional to make sure you understand how much your windfall is actually yours to keep.

Understanding Tax Implications Based on the Source of the Windfall

Whether or not you owe taxes on a windfall will depend on where your windfall is coming from. Here’s a look at some examples:

•   Inheritance: In general, any inheritance you receive does not need to be reported to the IRS. However, you may owe state taxes if the amount exceeds a certain threshold.

•   Life insurance payout: Proceeds you receive as a beneficiary of a life insurance policy typically aren’t taxable, but if the proceeds have accumulated interest, taxes may be due on that interest.

•   Lottery/prize winnings or large bonus: If your windfall is from a lottery, other prize, or large bonus, you are typically taxed at your ordinary income tax rate. This means you will pay taxes on your windfall based upon your tax bracket.

•   Sale of property or a business: Profits from selling real estate or a business are generally taxed at the long-term capital gains rate, depending how long you owned the asset.

•   A large cash gift: You typically do not have to pay taxes on a windfall that was given to you as a gift; the giver is responsible for paying any gift taxes.

What to Do With a $500 Windfall

Let’s say the amount of money you received was $500. While it isn’t a ton of money, it’s still significant enough that you should figure out what to do with it. Here are a few ideas for what to do with a small windfall.

1. Investing in Real Estate

Did you know that you can become a real estate investor with just $500? Real estate investment trusts (REITs) allow you to invest in real estate on a small scale. Similar to mutual funds, REITs are companies that own a mix of properties and typically pay dividends to investors. Although there is risk involved in investing in REITs, it might be a good way to get your feet wet if you’re interested in real estate investing.

2. Meeting With a Financial Advisor

Hiring a financial advisor to help you learn how to plan for your financial future might be a good use of this money. Financial advisor fees vary: Some charge a flat fee, some charge hourly, some are commission-based. If this professional will be managing a portfolio for you, they may charge 1% to 2% of the portfolio’s value.

3. Buying a New Wardrobe

You could refresh your wardrobe with your new supply of cash. Upgrading your clothes could give you the confidence to go after your professional goals. Or you might splurge on some clothes you’ve been eyeing that give you a self-esteem boost.

4. Traveling Somewhere Cheap

You might plan a weekend getaway or road trip for only $500. Throw in your credit card points or rewards you’ve accumulated to bump up your budget.

5. Investing in a Certificate of Deposit

Another thing you can do with a $500 financial windfall is put it into a certificate of deposit (CD). This is a type of savings account that holds a fixed amount of money for a set period of time and generally pays more than a regular savings account.

6. Getting Your Car Fixed

Have you been putting off car repairs because they’re too expensive? Now that you have $500, it might be time to invest in your vehicle so it’s less likely to break down when you’re on the road.

7. Buying Renter’s Insurance

If you’re a renter, your personal property is not covered under your landlord’s homeowners insurance policy. If you don’t have renter’s insurance, you might use your windfall to buy yourself some peace of mind. The average renter’s insurance cost in the U.S. is $148 per year, which means your windfall could insure your possessions for at least the next three years.

8. Purchasing a Life Insurance Policy

If your family depends on your income, life insurance helps protect them in the event that you pass away. The average cost of a life insurance policy is $26 per month. That means you could pay for the whole year up front with your $500 windfall. Typically, life insurance rates increase as you age and your risk of dying increases. So it’s likely to be less expensive to purchase life insurance while you’re young, rather than waiting until you feel like you can afford it.

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9. Taking a Professional Development Class

While private colleges and universities might be too pricey, you may be able to find a class online or at your local community college for less than $500. Finding something that is relevant to your career may even help you move up the ladder at your job.

What to Do With a $1,000 Windfall

Did you receive a $1,000 financial windfall? Here are some ideas for how you might use this sudden influx of cash.

10. Getting Started on Your Emergency Fund

An emergency fund is a separate savings account that you can tap to cover or offset the expense of an unexpected expense or loss of income. If you haven’t started building your emergency fund, or it’s not as robust as it should be, your $1,000 windful could boost your safety net.

