Investing Archives | Page 188 of 222

Feb

2022

What Is Extrinsic Value?

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

What is Extrinsic Value?

Extrinsic value is the difference between an option’s market price, known as the premium, and its intrinsic value. Extrinsic value reflects the factors outside of the price of the underlying asset. This value changes over time based on the time to expiration and the volatility of the underlying asset.

The intrinsic value is a straightforward calculation: It is simply the difference between an option’s strike price and the price of the underlying asset when the underlying asset is in-the-money. An out-of-the-money option has no intrinsic value.

Remember, an option is “in the money” would be profitable for the owner to exercise today, while it’s “out of the money” if the owner would lose money if they exercised their option today. An out-of-the-money option may present an investment opportunity because of its potential for the option to become in-the-money at expiration.

As expiration approaches, extrinsic value usually diminishes. So, for example, an option that has two weeks before expiry will have a higher extrinsic value than one that’s one week away. Extrinsic value equals the price of the option minus the intrinsic value.

Out-of-the-money option premiums are entirely made up of extrinsic value while deep-in-the-money options often have a small proportion of extrinsic value. Options that trade at-the-money might have a substantial proportion of extrinsic value if there is a long time until expiration and if volatility is high. On the other hand, a short-dated at-the-money option would likely feature little extrinsic value.

How Extrinsic Value Works

Beginners sometimes have a tough time grasping the extrinsic value concept. Simply put, the more time until expiration and the more a share price can fluctuate, the greater an option’s extrinsic value.

Factors that Affect Extrinsic Value

Two factors affect an option’s extrinsic value: contract length and implied volatility. In general, the longer the contract, the greater the extrinsic value of an option. That ‘s because the more time allowed until expiration, the more a stock price might move in favor of the holder. Options have the potential to be worth more money the more the underlying asset price varies.

The second factor that goes into extrinsic value is implied volatility. Implied volatility measures how much a stock might move over a specific period. It’s measured by the options Greek, vega.

1. Length of Contract

An option contract generally has less value the closer it is to expiration. The logic is that there is less time for the underlying security to move in the direction of the option holder’s benefit. As the time to expiration shortens, the extrinsic value decreases, all else equal.

The time to expiration is a key variable for traders. Suppose a trader bought a put option at-the-money with just one week left until expiration. That put option’s extrinsic value will likely decline more quickly than would an option with several months until expiration since there is less time for the underlying share price to decline.

To manage this risk, many investors use the options trading strategy of buying options with varying contract lengths. As opposed to standard option contracts, a trader might choose to buy or sell weekly options which usually feature shorter contract lengths. On the opposite side of the spectrum, Long-Term Equity Anticipation Securities (LEAPS) sometimes have contract lengths that measure in years. Extrinsic value could be a large piece of the premium of a LEAPS option.

Some traders will also use a bull call spread, in order to reduce the impact of time decay (and the loss of extrinsic value) on their options.

2. Implied Volatility

Implied volatility measures how much analysts expect an asset’s price to move during a set period. In general, higher implied volatility means more expensive options, due to higher extrinsic value. That’s because there is a greater chance a stock price will significantly move in the favor of the owner by expiration. High volatility gives an out-of-the-money option holder more hope that their position will go in-the-money.

So, if implied volatility rises from 20% to 50%, for example, an option holder benefits from higher extrinsic value (all other variables held constant). On the flip side, an out-of-the-money option on a stock with extremely low implied volatility has a lower chance of ever turning in-the-money.

3. Others Factors

Savvy traders might know that it is not just the length of the contract and implied volatility that affect the premium of an option.

• Time decay. Changes in time decay, or the rate at which time decreases an option’s value, can greatly impact the premium of near-the-money options, this is known as theta. Time decay works to the benefit of the option seller, also known as the writer.

• Interest rates. Even changes in interest rates, or gamma, impact an option’s value. A higher risk-free interest rate pushes up call options’ extrinsic value higher, while put options have a negative correlation to interest rates.

• Dividends. A stock’s dividend will decrease the extrinsic value of its call options while increasing the extrinsic value of its put options.

• Delta. An option’s delta is the sensitivity between an option price and its underlying security. In general, the lower an option’s delta, the higher it’s extrinsic value.

