What Is the Put/Call Ratio?

What Is the Put/Call Ratio?

The put to call ratio (PCR) is a mathematical indicator that investors use to determine market sentiment. The ratio reflects the volume of put options and call options placed on a particular market index. Analysts interpret this information into either a bullish (positive) or bearish (negative) near-term market outlook.

The idea is simple: the ratio of how many people are betting against the market versus how many people are betting in favor of the market, should provide a gauge of the general mood investors are in.

A high put-call ratio is thought to be bearish (because more investors are taking short positions) while a low put-call ratio is thought to be bullish (because more investors are taking long positions). Investor Martin Zweig invented the put-call ratio and used it to forecast the 1987 stock market crash.

What are Puts and Calls?

Puts and calls are the most basic types of options contracts. Options contracts give holders the right, but not the obligation, to buy or sell a specific number of shares of a given security by a certain date (the expiration date) at an agreed upon price (the strike price). For both puts and calls, one options contract is usually for 100 shares of the underlying security.

The seller of an option is also sometimes called the writer. Options writers receive a fee, called a premium, in exchange for the risk of having to buy or sell shares when the holder of the option chooses to exercise their contract.

There are many factors that influence an option’s premium, and many ways to calculate the value and the risk of options, including the Black-Sholes, trinomial, and Monte Carlo simulations.

Those interested in trading calls and puts and other options strategies may want to research the details further with our options trading guide.

For now, we’re concerned with the basics of call vs. put options so we can better understand the put-call ratio and what it means.

Puts

A put option (or “put”) gives its owner the right to sell a certain number of shares at a predetermined price by a certain date. Investors may also refer to puts as “short positions” because they represent bearish bets on a security’s future.

An investor who buys a put has the option to sell the stock at some point leading up to the expiration date of the contract. Investors may use puts in a variety of ways within the portfolio. For example, a protective put allows an investor who already owns the underlying asset to benefit even if the price of that stock asset goes down.

Calls

A call gives its owner the right to buy a certain number of shares at a predetermined price by a certain date. Calls are also referred to as long positions because they represent bullish bets on a security’s future.

An investor who buys a call has the option to buy the stock at some point leading up to the expiration date.

Recommended: Popular Options Trading Terminology to Know

What Is Put Call Ratio?

The put-call ratio is a measurement of the number of puts versus the number of calls traded on a given security over a certain timeframe. The ratio is expressed as a simple numerical value.

The higher the number, the more puts there are on a security, which shows that investors are betting in favor of future price declines. The lower the number, the more calls there are on a security, indicating that investors are betting in favor of future price increases.

Analysts most often apply this metric to broad market indexes to get a feel for overall market sentiment in conjunction with other data point. For example, the Chicago Board Options Exchange put-to-call ratio is one of seven factors used to calculate the Fear & Greed Index by CNN Business.

The put-call ratio can also be applied to individual stocks by looking at the volume of puts and calls on a stock over a certain period.

Recommended: Buying Options vs Stocks: Trading Differences to Know

How to Calculate the Put-Call Ratio

The put-call ratio equals the total volume of puts for a given time period on a certain market index or security divided by the total volume of calls for the same time period on that same index or security. The CBOE put call ratio is this calculation for all options traded on that exchange.

There can also be variations of this. For example, total put open interest could be divided by total call open interest. This would provide a ratio for the number of outstanding puts versus the number of outstanding calls. Another variation is a weighted put-call ratio, which calculates the dollar value of puts versus calls, rather than the number.

Looking at a put call ratio chart can show you how that ratio has changed over time.

Put-Call Ratio Example

Suppose an investor is trying to assess the overall sentiment for a stock. The stock showed the following volume of puts and calls on a recent trading day:

Number of puts = 1,400

Number of calls = 1,800

The put call ratio for this stock would be 1,400 / 1,800 = 0.77.

How to Interpret the Put-Call Ratio

A specific PCR value can broadly be defined as follows:

•   A PCR of less than 1 implies that investors are expecting upward price movement, as they’re buying more call options than put options.

•   A PCR of more than 1 implies that investors are expecting downward price movement, as they’re buying more put options than call options.

•   A PCR equal to 1 indicates investors expect a neutral trend, as purchases of both types of options are at the same level.