11. Hiring an Estate Planning Lawyer

Another important thing you could do with a $1,000 cash windfall is meet with an estate planning lawyer to write your will, establish a trust, and determine your power of attorney. You may feel some peace knowing your family will be protected and your assets will be distributed according to your wishes.

12. Opening a 529 Plan

A 529 plan offers a way to save for your child’s college education. With $1,000, you can get a nice head start on college savings. Your money will grow tax-free and if you withdraw the money for qualified educational expenses, you won’t pay any taxes on those withdrawals.

13. Doing Home Improvements

With $1,000, you could do a small home improvement project like replacing your curtains, painting a room or two, putting down a new kitchen floor, or sprucing up your backyard. If you do the work yourself, you may be able to stretch your financial windfall money even further.

14. Donating It

If there’s a nonprofit you’ve always wanted to support, you might consider using your $1,000 windfall to make a donation. Your money could make a big difference. Plus, you may also be able to deduct the contribution on your taxes (if you itemize).

15. Opening a High-Yield Savings Account

Savings accounts rates are averaging 0.42% APY as of December 16, 2024, according to the FDIC. A high-yield savings account, however, may pay 3.00% APY or higher. Plus, savings accounts are typically insured by the FDIC up to $250,000 per depositor, per insured bank, for each account ownership category, in the event of bank failure.

💡 Quick Tip: Most savings accounts only earn a fraction of a percentage in interest. Not at SoFi. Our high-yield savings account can help you make meaningful progress towards your financial goals.

16. Saving for Retirement

If you have a 401(k) but haven’t contributed much so far, your windfall could help you increase your savings rate. Or, if you’re eligible to contribute to a traditional or Roth individual retirement account (IRA), you might open one with your $1,000 windfall to boost your retirement savings.

17. Investing in Your Side Hustle

To make money on your $1,000 financial windfall, you might use it to start a low-cost side hustle. Maybe you’re a freelance graphic designer but you need to buy some software to be able to do more detailed work. Or, perhaps you need to purchase a domain name and hire a developer to create a business website. With this initial investment, you may be able to bring in much more money and improve your finances.

What to Do With a $5,000 Windfall

You just got a cash windfall of $5,000. Now what? Here are some ideas.

18. Saving Up for a Down Payment

In some cases, you only need to put 3% to 5% down on a home. That means you could conceivably buy a $150,000 home using your $5,000 financial windfall money as your down payment. More realistically, you could use your windfall to add to money you’ve already saved for your down payment.

19. Paying Off Credit Card Debt

The average consumer credit card debt balance is $6,730. A $5,000 windfall could pay most of that bill off in one fell swoop and could save you a significant amount of money in interest.

20. Investing Via Robo-Advisors

Do you want to invest your $5,000 cash windfall, but you don’t know where to start? Robo advisors create a diversified investment portfolio based on your investment goals and the level of risk you’re willing to take.

21. Investing in Blue-Chip Stocks

You might also consider using your windfall to invest in blue-chip stocks. These stocks are from well-established and financially stable companies that typically pay dividends to investors.

22. Investing in Bonds

Though they carry some risks, bonds are considered relatively safe and stable investments. When you purchase a bond, you’re lending money to an entity like a government or corporation. In return, you receive the interest payments at regular intervals. At the end of the repayment period, you get your original investment amount back.

23. Taking a Vacation

With $5,000, you and your family could potentially take a great vacation within the U.S. For example, your windfall might be enough to fund an RV excursion, urban getaway, visit to a theme park, or a beach retreat. Check out sites like Expedia, Costco Travel, and Booking.com for deals.

What to Do With a $10,000+ Windfall

If you received a cash windfall of $10,000 or more (lucky you!), here are some things you could do with it.

24. Opening a Money Market Account

You could use your $10,000 to open a money market account, which typically earns a higher interest rate than a regular savings account.