Extrinsic Value Example

Let’s say a trader bought a call option from their brokerage account on shares of XYZ stock. The premium paid is $10 and the underlying stock price is $100. The strike price is $110 with an expiration date in three months. Also assume there is a company earnings report due out in the next month.

Since the share price is below the call’s strike, the option is out-of-the-money. The option has no intrinsic value because it is out-of-the-money. Thus, the entire $10 option premium is extrinsic value, or time value.

As expiration draws nearer, the time value (otherwise known as time decay) declines. A trader long the call option hopes the underlying asset appreciates by expiration. A jump in the call option’s extrinsic value can also push its price higher.

Higher volatility, perhaps the earnings report or some other catalyst, might move an option’s vega higher. Let’s assume the stock has risen to $120 per share following strong quarterly earnings results. The call option trades at $11 immediately before expiration.

The call option’s intrinsic value is now $10, but the extrinsic value has declined to just $1 since there is little time to expiration and the earnings date volatility-driver has come and gone. In this case, the trader can sell the call for a small profit or simply hold through expiration.

Extrinsic vs Intrinsic Value

Extrinsic value reflects the length of the contract plus implied volatility while intrinsic value is the difference between the price of the stock and the option’s strike when the option is in the money.

Extrinsic Value Factors (Call Option)	Intrinsic Value Factor (Call Option)
Length of Contract	Stock Price Minus Strike Price
Implied Volatility

Extrinsic Value and Options: Calls vs Puts

Both call options and put options can have extrinsic value.

Calls

Extrinsic value for call options can be high. Consider that a stock price has no upper limit, so call options have infinite potential value. The more time until expiration and the greater the implied volatility, the more extrinsic value a call option will have.

Puts

Put options have a lower potential value since a stock price can only drop to zero. Thus, there is a limit to how much a put option can be worth — it is the difference between the strike price and zero. Out-of-the-money puts, when the stock price is above the strike, feature a premium entirely of extrinsic value.

Start Investing Today with SoFi

Understanding the fundamentals of intrinsic and extrinsic value is important for options traders. While intrinsic value is a somewhat simple calculation, extrinsic value takes a few more factors into consideration. Traders should make sure they understand all of these factors before they begin trading options.

It’s also possible to build a strong portfolio without using options at all. While SoFi does not offer options right now, the SoFi Invest® online brokerage is a great way for investors to start building a portfolio of stocks, exchange-traded funds, and initial public offerings.

Photo credit: iStock/alvarez

Feb

2022

Can Cryptocurrency Go Negative?

By Caroline Banton | Growing Wealth, invest, Investing | Comments Off

Cryptocurrency may be a virtual currency, but its value can never go negative. In short: The value of a cryptocurrency cannot be worth less than $0.

That said, the crypto market is volatile and it’s possible for investors themselves to lose considerable amounts of money, especially if they use higher-risk strategies such as short selling and margin trading, as these can potentially result in significant losses as well as gains.

So, can cryptocurrency go negative? Not in the technical sense, but an investor’s account could end up in the red if they don’t fully understand the risks of this fast-moving market. Keep reading to learn more.

Can Cryptocurrencies Go Negative? An Investigation

Cryptocurrency trading is one of the more volatile investment strategies, which is part of the attraction for high-risk traders. The largely unregulated crypto market can manifest huge profits for some, but cause severe losses for others.

As an example: In 2021 alone, bitcoin (BTC) saw a low of about $29,000 in July, and reached a record high of about $67,000 in November. By January of 2022, however, BTC had plunged to about $35,000 — off nearly 50% from the peak in November 2021. While that’s just one example of how volatile a single cryptocurrency can be, this type of fluctuation is common among most forms of crypto.

💡 Recommended: Bitcoin Price History from 2009 to 2022

Is it possible then that crypto can go negative? The short answer is no, though your investment account can.

The Short Answer

As mentioned earlier, no asset, virtual or not, can ever be worth less than zero. That includes property, security, or currency. So the lowest price crypto can ever reach is $0.

However, that doesn’t guarantee a bitcoin investor will not see losses from investing in cryptocurrency.

The Long Answer

The long answer is more complex. It is possible for an investor’s crypto account to fall into negative territory, especially if they open a short position or trade using a margin account — two strategies that involve leverage, i.e. debt.

Using leverage means an investor opens a margin account and borrows funds from their broker-dealer to buy securities in the hope that the price will go up (or down, in the case of short selling), and they will make a profit.