However, while PCR has a specific, mathematical root, it is still open to interpretation, depending on your options trading strategy. Different investors might take the same value to have different meanings.

Contrarian investors, for example, typically believe that the majority is wrong. The best move is to act contrary to what others are doing, in this view. If everyone else is buying something, contrarians believe it might be a good time to sell, or vice-versa. A contrarian investor might therefore perceive a high put/call ratio to be bullish because it suggests that most people believe prices will be heading downward soon.

Momentum investors believe in trying to capitalize on prevailing market trends. “The trend is your friend,” they might say. If the price of something is going up, it could be best to capitalize on that momentum by buying, in this view. A momentum investor could believe the opposite, and that a high PCR should be seen as bearish because prices could be trending downward soon.

To take things a step further, a momentum investor might short a security with a high put-call ratio, hoping that since most investors appear to already be short, this will be the right move. On the other hand, a contrarian investor could do the opposite and establish a long position, based on the idea that what most people expect to happen is the opposite of what’s actually coming.

The Takeaway

The put-call ratio is a simple metric used to gauge market sentiment. While often used on broad market indexes, investors may also apply the PCR to specific securities. Calculating it only involves dividing the volume of puts by the volume of calls on the market for a security.

The put-call ratio is one factor you might consider as you build your portfolio, even if you’re not investing in options. A great way to do that is by opening a brokerage account on SoFi Invest, which allows you to purchase company stocks, exchange-traded funds, and fractional shares through its app.

Photo credit: iStock/PeopleImages


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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What Is Volume in Cryptocurrency? A Guide

What Is Volume in Cryptocurrency?

Trading volume is a metric that investors use to see how often an asset is trading hands, indicating how popular it is to buy or sell that asset at any given time. Investors examine trading volume for a variety of securities, including stocks, bonds, and international currencies.

In cryptocurrency, in particular, trading volume is an important factor that traders use to determine the potential trajectory of a coin.

Recommended: Crypto 101: Crypto for Beginners

Crypto Trading Volume Meaning

Crypto trading volume measures how many times a coin changes hands over a given time frame. Investors analyze crypto volume baked on either trades taking place on a given crypto exchange or on all exchanges combined.

The most common timeframe for measuring volume is 24 hours, and the most common format used to show this metric is a bar chart. Typically when high volume cryptocurrency trading can mean an increase in prices and low volume cryptocurrency could indicate prices falling.

Calculating Cryptocurrency Volume

Calculating crypto trading volume requires determining the total value of a type of cryptocurrency that has changed hands in a given period. For example, if the total amount of bitcoin (BTC) traded on Binance in the last 24 hours added up to $10 billion, then the 24-hour trading volume of BTC on Binance was $10 billion.

Why Is Volume Important in Cryptocurrency?

Tracking cryptocurrency is particularly important when trading coins with low crypto liquidity on smaller exchanges, the importance of volume becomes apparent. Say a trader wants to sell one million SHIB coins, for example. But the hypothetical exchange she is using doesn’t have a lot of SHIB volume. To sell 1 M SHIB could require going through dozens of buy orders, each one being at a slightly lower price than the one before it.

This results in the trader receiving a lower price for her coins than she might have if the exchange had higher volumes (a phenomenon referred to as “slippage”). In extreme cases, there might not be any buy orders at all, and a trader would have to make new sell orders, hoping they get filled at some point.

Likewise, if someone wants to buy a coin with low volume, they could end up spending more money than they would have if trading volumes were higher. Having to buy up existing sell orders bids prices higher.

Higher volume tends to translate to higher price stability and less volatility. Of course, times of extreme fear or greed might bring surges in volume and large price movements. But, in general, coins or assets that consistently have higher volume tend to have less volatility.

What Does Cryptocurrency Volume Indicate?

Crypto trading volume indicates interest in a cryptocurrency. The more people are buying and selling something, the higher the volume, which can drive even more interest in that cryptocurrency.

Surges in trading volumes suggest either strongly bullish or strongly bearish sentiment. Meme coins like Dogecoin (DOGE) and Shiba Inu (SHIB) have enjoyed plenty of volume during their big market run-ups. Over time, interest in such coins tends to wane, and volume tapers off along with the price.