25. Paying Off Student Loan Debt

The average federal student loan debt in the U.S. is $37,853 per borrower. If you have a $10,000 financial windfall, you could put a nice dent in your student loan balance.

26. Trying Peer-to-Peer Lending

Using a peer-to-peer lending platform, you could lend your financial windfall money to someone who is looking for a loan and potentially earn a good return. Just keep in mind that this type of lending involves risks.

27. Making Mortgage Payments

You could make a large principal-only payment toward your mortgage loan with a $10,000 cash windfall. This can help you pay off your loan off sooner and save a significant amount of interest. First, verify that there are no prepayment penalties tied to your loan.

28. Going to College

While $10,000 won’t cover a bachelor’s degree unless you also get grants or scholarships, you may be able to earn your associate’s degree at your local community college with your financial windfall money. Or it might cover several classes at a public university that could lead to career advancement.

29. Starting Your Business

Let’s say you want to do more than start a side hustle, and you’re ready to open a small business. A $10,000 windfall could help you get the ball rolling on your business without needing to borrow money. You might consult with a successful business owner in your industry for guidance on how best to allocate your money.

30. Increase Contributions to Your Retirement Account

This can help you build your nest egg, while also reducing your taxable income, which could help offset taxes owed on your windfall (if applicable).

31. Make a Move

If you’re looking to be closer to work or simply want to live in a quieter — or busier — location, a $10,000 financial windfall could be enough to cover the cost of hiring movers.

The Takeaway

Receiving a financial windfall opens up all kinds of possibilities. You might pay down debt, take a vacation, invest the funds, pursue higher education…or even do a little of each. Though it’s tempting to spend your windfall right away, it’s a good idea to step back and think through the wisest way to use your newfound cash. In the meantime, you might park the money in a high-yield savings account. This allows you to earn an above-average interest on your windfall but still keeps the money accessible.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.60% APY on SoFi Checking and Savings.

FAQ

What amount of money is considered a windfall?

The amount that’s considered a windfall can vary from person to person. For some, it could be a few hundred dollars. For others, a windfall might be thousands or even millions of dollars.

What to do with a $50,000 windfall?

There are many ways to use a $50,000 windfall. You could pay down debt, put a down payment on a home, pump up your retirement account, start or add to a college savings account, do a home renovation, or use it as seed money to start a business.

What can you do with a $100K windfall?

With a $100,000 windfall, you might pay off your mortgage, put a down payment on a home, build your retirement or college savings fund, invest the money for long-term growth, or a combination of the above.

Should you save or invest a windfall?

It depends on your financial situation and goals. If you have high-interest debt, a good use of a windfall is to pay it off. Next, you might start or top off your emergency fund. Whether to save or invest the rest will depend on your goals. For short-term goals, like saving for a vacation, wedding, or new car, consider putting the funds in a high-yield savings account. For goals that are at least five years off (like retirement, buying a house, or a child’s college education) investing may be a better choice.

How can you avoid common mistakes with a windfall?

To avoid common mistakes with a windfall, it’s important to pause and make a plan for how to use the money, rather than spend impulsively. Smart ways to use a windfall include paying off high-interest debt, building an emergency fund, and investing for long-term goals like retirement or a child’s college education.

About the author

Kylie Ora Lobell

Kylie Ora Lobell

Kylie Ora Lobell is a personal finance writer who covers topics such as credit cards, loans, investing, and budgeting. She has worked for major brands such as Mastercard and Visa, and her work has been featured by MoneyGeek, Slickdeals, TaxAct, and LegalZoom. Read full bio.