By using margin funds, loaned to them at a certain interest rate, investors can typically purchase greater amounts of a security than they could using only cash. Thus, if the security appreciates beyond the purchase price (and the amount of interest charged in the margin account), the investor could see a substantial gain, pay back what they owe, and pocket the rest.

Here’s the rub, though: If the price of the asset drops below the purchase price, the investor would be on the hook for all the money they lost plus the interest owed on the money they borrowed. (More on margin trading below.)

Can You Lose Cryptocurrency Investments?

Unfortunately yes, you can lose cryptocurrency — but not because a coin’s value can sink so low that it’s underwater. Rather, cryptocurrencies themselves are vulnerable to being hacked, and sometimes crypto literally gets lost, thanks to human error.

There are two factors to understand here: how the blockchain works, and how crypto wallets work.

What Happens When the Blockchain Is Hacked?

Blockchain technology, which emerged with the launch of Bitcoin in 2009, is a decentralized web of computers that essentially allows for the creation and trading of various types of crypto. Typically, each form of crypto (e.g. bitcoin, ether, dogecoin, ada, polka dot) exists on its own blockchain.

Because most cryptocurrencies are decentralized, they don’t require a third party like a bank or government agency to verify buying, selling, crypto payments, and other transactions. Also, most forms of cryptocurrency are not regulated by the government or a body like the Securities and Exchange Commission (SEC), although that may change.

In effect, it’s the people who own the crypto who monitor the platforms and each other.

That kind of self-policing works well, until it doesn’t — and there have been some well-known instances where a blockchain or crypto exchange was penetrated by hackers who stole millions of coins. In some cases, the hackers managed to fraudulently “mint” additional coins (sort of like digital counterfeit).

Unfortunately, individual traders can’t do much about these vulnerabilities, but crypto platforms continue to evolve new ways to keep investor’s crypto secure.

You Can Lose Crypto When You Lose Your Keys

Then there’s the unfortunate impact of human error.

When you buy crypto you become the sole owner of the cryptographic string of numbers and letters that comprise the private key that gives you, and only you, access to your cryptocurrency. You cannot buy, sell, or trade your crypto without the private keys.

Unfortunately, some people have simply lost the private keys to their own crypto — effectively losing all their coins. A study done in January 2021, for example, found that about 20% of the existing 18.5 million bitcoin has been lost or is inaccessible.

So, while the unregulated nature of crypto platforms and exchanges may allow for some independence and anonymity, the downside is that there are fewer legal guardrails to protect ordinary investors. The cash in your traditional checking or savings account is insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000, but that’s not always the case with crypto exchanges.

Some crypto exchanges may store your crypto offline to keep it secure. Others may offer FDIC protection for the cash in your custodial account, up to $250,000, but terms vary from exchange to exchange. Often it falls to investors to suss out how secure their crypto is — and decide how much risk they’re comfortable with. According to Cryptonews.com, exchanges lose $2.7 million every day on average.

Some exchanges are more secure than others. The better ones use valid HTTPS certificates; secure passwords with two-factor authentication (2FA); cold storage where crypto is secured offline rather than held in a hot wallet accessible on a computer or mobile device; and whitelisted IP and withdrawal addresses so that funds can only be withdrawn by approved addresses.

The best line of defense against hackers is to use a private crypto wallet and to back it up.

Can You Lose More Than You Put In?

We’ve established that the value of crypto can never fall below zero. But investors can lose money on crypto investments and see a negative balance depending on their investing strategy. How? By over-leveraging. Two situations where this can occur are short selling and buying on margin.

Margin and Leverage Risks and Possible Benefits

To margin trade crypto, a user will put down a certain percentage of the margin position they want to open, and borrow money from an exchange to cover the rest. (Depending on the crypto exchange, margin trading may or may not be allowed, and margin terms may vary.)

If the price of the security rises, the trader makes money. However, if the price drops, and the exchange requires a certain borrowing ratio or margin balance, the buyer will have to deposit more money. In some cases, the exchange may automatically sell the investor’s assets to cover the difference — this is known as a margin call.

The United States is cracking down on margin trading so that only qualified investors with plenty of capital can access these accounts. Investors also have the option of limiting their losses with crypto futures contracts. Futures contracts can protect short and long positions because speculators can also buy the opposite option contract.