A high-volume cryptocurrency can become a low-volume cryptocurrency and vice versa.

Low trading volume means investors aren’t very interested in buying or selling a particular asset. There could be any number of reasons for this. When prices and trading volumes diverge, this can mean that prices aren’t telling the whole story.

Can Volume Be Faked in Crypto?

Yes, it’s possible to exchange volumes through a practice known as “wash trading.” This practice involves placing buy and sell orders at nearly the same time. The orders can cancel each other out and not result in any material movement of markets. This gives the appearance of an active market but is really just noise.

According to crypto research firm Messari , “it is well known that many exchanges conduct wash trading practices in order to inflate trading volume.”

The exchanges may believe that higher volume will entice traders into using their platform, and the more traders that use their platform the more money they make.

Wash trading can take place in several different ways, including:

•   A trader colluding with an exchange

•   A trader colluding with another trader

•   The use of high-frequency trading algorithms

In cryptocurrency markets, high-frequency trading (HFT) algorithms may account for much of the fake volume. These are basically computer bots that can make large numbers of trades very fast.

Concerns about fake volume on exchanges may be one reason that some traders prefer decentralized exchanges, on which it’s harder to fake volume.

Crypto by Volume

Coinmarketcap is a commonly cited source for crypto prices and trading volumes. But the site makes no distinction between exchanges that may have high amounts of wash trading and those that do not. Messari provides “real” volume data, gleaned from exchanges that they believe with a high degree of confidence do not engage in wash trading.

This distinction is important to make because when looking at volumes for different coins or exchanges, the results can be very different depending on the source.

On December 9, the top 5 crypto assets by 24hr trading volume according to Coinmarketcap were:

1.    Tether (USDT)

2.    Bitcoin (BTC)

3.    Ethereum (ETH)

4.    Binance USD (BUSD)

5.    XRP (XRP)

However, according to Messari, the top 5 crypto assets by 24hr “real” trading volume were:

1.    Bitcoin (BTC)

2.    Ethereum (ETH)

3.    Cardano (ADA)

4.    USD Coin (USDC)

5.    Tether (USDT)

These rankings show that the popular stablecoins USDC and USDT are among the top 5 coins by volume with or without alleged fake trading transactions.

Binance’s exchange token, BUSD, is fourth when including wash trades, but didn’t make the top five for real volume. Cardano (ADA), a cryptocurrency designed for cheap, fast transactions and smart contracts, ranked second in real volumes but didn’t make the top five for volumes that include wash trading.

Bitcoin (BTC), the oldest and largest cryptocurrency, had volume of more than twice the next-highest volume coin.

Is Volume a Necessary Metric for Valuing Coins?

Many crypto traders see volume as the most important metric for valuing a cryptocurrency.

In 2018, nearly 40% of 39% of respondents to a Coindesk survey chose volume as the indicator they couldn’t live without. The main reason they gave was that other technical indicators rely on an individual’s ability to interpret charts, while volume is more objective.

When price and volume fall together, traders may believe that the market is exhausted and will reverse course soon. On the other hand, when price rises and volume falls, investors often see that as a bearish sign that means prices will pull back soon.

The Coindesk survey quoted one trader as saying that trading volume “speaks to the sincerity of price action.” In other words, the movement of prices alone can be deceiving. When factoring in volume, it can be easier to get a more comprehensive view of how the market is behaving.

The Takeaway

Cryptocurrency volume trading is a measure of how many cryptocurrency transactions are taking place. Much of what’s been covered here also applies to volume in stocks, although there are more regulations around wash trading in equities.

If you’re interested in beginning to trade cryptocurrency, a great way to get started is by opening a SoFi Invest® investment account. SoFi members can manage their investments in up to 40 different coins through the SoFi app.

Photo credit: iStock/hsyncoban


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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.
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Advance/Decline Line: Definition, Formula, Examples

Advance/Decline Line: Definition, Formula, Examples

The Advance/Decline line, or A/D line, is a technical stock market indicator used by traders to measure the overall health of the stock market. This measurement tells market participants whether there are more stocks rising or falling on a trading day, and whether a majority of stocks are pushing the market in either direction.