Photo credit: iStock/TARIK KIZILKAYA

SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Annual percentage yield (APY) is variable and subject to change at any time. Rates are current as of 11/12/25. There is no minimum balance requirement. Fees may reduce earnings. Additional rates and information can be found at https://www.sofi.com/legal/banking-rate-sheet

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning the APY for account holders with Eligible Direct Deposit, we encourage you to check your APY Details page the day after your Eligible Direct Deposit posts to your SoFi account. If your APY is not showing as the APY for account holders with Eligible Direct Deposit, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning the APY for account holders with Eligible Direct Deposit from the date you contact SoFi for the next 31 calendar days. You will also be eligible for the APY for account holders with Eligible Direct Deposit on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, Wise, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi Bank shall, in its sole discretion, assess each account holder's Eligible Direct Deposit activity to determine the applicability of rates and may request additional documentation for verification of eligibility.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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.

We do not charge any account, service or maintenance fees for SoFi Checking and Savings. We do charge a transaction fee to process each outgoing wire transfer. SoFi does not charge a fee for incoming wire transfers, however the sending bank may charge a fee. Our fee policy is subject to change at any time. See the SoFi Bank Fee Sheet for details at sofi.com/legal/banking-fees/.
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.

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.

Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

SOBNK-Q125-090

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Mar
04
2025
woman office phone

How to Save Money From Your Salary

By | Budgeting & Goals, Life & Career | No Comments

When times are tight, it can feel as though putting even a few dollars away every month is next to impossible. How can you save money when you have a low salary and so many expenses?

There are ways to get that needle moving in the right direction — even for those who are new to working full time and living on their own. Here’s a look at some simple strategies that can help you save the maximum from your paycheck.

Key Points

•   A good way to save more from your salary is to leverage an employer match in a 401(k) plan.

•   Based on the 50/30/20 rule, aim to save around 20% of your monthly take-home pay to fund your goals.

•   Consider putting a budgeting app on your phone to help you track spending and stay on budget.

•   To consistently save from your salary, automate savings with a recurring transfer or split direct deposit.

•   Allocate savings to both short- and long-term financial goals, using appropriate accounts and investments for each.

Taking Advantage of the Employer Match

Concerning but true: One in five adults ages 50-plus have no retirement savings, and more than half (61%) are worried they will not have enough money to support them in retirement, according to a 2024 survey by the AARP. Thankfully, it’s never too late — or too early — to start putting money aside for retirement. Enrolling in your company’s 401(k) plan can be a great place to start, and they may even offer matching contributions.

Maximize Retirement Contributions

Even if retirement feels a long way off, a great way to save more from your salary is to contribute as much as you can to your 401(k). That way, you let compound returns — when the money you earn on your contributions gets reinvested and also generates earnings — have an opportunity to work in your favor. The earlier you start saving for retirement, the less you’ll need to save each year to reach your goal.

If your employer offers a match, it’s a good idea to contribute at least enough to maximize this benefit, which is essentially free money. For example, let’s say your employer offers a 50% match up to 5% of your salary and you make $60,000. You would contribute $3,000 over the course of the year, and your employer would kick in another $1,500. Failing to contribute at least 5% means you’re leaving money on the table. This match significantly increases your retirement savings without additional effort on your part.

You might also consider increasing your contributions over time. Many employers allow you to automate annual increases, which helps you save more as your salary grows.

💡 Quick Tip: Your money deserves a higher rate. You earned it! Consider opening a high-yield checking account online and earn 0.50% APY.

Preparing a Budget and Following It

Creating a realistic budget ensures that you allocate your income wisely and consistently save a portion of your salary. Without a budget, it’s easy to overspend and neglect your financial goals.

If the idea of a budget seems daunting — or past attempts have been less than successful — it might be because your approach to budgeting is too complicated. It’s not necessary to create a complex set of spreadsheets. In fact, when you’re new to budgeting, a simple approach often works better.

One easy budgeting framework you might consider is the 50/30/20 rule. This approach streamlines expenses into three categories so you don’t have to monitor every single expenditure to make it work. Instead, you divide your take-home pay (what you make after taxes are taken out) into three main categories: needs, wants, and goals. Here’s how it works.