Pros and Cons of Buying on Margin

Pros	Cons
Profitable opening positions compared to other asset vehicles	Higher risk of losses if prices drop
Profits are possible in a bear market if you sell short on margin	Losses could theoretically exceed committed assets
Investors have more buying power, which means they can purchase additional securities and diversify their portfolios.	Interest is charged on borrowed amounts

Short Selling Crypto: Risks and Possible Benefits

To short sell, investors borrow crypto at current market price, sell it, and then hope to buy it back at a lower price, making a profit. Of course, if the price of the asset being sold short continues to rise, the potential loss is unlimited. The higher the price goes, the more the investor will lose. As with any high-risk strategy, there are also benefits to shorting crypto.

Pros	Cons
Opening positions could be more profitable	High risk
Profits are possible in a bear market	Losses could theoretically exceed committed assets
Because positions are short term, there is limited risk	It requires a margin account, which comes with fees and interest charges
Short positions can reduce a portfolio’s volatility	Rapid price spikes, or short squeezes, can add risk
	Borrowing crypto could be difficult

Tips on Preventing Crypto Losses

The crypto market is volatile without a doubt. So, the wise crypto investor does what they can to reduce exposure and minimize losses. Three ways to do this are:

• Realize losses to offset gains. (Note that the wash sale rule does not apply to crypto, which makes this strategy easier.)

• Set up a trading strategy with entry and exit points and stick to it. Some investors use stop losses as a fundamental risk mitigator.

• Lastly, crypto futures trading allows traders to use leverage to hedge the market.

Losses and Taxes

Crypto gains are taxable, but the taxes that apply depend on whether the gains are treated as investment gains, income, or profit from the sale of a property.

But there are some rules that can help with losses. Losses and gains in the crypto market can be substantial. But there is an upside to the downside — as of early February 2022, the wash sale rule doesn’t apply to crypto (although there is a movement to change that, so be sure to check if you think wash sale terms may apply to you).

According to the SEC, a wash sale occurs when a trader sells or trades a security at a loss and buys a “substantially identical” stock or security, or acquires a contract or option to do so, within 30 days.

The loophole is that crypto is not technically considered a “security,” it’s considered property. Crypto investors can sell crypto for a loss, use that loss to reduce or eliminate capital gains tax on winning investments, and also buy back the crypto they sold and avoid missing out on a subsequent rebound in price.

Let’s say a bitcoin investor incurs a $20,000 loss in one year but then sells another crypto and realizes a $20,000 gain. The bitcoin loss would cancel the capital gain, and the investor could also buy up bitcoin at its low price. A stock investor who incurred a loss could not buy back stock they had sold in the same way because of the wash sale rule.

Stop Losses

Many traders use stop loss orders to reduce their exposure. A stop loss order allows the investor to automatically buy or sell once the price of an asset, like bitcoin, touches a specified price, i.e. the stop price. This limits losses or locks in profits on a long or short position.

For example, setting a stop-loss order for 15% below the buy price would limit losses to 15%. The advantage of stop-loss orders is that they can prevent investors from making decisions based on emotion. The best traders choose entry and exit points and stick to their plan.

Futures

Crypto futures trading is another way to limit losses in cryptocurrency trading. Similar to commodity futures trading, the trader does not need to own the crypto assets. Rather, the trader only takes risks on the price changes.

For example, let’s say a trader enters a bitcoin futures position at $50,000 each. They take a long position. When the futures contract expires, if the bitcoin futures price settles at $55,000 for each contract, the trader receives a profit of $5,000 from the exchange.

Crypto traders also use leverage in crypto futures trading, which is capital efficient. For example, one bitcoin might cost $50,000. A futures contract would allow a trader to open a position with only a fraction of that cost, perhaps $5,000 worth of bitcoin.

Alternatives to Crypto Investing

Crypto is probably the most volatile asset there is, and few alternatives have the same level of risk. Thus finding ways to diversify your holdings may help manage risk.

The obvious alternatives to crypto investing are stocks, bonds, and precious metals. ETFs and mutual funds may also offer some options for diversification. Fine art, jewelry, and other collectibles are an example of alternative investments for those with a talent for selecting those kinds of valuables.