For traders who are looking for greater insight into market trend analysis, the A/D line may be a suitable indicator to help determine where the market is trending, how strong that trend is, and the direction the market could be going in the short-term.

What Is the Advance/Decline Line (A/D)?

The advance/decline line (A/D) is a market indicator that traders use during stock technical analysis to estimate the breadth, or the overall strength or weakness of the stock market. The A/D line monitors how many stocks are currently trading above or below the previous day’s close. Traders may follow these changes over time to try to forecast the direction of the market.

In a particular index, like the S&P 500, Nasdaq, or Dow Jones Industrial Average, stocks go up and down. But just because some stocks move in one direction, it doesn’t mean that all stocks move in that same direction. Sometimes it can be difficult for investors to discern whether the direction of the market is being influenced by larger stocks that hold more weight in an index, or by a majority of stocks that are pushing the markets in a particular direction.

The purpose of the A/D line is to see how it correlates with the price movement of the index it’s being compared to. Traders and investors can use the A/D line to see how many stocks are rising or declining to form an estimate on market direction.

Where Is the Advance/Decline Line on a Chart?

Market participants can find the advance/decline line above or below a stock index chart. Investors can reference the A/D line and compare it to the chart stock market indexes to better understand the strength of the market and to help gauge the direction of where the market might be headed.

Recommended: How to Read Stock Charts as a New Trader

Advance/Decline Line vs the Arms Index

The Arms Index — also known as the story-term trading index (TRIN) — is another technical analysis indicator used to estimate market sentiment and measure volatility. It’s a ratio between advancing and declining stocks versus the volume of stocks whose price increases or decreases. In other words, the TRIN compares advancing and declining stocks to their volume and shows whether the volume is flowing toward advancing or declining stocks.

If more volume is trending toward declining stocks, the TRIN for that day will be greater than one. If more A/D volume correlates with advancing stocks, then the TRIN will be below one for that day. A high TRIN reading could signal to traders that stock selling may be on the horizon. A TRIN reading below one could indicate a buying opportunity.

Traders may use the TRIN ratio as a short-term market gauge to measure overbought or oversold market levels, while the A/D line can be used to gauge longer term market sentiment by measuring the rise and fall of stock over a period of time.

Advance/Decline Line Formula

The A/D Line is calculated by taking the difference between the number of stocks that advance and the number of stocks that decline, compared to the prior close. This value is added to the previous day’s A/D Line value. If there are more declining stocks versus advancing stocks on a particular day, then traders will see the A/D line start to move downward. If there are more stocks that are advancing, the A/D number is going to be increasing. Here is the formula:

Advance/Decline Line = Number of advancing stocks – Number of declining stocks + Previous A/D Line value

Calculating the Advance/Decline Line (A/D)

The A/D line is a cumulative, daily calculation that is plotted each day so market participants can see the direction of where stocks are moving. When reading the A/D line, it’s important for traders to look at the direction of the line and not its value.

Traders may use the A/D line to help decide which trades to place next. For example, if the market shows more declining stocks than advancing stocks, this means a majority of stocks closed at a lesser value than their previous day close. As a result, traders may anticipate that the market will fall in the near term, and may choose to sell because the market trend is moving in a bearish direction.

Some indexes, like the S&P 500, are market-cap weighted, which means the larger companies hosted in the index influence the direction of the index. The A/D line allows investors to look at stocks on a level playing field. When a market rises, for example, the A/D line shows investors whether this rise was driven by a majority of stocks increasing or if the rise was caused by a select few of stocks that hold a larger weight in the index.

What Does the Advance/Decline Line Show?

The advance/decline line shows traders the degree of participation of stocks in a market that is either rising or falling and whether the majority of stocks are moving in a similar direction of the market.

The line is a representation of stocks that are ticking up or down cumulatively, adding stock movements each day to see the trend of advancing stocks vs. declining stocks. If there were more declining stocks than advancing stocks on a particular day, the A/D line would start to slope downward. If there were more advancing stocks than declining stocks on the day, then the A/D line would slope upwards.

Sometimes there might be a difference in direction between the index and the A/D line. This is called a divergence, and it can happen in one of two ways.

Bearish Divergence: Declining Line

If the index is on an upward trend but the A/D line has a negative slope, this is known as a bearish divergence. The increase in the index may be driven by some stocks, but this scenario signals to traders the market may reverse and trend downward in the short term.