•   Put 50% of your money toward needs: This includes housing, utilities, groceries, transportation, insurance, prescription medications, minimum payments on credit cards and other debt, and any other expense you have to cover.

•   Put 30% toward wants: Here’s where everything from vacations to fancy coffees can come in. If it isn’t essential, it goes into this chunk of your budget. You might look at what you are currently spending on wants and see if you can find places to cut. Are you paying for streaming services you rarely watch? Are you a member of a gym you never go to? Could you cook one or two more nights per week and spend less on takeout? It’s all your call — but these costs all must fit into the allotted amount of money.

•   Put 20% towards goals: This category allows you to siphon off some of each paycheck to build your emergency fund, save for other short-term goals (like buying a car or going on vacation), and fund your retirement account. If you’re carrying high-interest debt, you’ll want to use some of this money to pay it down by making payments beyond the minimum.

•   Feel free to tweak: The 50/30/20 guideline is just that — a guideline. You may want to adjust the breakdown if the cost of living is particularly high in your area, and you need to spend more than 50% of your take-home pay on needs. On the other hand, if you’re in a hurry to pay down debt, you might want to cut back on your wants spending to make it work. The key to budget success, however, is to stick with it. So you don’t want to come up with a spending plan that is so austere you can’t maintain it.

💡 Quick Tip: If you’re saving for a short-term goal — whether it’s a vacation, a wedding, or the down payment on a house — consider opening a high-yield savings account. The higher APY that you’ll earn will help your money grow faster, but the funds stay liquid, so they are easy to access when you reach your goal.

Allocating Savings To Short- and Long-Term Goals

The goals category of your budget should include both short- and long-term goals. Here’s a look at how they differ:

•   Short-term goals: These are things you want to accomplish within the next several months or years, such as building an emergency fund, going on vacation, or making a major purchase. CDs, money market accounts, and high-yield savings accounts can be good choices for short-term goals.

•   Long-term goals: These goals are generally five or more years off and might include saving for retirement, a home purchase, or a child’s future college education. Consider investing the funds you set aside for these goals, since there’s time to withstand market fluctuations.

Using Budgeting Tools to Track Your Spending

Once you have a sense of how you want to divide up your salary and increase your savings, you might lean on some tools or apps to help you stay on track. Your bank may offer a free spending tracker as part of their mobile app. If not, consider downloading a separate budgeting app. Some popular options include:

•   YNAB (You Need A Budget): This app allows you to set specific savings goals, then keeps track of your spending and saving and charts your progress.

•   PocketGuard: This tool connects to all of your financial accounts and syncs transactions in real-time, helping you stick to your budget.

•   Goodbudget: Based on the envelope system of budgeting, Goodbudget divides up your salary into categories, then monitors your spending and helps you stick to the plan.

Automating Your Savings and Payments

Once you come up with a framework for how much you will spend and save each month, it’s a good idea to put as much of the plan on autopilot as possible.

Setting up autopay for your regular monthly bills, for example, eliminates the risk of missing payments and racking up late fees. In addition, you may want to consider automating your savings — this way, you won’t have to remember (and, quite possibly, forget) to transfer some money from your salary to savings each month, or be tempted to spend that money.

There are two different ways to automate savings. One is to split your direct deposit into two accounts. For example, you might have the majority of your paycheck go into your checking account and a smaller percentage into a high-yield savings account. If a payroll split isn’t an option, you can set up an automatic transfer from your checking to your savings on the day your paycheck clears. This way, the money gets whisked away before you have a chance to spend it.

The Takeaway

A savings plan doesn’t have to be complicated — or painful. In fact, you can start saving more from your salary by making just a few simple changes. These include: making sure you are putting some of your paycheck into your retirement plan at work (at least up to any employer match), coming up with a basic spending plan (such as the 50/30/20 breakdown), and putting your savings on autopilot. Before long, budgeting and saving will likely become a habit you don’t even have to think about.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.


Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall.* Enjoy up to 3.60% APY on SoFi Checking and Savings.