TheTakeaway

While cryptocurrency can never go negative in the true sense, it is possible that traders can lose money, particularly if they use strategies like margin trading or futures contracts.

Wise investors can choose risk mitigation strategies like stop losses and hedging.

Lastly, bear in mind that cryptocurrency is largely an unregulated asset class, and the ways to make money using crypto are still evolving. Still, fake crypto schemes are rife. According to the Federal Trade Commission, from October 2020 to May 2021, some 7,000 people reported combined losses of more than $80 million total, with an average loss of $1,900. So, buyer beware applies here. Investors can protect themselves by signing up with a reputable trading platform and explore potentially profitable ways to invest in crypto.

Photo credit: iStock/Dilok Klaisataporn

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.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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.
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Feb

2022

Everything You Need to Know About AXIE Infinity

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

With the invention of cryptocurrency, smart contracts, and NFTs has come a new business model for the gaming world: play-to-earn. Play-to-earn games are those in which participants have the ability to earn digital assets that have real market value by simply playing a game.

Axie Infinity tops numerous lists as the current most popular play-to-earn game, but in fact the Tamagotchi craze of the late 1990s served as inspiration for the characters in the game. Axie Infinity is also a lot like Pokemon in that most of the game involves players collecting and battling different anime-like creatures.

How Does AXIE Infinity Work?

Axie Infinity is a play-to-earn crypto game. This is a new business model that creates an open economy within the game that can deliver financial benefits to players who perform certain actions.

In the game, players own Axies — cute digital monsters — and take turns battling them against each other. Each Axie has abilities based on its type. There are bird, bug, plant, and other types of Axies.

Where the game differs from Pokemon or Tamagotchi is that players can earn digital currency by winning battles or breeding their Axies and selling the new characters to other players.

The in-game economy includes Axies, which are NFTs, and two digital currencies: Smooth Love Potion (SLP) and Axie Infinity Shards (AXS). All of these have potential market value and can be sold outside of the game.

How Players Generate Income

To play, gamers need to purchase three Axies, which can cost around $350 each (as the game’s popularity has increased, the cost of Axies has risen). Players can earn about $10-50 worth of digital assets per day by playing the game. Players can also earn by selling SLPs or Axies.

SLPs can be earned by completing challenges or winning battles. SLP is an ERC-20 token on Ethereum that can be sold on different decentralized exchanges. If the price of SLP rises, users can earn more by selling their SLP tokens.

Or, users can spend their SLP in the game to breed additional Axies from two existing Axies. Each time Axies are bred, the SLP cost to breed the next generation rises. An Axie can be bred a maximum of seven times and can be sold at any time. The characters exist as NFTs and can be sold on NFT marketplaces.

How the Business Generates Revenue

If Axie Infinity players are making money with crypto through the game, it begs the question: how does the business itself make money? There are actually three ways that the Axie Infinity company generates revenue:

• By taking a 4.25% fee on every NFT sale

• By charging a small fee for every new Axie that users breed

• Through fundraising rounds

In July 2021, revenues exceeded $23 million, which represented a doubling of growth from the previous month. In January of that same year, revenue was only about $100,000.

One way the business has generated revenue is by attracting the interest of big investors. Sky Mavis, the company behind Axie Infinity, is now valued at $3 billion after raising $7.5 million in a Series A funding round and another $152 million in a Series B.

Is Playing Axie Infinity Really Profitable?

Axie Infinity has become a big way for people to earn some extra income in developing countries like Vietnam and the Philippines. The game serves as a better revenue-generator for people in countries like these due in part to the fact that their local fiat currencies are weaker, making the crypto they earn more valuable by comparison.

For example, the average daily minimum wage in the Philippines is the equivalent of about $5-10 dollars. This means that some workers may be able to make more money by playing Axie Infinity than they would by working their regular jobs.

For the average person in a first-world country, the income generated by playing the game is likely to be small, although some players have allegedly made as much as $2,500 a month playing the game. Getting lucky by breeding a few rare Axies and selling them could theoretically lead to higher-than-average profits, for example. As of now, that is not the norm.

Those asking the question “is Axie Infinity legit?” can rest assured that there’s potential for profit to be made in games like this, although the actual amount will vary and there is never a guarantee of any profit at all.