Bullish Divergence: Rising Line

If the index is on a downward trend but the A/D line has a positive slope, this is called a bullish divergence. The index seems to be bearish, but the A/D line tells market participants there are more advancing than declining stocks during the period that the index is declining. This may signal a trend reversal in market prices and indicate the market has more strength than meets the eye.

Example of Using the A/D Line

Traders use the A/D line to compare it to the price movement of the index.

For example, when an index you’re monitoring is moving to new highs, you want to see the A/D line moving new highs to confirm the index’s direction.

If the index and the A/D line are both hitting new highs, the market is hitting a bullish trend. If the stock market reaches a new peak but the A/D line reaches a lower peak than the previous rally, that means fewer stocks are participating in a higher move and the rally could be coming to an end. This could suggest that the strength of the market is driven by a few names with larger market caps.

Is the A/D Line a Good Indicator?

The A/D line is considered a reputable and popular measurement for traders to gather reliable insight into the strength of a market trend. When the price of an asset changes, traders will want to know whether it’s best to buy or sell. With the A/D line, traders can estimate price trends of assets and potential reversals by reviewing the direction of the A/D line, which is considered to be a reasonably reliable indicator in predicting trends since it shows market participants how the market is behaving.

Pros of the A/D Line

Traders can find the A/D Line indicator either above or below a stock chart on a trading platform and may use it as a tool to try to time the market and potentially catch a particular stock price.

By gauging the direction of where markets are headed, the A/D Line can help traders forecast stock price movements on the upside or downside. This may help market participants position their trades favorably.

Cons of the A/D Line

It’s important for market participants to be careful to not rely on the A/D Line as their only market indicator. While the A/D Line offers insight into overall market direction, it may not be able to capture minor market changes.

The A/D Line does not capture price changes between trading gaps, or when a stock’s price moves higher or lower throughout the trading day even though there’s not much trading going on.

Another limitation is that even though the line shows the general direction of where the market is trending, either a positive or negative slope, the A/D line doesn’t show the precise percentage the stock moved.

How Investors Can Use the Advance/Decline Line

The A/D line is positioned against an index to help spot market trends and reversals. Traders who trade on the major indexes can use the A/D line to gauge overall market sentiment. Market participants can look at a historical A/D line to see how the market performed in different periods of time.

The Takeaway

The Advance/Decline Line is a tool used by traders and investors to forecast the direction of where the overall stock market is headed. The A/D Line is a well-known market indicator used to predict and confirm trends and forecast market reversals.

The A/D Line offers a great visual guide that may help traders make decisions on market strategies and positions in the short term. But while there are benefits of using this metric, it’s important for market participants to know the A/D line’s drawbacks as well.

Investors typically have many tools at their disposal when trading stocks, in order to be well informed. With a SoFi Invest® brokerage account, investors get access to stock market data, the latest investing news, and more — all at their fingertips — making it simple to trade stocks, exchange-traded funds (ETFs), cryptocurrency, and Initial Public Offerings (IPOs).

Find out how to get started with SoFi Invest.

Photo credit: iStock/utah778


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
Third-Party Brand Mentions: No brands or products 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.
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.
Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. IPOs offered through SoFi Securities are not a recommendation and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation.

New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For SoFi’s allocation procedures please refer to IPO Allocation Procedures.

Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected] Please read the prospectus carefully prior to investing. Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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What Is a Volatility Smile?

What Is a Volatility Smile?

A volatility smile is a common graphic visualization of the strike prices and the implied volatility of options with the same underlying asset and expiration date. Understanding an implied volatility smile can help traders make decisions about their portfolio or certain securities.

Volatility Smile Definition

Implied volatility smiles involve the plotting of strike prices and implied volatility of a bunch of different options on a graph with levels of implied volatility and different strike prices along its axes. Each of the options plotted share the same underlying asset and expiration date. On a graph, they appear in a U shape (or a smile).

The volatility smile is a graphical pattern that shows that implied volatility for the options in question increases as they move away from the current stock or asset price.

Recommended: A Guide to Options Trading

What Do Volatility Smiles Indicate?