FAQ

How much of my salary should I save every month?

A common recommendation is to save at least 20% of your take-home salary. This 20% includes emergency savings, retirement contributions, and other investments. However, this is just a guideline. If you have a high income and relatively low expenses, you may be able to save much more than 20%. If money is tight, on the other hand, you might need to start with a smaller percentage and gradually increase it over time.

How big of an emergency fund do I need?

A general rule of thumb is to have three to six months’ worth of living expenses set aside in an emergency fund. To come up with an exact amount, tally up all of your fixed expenses (e.g., rent/mortgage, utilities, groceries, transportation, debt, etc) and multiply that number by three or, ideally, six. Having that big of an emergency fund can help you cover your monthly bills in the event of a financial set-back without running up debt.

Should I pay debt instead of saving?

It depends. If you don’t have a solid emergency fund, you’ll want to prioritize saving over paying off debt. After that, you generally want to prioritize paying off high-interest debt (such as credit cards) over saving, since the interest rate you’re paying on your balances likely exceeds what you could earn by saving or investing. If your debt has a relatively low-interest rate, however, it’s a good idea to balance paying it off with putting money into savings.

What does an employer match mean?

An employer match is when your employer contributes to your retirement savings plan, such as a 401(k), based on how much you are contributing, up to a certain limit. For example, if your employer offers a 50% match up to 5%, it means they will contribute 50 cents for every dollar you contribute up to 5% of your salary. Any contributions you make above 5% of your salary will not be matched.

What is the max amount my employer is allowed to match?

Employer match maximums vary by company. The average 401k employer match is 50% partial match contributions up to 4% to 6% of an employee’s salary.

While companies can set their own matching policies, keep in mind that the internal revenue service (IRS) sets overall contribution limits for retirement plans, both for employees and for combined employee/employer contributions. These limits are updated every year.

SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Annual percentage yield (APY) is variable and subject to change at any time. Rates are current as of 11/12/25. There is no minimum balance requirement. Fees may reduce earnings. Additional rates and information can be found at https://www.sofi.com/legal/banking-rate-sheet

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning the APY for account holders with Eligible Direct Deposit, we encourage you to check your APY Details page the day after your Eligible Direct Deposit posts to your SoFi account. If your APY is not showing as the APY for account holders with Eligible Direct Deposit, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning the APY for account holders with Eligible Direct Deposit from the date you contact SoFi for the next 31 calendar days. You will also be eligible for the APY for account holders with Eligible Direct Deposit on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, Wise, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi Bank shall, in its sole discretion, assess each account holder's Eligible Direct Deposit activity to determine the applicability of rates and may request additional documentation for verification of eligibility.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

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.

We do not charge any account, service or maintenance fees for SoFi Checking and Savings. We do charge a transaction fee to process each outgoing wire transfer. SoFi does not charge a fee for incoming wire transfers, however the sending bank may charge a fee. Our fee policy is subject to change at any time. See the SoFi Bank Fee Sheet for details at sofi.com/legal/banking-fees/.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®

SOBNK-Q125-086

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Feb
28
2025
What Is a Bear Call Spread? How It Works

Bear Call Spread, Explained

By | Growing Wealth, invest, Investing, Terminology | Comments Off on Bear Call Spread, Explained

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.

A bear call spread is one of four basic vertical options spreads that traders put to regular use. This strategy aims to generate income in bearish or neutral markets with limited upside potential while carrying defined risks.

Traders use a bear call spread strategy to seek potential profit on a decrease in value of the option’s underlying asset. Hence, the “bear” in the strategy’s name.

As such, a trader would typically use a bear call spread when they believe the underlying asset’s value is likely to fall.

Key Points

•   A bear call spread involves selling a short call with a lower strike price and buying a long call with a higher strike price, both expiring simultaneously.

•   A bear call spread can generate a net premium, be profitable if the underlying asset’s value declines, and come with limited maximum profit or loss.