How the Game Works

In Axie Infinity, players can raise, collect, breed and battle token-based creatures called Axies. The digital creatures take on different combinations of characteristics and more than 500 available body parts which are categorized according to their rarity. Categories include:

• Common

• Rare

• Ultra-rare

• Legendary

An Axie is an NFT and has its own unique attributes. Players can upgrade their Axies and trade them for one of the two types of cryptocurrency in Axie Infinity: the Special Love Potion (SLP), and Axie Infinity Shards (AXS), the native token of the Axie network. Users can stake their AXS to earn income or use it to participate in the game’s governance.

How AXIE Infinity Is Growing

Aixe Infinity grew more than 30x over the course of the last year, with about 350,000 daily active players as of mid-2021. The game’s Discord server, where players can meet and chat, has also grown exponentially, making it one of the most popular Discord servers in the world.

A lot of the growth is thought to be coming from people in developing countries seeking economic opportunity. Given that anyone can access the Axie economy without even needing a bank account, this seems to be ideal for those with few other options and a lack of access to traditional financial tools.

As word spreads about the ability to make money playing a game, growth can continue coming from just about anywhere.

The Takeaway

Axie Infinity is a play-to-earn game in which players enter their Axies in battle with others, and can earn crypto tokens for certain game moves. In addition to the novelty and fun of the game, and the ability to own NFTs (the Axies themselves), players might be drawn to the game in hopes of earning real-world money.

FAQs

Is Axie Infinity a game?

Yes. Axie Infinity is a video game that uses a play-to-earn business model, where users can earn one or more types of digital currencies by performing certain actions within the game. The tokens can then be sold on marketplaces outside of the game.

How much money can you make using AXIE Infinity?

This is always changing, but on average, right now users might be able to make anywhere from $10-50 per day playing the game. Various factors influence this, such as the current market price of the tokens involved, demand for Axies, and how much time someone spends playing.

How can you buy an AXIE?

Axies can be bought and sold on various NFT marketplaces. Doing so requires the MetaMask Ethereum wallet and some ETH tokens. A minimum of three Axies is required to have a big enough team to start battling.

Photo credit: iStock/Edwin Tan

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.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

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.

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.

SOIN0122017

Feb

2022

SPAN Margin: How It Works, Pros & Cons

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

Options trading is far more complex than trading stocks and exchange-traded funds (ETFs). Trading and valuing options includes many variables including intrinsic value and time value, implied volatility, and weighing changes in interest rates.

The SPAN system determines margin requirements on options accounts by considering many inputs along with a portfolio’s global (total) assets to conduct a one-day risk assessment. This article will dive deep into how SPAN works and what investors need to know about it.

What Does SPAN Stand For?

SPAN stands for standardized portfolio analysis of risk, and is an algorithm used in options and futures margin trading.

What Is SPAN Margin?

The SPAN margin calculation helps options traders understand risk in their accounts and assists brokers in managing risk. SPAN is used by options and futures exchanges around the world to determine a trader’s one-day worst-case scenario based on their portfolio positions. Margin requirements can be set in an automated way from the calculation’s output.

Unlike the margin in a stock trading account, which is essentially just a loan from a broker, the margin in an options or futures account is considered a good-faith deposit or a performance bond. It is helpful to understand how a margin account functions before trading complex strategies.

How Does SPAN Margin Work?

The SPAN margin calculation uses modeled risk scenarios to determine margin requirements on options and futures. The primary variables included in the algorithm are strike prices, risk-free interest rates, price changes in the underlying assets, volatility shifts, and the effect of time decay on options.

While buying options typically does not require margin, writing (or shorting) options requires a deposit. In essence, the options seller exposes the broker to risk when they trade. To reduce the risk that the trader cannot pay back the lender, margin requirements establish minimum deposits that must be kept with the broker.

Rather than using arbitrary figures, the SPAN system automates the margin setting process, using algorithms and many sophisticated inputs to determine margin requirements. SPAN margin looks at the worst-case scenario in terms of one-day risk, so the margin requirement output will change each day.

The analysis is done from the portfolio perspective since all assets are considered. For example, the SPAN margin calculation can take excess margin from one position and apply it to another.

SPAN margin also imposes requirements on options and futures contract sellers, known as writers. Traders who are short derivatives contracts often expose the lender to greater risk since losses can be unlimited depending on the positions taken. The broker wants to ensure their risk is protected if the market turns against options and futures writers.