When plotted out, volatility smiles illustrate different levels of implied volatility at different strike prices. So, at strike price X, the level of implied volatility would be Y, and so on. At an extremely basic level, the “smile” appearing on a chart could be an indication that the market is anticipating certain conditions in the future.

The appearance of a volatility smile could also indicate that demand is higher for options that are “in the money” or “out of the money” than it is for those that are “at the money.”

Recommended: In the Money vs Out of the Money Options

Understanding Volatility Smiles, and How to Use Them

A volatility smile can have an effect on options prices. If a trader is considering buying or selling a new option, the chart can help the trader understand the likely pricing of that option, given its strike price and how the market values volatility at a given time. Some options (like those related to currency) have a higher likelihood of producing a volatility smile, and some options will never produce one.

Volatility Smiles and Skews and Smirks

It’s not all smiles when it comes to volatility. There are also volatility skews, and volatility smirks in the mix, too. But don’t worry, there isn’t a ton of new ground to cover.

Volatility Skew

A volatility skew, as seen on a graph, is the difference of measured implied volatility between different options at different strike prices. Basically, a skew appears when there’s a difference in implied volatility between options that are out-of-the-money, at-the-money, and in-the-money. In effect, different options would then trade at different prices.

So, a volatility smile is actually one form of a skew.

Volatility Smirk

Volatility smirks are another form of skew, except rather than having a symmetrical “U” shape, a smirk has a slope to one side.

Instead of a straight line on a graph that would indicate no difference in volatility between the in-the-money, out-of-the-money, and at-the-money options, a smirk shows three different measures of volatility depending on where in “the money” the option lands. This is different from a volatility smile in that a smile indicates that in-the-money and out-of-the-money options are at similar, if not equal, levels of implied volatility.

A smirk is commonly seen when plotting the volatility skew of equity options, where implied volatility is higher on options with lower strikes. One explanation for this phenomenon is that traders favor downside protection, and so purchase put options to compensate for risk.

Volatility Smile Limitations

An important thing for traders to remember about volatility smiles and skews is that they are theoretical, and reality may not necessarily line up with what’s being portrayed on a graph. In other words, it’s not a fool-proof way to get a read on current market conditions.

Also not all types of options will showcase smirks or smiles, and for those that do, those smirks or smiles may not always be so clearly defined. A volatility smile may not look like a clear-cut semi-circle — depending on the factors at play, it can look like a much rougher grin than some traders expect.

Volatility Smiles and the Black-Scholes Model

The Black-Scholes Model is a formula that takes several assumptions and inputs — strike prices, expiration dates, price of the underlying asset, interest rates, and volatility — and helps traders calculate the chances of an option expiring in-the-money. It’s a tool to help measure risk, including tail risks.

While popular with many traders for years, it fails to predict volatility smiles — exposing a flaw in its underlying assumptions. Because of that, the Black-Scholes Model may not be as accurate or reliable as previously thought for calculating volatility and corresponding options values.

The Takeaway

Experienced options traders may use volatility smiles as one tool to evaluate the price and risk of a specific asset. They’re typically used by more experienced traders who have advanced tools to help plot securities and who are comfortable trading options and other derivatives.

However, you don’t need such advanced tools to start building a portfolio. A great way to get started is via the SoFi Invest online investment app, which allows you to invest in stocks, exchange-traded funds, and even IPOs right from your phone.

Photo credit: iStock/zakokor


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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What Is the Ebitda Formula?

EBITDA is an acronym that stands for earnings before interest, taxes, depreciation, and amortization. The EBITDA formula is a common way for companies to assess their performance. By looking at earnings without deducting taxes, interest, or other expenses, it’s easier to assess business results and compare them to other companies in the same industry.

The EBITDA formula can also be useful for investors. When investing in the stock market, it’s important to research companies before buying shares of their stock, and EBITDA is a basic measure of profitability that can help investors gauge an organization’s performance.

What is EBITDA, and how is EBITDA calculated?

The EBITDA formula is a way of considering a company’s net income — without deducting costs like interest, taxes, depreciation, and amortization. The idea is to create a more apples-to-apples view of how different companies’ perform. Two similar companies in the same industry could have very different tax rates or different capital structures (which can impact debt, and therefore interest paid), making it hard to compare one to the other.