•   The performance of the strategy is influenced by stock price changes, volatility, and time until expiration.

•   The strategy is best used when anticipating a decline in the underlying asset’s value, requiring careful market analysis.

•   Consider risk management, early assignment risk, and the speculative nature of options trading.

What Is a Bear Call Spread?

A bear call spread is an options trading strategy that investors may use to potentially profit from a declining (or neutral) stock price and time decay, while also limiting the risk of loss.

With this strategy, a trader creates a spread by buying and selling two call options at the same time, attached to the same underlying asset, with the same expiration date. The key difference between the two call options is their strike price.

One call option is a long call option strategy, involving purchasing a call with a higher strike price, and the other is a short call strategy (similar to shorting a stock), involving selling a call with a lower strike price than the long call.

The bear call spread strategy benefits from the stock price staying below the lower strike price of the sold call. By selling a call option at a lower strike price and buying another at a higher strike price, the investor hopes to collect a premium for the bearish short call, while limiting potential losses through the bullish long call.

How Does a Bear Call Spread Work?

A bear call spread consists of two key positions: buying a long call and selling a short call. When the trader simultaneously purchases a long call and sells a short call (with a lower strike price), it creates a credit in the trader’s account, since the long call the trader is buying is less expensive than the short call the trader is selling. As noted above, the short call generates income for the trader by providing a premium, and the long call helps limit the trader’s potential loss.

Max Profit of a Bear Call Spread

Setting up these two call positions creates a spread, and the trader benefits when the underlying asset’s value declines. The maximum potential profit is capped at the net premium received from the sale and purchase of the call options. The investor may see the max potential profit if the stock price remains below the strike price of the sold call at expiration.

However, if the stock price rises above the strike price of the sold call, the trader may incur losses. The premium from selling the call can reduce these losses, but they could still be substantial if the strike prices move significantly higher.

Max Loss of a Bear Call Spread

If the underlying asset’s value increases, the spread can result in a loss for the trader, since the buyer of the call option may then choose to exercise the option. However, the maximum potential loss is capped at the difference between the strike prices of the two options, minus the premium received. The long call option limits loss by offsetting the risk of the short call being exercised.

Example of a Bear Call Spread Strategy

As an example, a bear call spread could involve a trader selling a short call option on a stock, which expires in one month, with a strike price of $10, for a premium of $2. The trader also buys a call option with the same expiration and a strike price of $12 for a premium of $1.

By selling the short call, they’ve received a net premium of $1. Option contracts typically control 100 shares, providing a total credit of $100. The trader has two calls with the same expiration date, but two different strike prices.

Let’s say a month goes by, and the trader’s bearish instincts have proven correct. The stock’s price declines and their call options expire below the $10 strike price of the short call. They keep the net premium of $100 and walk away with a profit.

In a downside scenario, suppose the stock climbs to $13 on expiration day. The trader closes out both contracts for a net loss of $2 per share, or $200 for each set of contracts, resulting in a $200 total loss for the strategy. This is offset by the $100 received upfront, so their net loss is just $100.

Finally, let’s analyze the break-even point. Break-even occurs at the strike price of the short call, plus the net premium received. In our example, this is the $10 lower strike, plus $1 of net premium, or $11.

Factors That Impact Bear Call Spreads

Several factors influence the outcome of a bear call spread strategy. These include the underlying asset’s price movements, market volatility, and the passage of time. Price movements influence the cost of options contracts. Market volatility impacts the extrinsic value of the contracts. The passage of time determines time decay, also known as theta.

Stock Price Change

Movement in stock price can affect a bear call significantly. This strategy benefits from a neutral to bearish market trend. When stocks rise, there is a greater chance of loss. The difference in strike prices caps both the potential profit and loss, which can therefore reduce profitability. A wider gap between the strikes can result in a lower net premium, and create higher risk exposure for the trader.