Pros and Cons of SPAN Margin

There are upsides and downsides to SPAN margin in options and futures trading.

The Advantages

Futures options exchanges that use the SPAN margin calculation allow Treasury Bills to be margined. Though fees are typically also imposed by many clearinghouses, the interest earned on the Treasurys may help offset transaction costs if interest rates are high enough.

There is another upside: Net option sellers benefit from SPAN’s holistic portfolio approach. SPAN combines options positions when assessing risk. If you have an options position with a substantial risk in isolation but another options position that offsets that risk, SPAN considers both. The effect is a potentially lower margin requirement.

The Downsides

While SPAN is savvy enough to look at both pieces of an option seller’s combination trade, there are never perfect hedges. Many variables are at play in derivatives markets. There can still be strict margin levels required based on SPAN margin’s one-day risk assessment.

Summary

Pros	Cons
Determines margin requirements from an overall portfolio perspective	There still might be high margin requirements when two positions do not offset
Traders know their margin amount each day based on the latest market variables	Changing market conditions can mean big shifts in day-to-day SPAN margin amounts
Margin deposits in options or futures accounts can collect interest

SPAN and Exposure Margin

Exposure margin is the margin blocked over and above the SPAN margin amount to protect against any mark-to-market losses. Like SPAN margin, exposure margin is set by an exchange. The exchange will block off your entire initial margin (both SPAN margin and exposure margin) when you initiate a futures transaction.

The Takeaway

SPAN margin is helpful to manage risks in trading markets. Algorithms determine margin requirements based on a one-day risk analysis of a trader’s account. While primarily used in futures trading and when writing options, investors should know about this critical tool in financial markets.

Margin accounts come with a unique set of risks and rewards. You can learn more about margin trading with SoFi’s resources.

You can also explore investing options on the SoFi Invest® app. It allows members to research investment opportunities based on their individual risk and return objectives.

Find out how to get started at SoFi Invest.

FAQ

What does SPAN stand for in margin trading?
SPAN margin stands for “standardized portfolio analysis of risk.” It is a system used by many options and futures exchanges worldwide.

How is SPAN margin used?

SPAN margin is used to manage risk in trading markets. It calculates the suggested amount of good-faith deposit a trader must add to their account in order to engage in options or futures trading. To help mitigate the risk that traders will not be able to pay back the funds the broker lends them, exchanges use the SPAN system to calculate a worst possible one-day outcome and set a margin requirement accordingly. SPAN margin reduces the risk of a trader growing their leverage ratio too high based on the automated risk calculations. SPAN margin can also allow lower margin requirements for options sellers who trade multiple positions.

What is a SPAN calculation?

SPAN is calculated using risk assessments. That means an array of possible outcomes is analyzed based on different market conditions using the assets in a portfolio. These risk scenarios specify certain changes in variables such as price changes, volatility shifts, and decreasing time to expiration in options trading.

Inputs into a SPAN calculation include strike prices, risk-free interest rates, price changes in underlying assets, implied volatility changes, and time decay. After calculating the margin on each position, SPAN can shift excess margin on a single position to other positions that might be short on margin. It is a sophisticated tool that considers a trader’s entire portfolio.

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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.
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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.
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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.

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.

*Borrow at 10%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
SOIN1221521

Feb

2022

What Is a Naked Call Options Strategy?

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

A naked call, or uncovered call, is an aggressive, high-risk option strategy. It occurs when an investor sells or writes call options for which they don’t own the underlying security. The seller is betting that the underlying stock price will not increase before the call’s expiration date.

It is safer for traders to sell calls on a stock they already own. This way, if the stock price increases sharply, the trader’s net position is hedged. A hedged position, in this example, means that as the stock value rises, the long-stock position grows while the short-call option position loses. This situation describes a “covered call” position, which is a much lower risk strategy.

Naked calls, on the other hand, are speculative trades. You keep the premium if the underlying asset is at or in the money at expiration, but you also have the potential for unlimited losses. Read on for more about what naked calls are, how they work, their risks and rewards, and more.

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 significantly less risky to use a “covered call strategy” or 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 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 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 is made when the stock price is below the breakeven price.

Investing in naked calls requires discipline and a firm grasp on common options trading strategies.