By not deducting certain expenses that aren’t related to performance, EBITDA helps level the playing field.

EBITDA is also relatively easy to calculate. The information can be found on a company’s balance sheet and income statement. Here’s a quick breakdown of each letter of the acronym, and why it matters in the EBITDA formula:

Earnings

Earnings are a company’s net income over a specific period of time like a fiscal year or a quarter. This number can be found on the company’s income statement; it’s essentially the bottom line, after subtracting all expenses from total revenue.

Interest

This refers to any interest that the company pays on loans and debts. In some cases interest might include interest income, in which case you’d use the total interest amount (interest income – interest paid). Interest is added back to total earnings in the EBITDA formula because the amount of interest paid depends on the types of loans and funding a company has. This number can muddy the waters, when trying to compare two companies that might have very different financing situations.

Taxes

Federal, state, and local taxes are also added back because tax rates depend on where a company is based geographically, and where they conduct business. Thus, taxes aren’t something that a company has much control over, so they aren’t an indicator of performance.

Depreciation & Amortization

Depreciation calculates the decreasing value of tangible physical assets over time (e.g., equipment, vehicles, buildings, etc.). Amortization is a way to account for the expenses of non-tangible assets like intellectual property, like patents and copyrights.

Depreciation and amortization are added back to earnings because they are non-cash expenses. As such, they don’t necessarily reflect on a company’s overall performance or profitability.

EBITDA Formula and Calculation

EBITDA can be calculated simply by adding a company’s interest, taxes, depreciation, and amortization to net income. Another method is to add a company’s operating income — or Earnings Before Interest and Taxes (EBIT) to its non-cash expenses of depreciation and amortization.

Earnings, or net income, can be calculated as follows:

Net income = Revenue – Cost of Goods Sold – Expenses

How to calculate EBITDA

EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization

Or

EBITDA = Operating income (EBIT) + Depreciation & Amortization

For example, if a company has $4,500,000 in revenue and $500,000 in expenses, their operating income (EBIT) is $4,000,000.

If the company’s assets have depreciated by $100,000 and they have an amortization amount of $75,000, the calculation would be as follows:

EBITDA = $4,000,000 (EBIT) + $100,000 (D) + $75,000 (A)

EBITDA = $4,175,000

It’s possible for EBITDA to be negative if a company has significant losses within a particular quarter or year.

A more specific EBITDA formula is LTM EBITDA, or Last Twelve Months EBITDA, also called Trailing Twelve Months EBITDA (TTM). This calculation finds EBITDA for only the past year.

How Does EBITDA Differ From Other Measurements of Income?

There are a number of different ways to view an organization’s income, each with their pros and cons. Depending on which lens you use, or which formula, one metric can provide insights into a company’s performance that another won’t. Here are a few common measurements of company income:

•   Cash Flow is an analysis of the amount of money coming into a business versus the amount of money going out. Because of timing issues with sales, you can be profitable without being cash flow positive and vice versa.

•   EBIT is also known as operating income, as discussed above. EBIT adds back the expenses related to interest and taxes, but keeps deductions for depreciation and amortization to give a clearer picture of a company’s earnings inclusive of actual operating costs.

•   EBT is another variation on EBIT. It allows for interest expenses, but eliminates the impact of taxes — since a company’s tax burden has nothing to do with its performance.

•   Net Income appears at the bottom of an income statement, after subtracting all business expenses (including interest, taxes, depreciation, and amortization) from total revenue.

•   Revenue is also called gross income. It specifically refers to the money a company earns from sales. As such, it’s really only a window into one aspect of the business’s performance.

Understanding company performance can be a complex endeavor, and it’s best to use a combination of metrics that are most meaningful for that company or industry.

Why Is EBITDA Important?

The EBITDA formula is useful because it provides a view of company profitability, without the impact of capital expenditures and financing. By using the EBITDA formula, analysts can compare companies within an industry and investors can quickly evaluate companies they might want to invest in.

In that way, EBITDA can also be a tool used by financial advisors to help their clients make investment decisions.

It’s also useful for business owners to calculate their EBITDA each year to see how their company is performing. This is especially important if they are looking to take out a loan or seek investment. Business owners can use the EBITDA formula to gain insight into operating performance, how their company stands in relation to others in the same industry, and the company’s ability to meet its obligations and grow.