Stock Price Volatility

Volatility plays a moderate role in a bear call spread’s performance. The strategy’s maximum profit and loss are mainly influenced by the strike prices and the premiums received, rather than large price swings. That said, higher volatility generally leads to higher premiums, which can increase the income generated upfront. This also comes with a higher risk of the stock price moving beyond the strike prices, which could potentially lead to losses.

Although volatility does affect the strategy, it tends to perform best in environments with moderate or low volatility. Stable market conditions can allow the stock to stay within the expected range, which may increase the likelihood of the options expiring worthless and enabling the trader to keep the full premium as profit.

Time

Time decay plays an important role in the potential profitability of bear call spreads. As expiration approaches, the time value of the short call (i.e. lower strike) erodes more rapidly than the long call (i.e. higher strike), which benefits the position. This can work in the trader’s favor so long as the stock price remains below the short call strike, potentially turning a profit as both options lose value over time.

Benefits and Risks of a Bear Call Spread

Following are some of the potential benefits and risks associated with bear call spreads that investors should consider before using this strategy.

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Pros:

•   Flexibility

•   Capped potential losses

•   Relative simplicity

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Cons:

•   Capped potential gains

•   Limited potential use

•   The strategy could backfire

Benefits of a Bear Call Spread

There are some advantages to bear call spreads, which is why some traders use them to attempt to manage risk and pursue potential gains.

•   Flexibility: Depending on the specific calls sold and purchased, traders can see a profit under a variety of scenarios, such as when the underlying asset’s value remains the same, or when it declines.

•   Capped potential losses: There’s a maximum that a trader can lose, which also means profits are also capped. These types of strategies are used not only to seek profits, but to also limit risk.

•   Relative simplicity: Bear call spreads are more straightforward than other advanced options trading strategies.

Risks of a Bear Call Spread

Bear call spreads can have their disadvantages.

•   Capped potential gains: Like other vertical spread strategies, potential gains are capped — in this case, at the initial net premium credited to the account.

•   Limited potential use: The strategy is most effective in neutral to bearish markets, typically with moderate to low volatility.

•   The strategy could backfire: The risk is that the underlying asset sees a dramatic rise in value, rather than a fall in value as the trader predicted, resulting in significant losses on the short position. This could mean that the trader would need to sell the underlying asset at the strike price of the short call, which may lead to a loss.

Bear Call Spread Considerations and Tips

There are a few other things worth keeping in mind when it comes to the bear call spread strategy.

•   There’s an early assignment risk: Since options can be exercised at any time, traders with short option positions should remember that they’re putting themselves at risk of early assignment — meaning they may be required to sell the underlying asset at the lower strike price if assigned.

•   The strategy can be used in variations: A bear call spread is only one of several vertical options spreads that traders can put to use. Depending on market conditions, it could be wise to use a bullish strategy instead.

•   Options trading comes with risk: It’s critical to remember that options trading is speculative. There are no guarantees, and the risk of loss is real. No matter how good any trader thinks they are at predicting the market, the risk of loss is significant. It’s important for investors to calculate the risk-reward ratio before choosing their speculative tools.

The Takeaway

A bear call spread is one of many options trading strategies a trader may employ in trying to protect themselves from losses and try to benefit from gains when they foresee a moderate decline in the underlying asset. But as with all strategies, it’s not foolproof, and there is a risk that the price of the asset might rise causing the strategy to backfire.

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

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

Explore SoFi’s user-friendly options trading platform.

FAQ

How do you close a bear call credit spread?

If the stock price is moving against the position, such as the stock rising and nearing the short strike price, a trader may close the position early to limit potential losses by.

On the other hand, if the stock price stays below the short strike and both options expire worthless, the trader can simply let the position run its course, keeping the premium as profit. The decision to close often depends on the stock’s movement and how much risk the trader is willing to take.

How do you set up a bear call spread?

In order to set up a bear call spread, a trader sells a call option with a lower strike price and buys a call option with a higher strike price, both with the same underlying asset and expiration date. These two positions create the spread.

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