Writing a Naked Call

While there are significant risks, the process of naked call writing is relatively easy. 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 do not rise quickly, and ultimately remain below the strike price at expiration, the naked call writer will keep the premium collected (also known as the credit). Unexpected good news or simply positive price momentum can send the stock price upward, leading to higher call option values.

On the most common stocks and exchange-traded funds (ETFs), there are dozens of option strike prices at various expiration dates. For this reason, a trader must make both a directional bet on the underlying stock price and a time-wager based on the expiration date. Keeping a close eye on implied volatility is important, too.

Closing Out a Naked Call

When the trader wants to exit the trade, they punch in a buy-to-close order on the 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.^*

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

*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 XYZ. Let’s also assume the stock trades at $100 per share.

For our example, we will assume the trader sells a call option at the $110 strike price expiring three months from today. This option might have a premium, or cost, of $5. The call option is said to be “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 its theta. At initiation, the trader sells to open, then collects the $5 premium per share.

The trade’s breakeven price is $115 ($110 strike price plus $5 premium). Jump ahead a month, and shares of XYZ have rallied to $110. The value of the $110 strike call option, now expiring in just 60 days, is worth $9 since the share price rose $10.

On the other hand, the option’s time value dropped modestly since the expiration date drew closer. After pocketing the $5 premium at the trade’s initiation, the trader effectively owes $9 back, resulting in a net loss on paper.

Fast-forward to the week of expiration: XYZ’s stock price has fallen to $100. The $110 call option with just a few days left until expiration – Friday, is worth just $0.50 of time value with no intrinsic value. The trader chooses to close the trade with a buy-to-close order to lock in that $0.50 price.

In summary, the trader collected the $5 premium at the onset of the trade, experienced paper losses when XYZ’s stock price rose, but then ended on the winning side of the ledger by expiration when the position closed. The traders realized a profit of $4.50 considering the $5 sell and $0.50 buy-back. The trader could have also allowed the option to potentially expire worthless, which could have netted a $5 profit.

Using Naked Calls

Trading naked calls sometimes appeals to new traders who do not fully grasp risk and return probabilities. The notion that you can make money simply if a stock price or ETF does not go up in value sounds great. The problem arises when the underlying security appreciates quickly.

A naked call writer might not have enough cash to close the position. For this reason, brokers often have margin requirements on traders seeking to sell naked calls. When an account’s margin depletes too far, the broker can issue a margin call requiring the trader to deposit more cash or assets.

In general, naked calls make the most sense for experienced traders who have a risk management strategy in place before engaging in this type of trade.

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
Allows theta to work in your favor	Reward limited to the premium collected
Generates income	Margin calls when the underlying appreciates

Naked Call Alternatives

A common alternative to selling a naked call is to simply own the stock then sell calls against that position. This technique is known as “covered call writing”. This is a safer alternative to risky naked calls, but the trader must have enough cash to purchase the necessary shares.

One options contract covers 100 shares, so purchasing 100 shares of XYZ at $100 per share requires $10,000 of capital, unless the investor makes use of margin trading.

Other complex options strategies can 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. 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.

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.

To make informed options trading decisions, it can help to have a platform that offers educational resources you can reference along the way. SoFi’s options trading platform offers a library of such resources, as well as an intuitive and approachable design. Plus, investors have the choice of trading options either on the mobile app or the web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/twinsterphoto

What Is Extrinsic Value?

What is Extrinsic Value?

How Extrinsic Value Works

Factors that Affect Extrinsic Value

1. Length of Contract

2. Implied Volatility

3. Others Factors

Extrinsic Value Example

Extrinsic vs Intrinsic Value

Extrinsic Value and Options: Calls vs Puts

Calls

Puts

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Is Playing Axie Infinity Really Profitable?

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FAQs

Is Axie Infinity a game?

How much money can you make using AXIE Infinity?

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SPAN Margin: How It Works, Pros & Cons

What Does SPAN Stand For?

What Is SPAN Margin?

How Does SPAN Margin Work?

Pros and Cons of SPAN Margin

The Advantages

The Downsides

Summary

SPAN and Exposure Margin

The Takeaway

FAQ

What Is a Naked Call Options Strategy?

Understanding Naked Calls

How Do Naked Calls Work?

Writing a Naked Call

Closing Out a Naked Call

Finally, user-friendly options trading is here.*

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Naked Call Example

Using Naked Calls

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