What Makes a Good EBITDA?

EBITDA is a measure of a company’s performance, so higher EBITDA is better than lower EBITDA when comparing two or more organizations in the same sector. This is important, because companies that vary in size or operate in different sectors can, of course, also vary widely in their financial performance. So one way to determine whether a company has “good” EBIDTA is to compare it to others of a similar size in the same industry.

Here are two other ways to gauge whether a company’s EBIDTA is good or not.

The EBITDA Coverage Ratio

To add more helpful information to the EBITDA calculation, the EBITDA Coverage Ratio compares EBITDA to debt and lease payments.

The EBITDA coverage ratio calculates a company’s ability to pay off lease payments, debts, and other liabilities.

The calculation for the EBITDA coverage ratio is:

EBITDA Coverage Ratio = (EBITDA + Lease Payments) / (Interest Payments + Principal Payments + Lease Payments)

A ratio equal to or greater than 1 indicates that a company will have a better ability to pay off liabilities. If the ratio is lower, a company may not be able to pay off its debts. The higher the ratio, the more solvent a company is. The current average coverage ratio is 2.

EBITDA Margins

Another EBITDA calculation investors can do to learn about a company’s performance is the EBITDA Margin calculation. This formula compares annual cash profits to sales. It’s a useful indicator to find out if a company’s EBITDA is ‘good’ or not. The EBITDA Margin calculation is:

EBITDA Margin = EBITDA / Total Revenue

The resulting number is a percentage that shows what portion of revenue was able to be converted into profit within a year. The higher this percentage is, the better a company is performing because it means their expenses aren’t eating into their profits. In general, an EBITDA margin of 60% or higher is considered a good number.

Downsides of the EBITDA Formula

Although the EBITDA formula is a useful tool for investors, it also has some drawbacks. For example: EBIDTA is considered a “non-GAAP” measure, meaning it doesn’t fall under generally accepted accounting principles (a set of rules issued by the Financial Accounting Standards Board and procedures commonly followed by many businesses). This also means that the way EBIDTA is calculated isn’t wholly standardized.

Thus, companies also may not include the same information in each report, and they aren’t required to record all information that may be relevant to the equation. For these reasons, it’s best to calculate EBITDA along with other types of evaluations, such as net income and debt payments.

Companies with a low net income may use the EBITDA formula to make themselves look better since the EBITDA number will likely be higher than their income.

Or, because EBITDA tends to obscure the impact of debt and capital investments, a company that’s spending heavily on development costs, or has incurred a lot of debt, may look more robust than it is.

Also, the formula doesn’t work well with certain types of companies, such as companies that have a need to constantly upgrade their equipment.

The Takeaway

Comparing companies you may want to invest in can take a lot of time and technical analysis. If you’re choosing your first stocks, the amount of information and choices can be overwhelming. EBITDA is one measure of company performance that can be useful, because it takes net income and then removes certain factors that can be confounding: interest paid or earned; federal, state, and local taxes; the impact of capital depreciation and amortization.

For investors interested in learning more about specific companies, staying updated about the latest financial news and building a stock portfolio, opening an account with SoFi Invest® is a great way to gain access to the world of investing. SoFi provides a suite of financial tools at investors’ fingertips. Investors can buy and sell stocks, ETFs, and cryptocurrencies, as well as track expenses and set financial goals. Even better, SoFi Members are eligible for complimentary advice from a financial professional.

Download the SoFi app to get started.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . SoFi Invest refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
1) Automated Investing—The Automated Investing platform is owned by SoFi Wealth LLC, an SEC Registered Investment Advisor (“Sofi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC, an affiliated SEC registered broker dealer and member FINRA/SIPC, (“Sofi Securities).
2) Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
3) Cryptocurrency is offered by SoFi Digital Assets, LLC, a FinCEN registered Money Service Business.
For additional disclosures related to the SoFi Invest platforms described above, including state licensure of Sofi Digital Assets, LLC, please visit www.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. Information related to lending products contained herein should not be construed as an offer or pre-qualification for any loan product offered by SoFi Lending Corp and/or its affiliates.
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