Oct
15
2025
Understanding the Different Types of Mutual Funds

Understanding the Different Types of Mutual Funds

By | Growing Wealth, invest, Investing | Comments Off on Understanding the Different Types of Mutual Funds

A mutual fund is a portfolio or basket of securities (often stocks or bonds) where investors pool their money. Nationally, there are more than 7,000 mutual funds investors can choose from, spanning equity funds, bond funds, growth funds, sector funds, index funds, and more.

Mutual funds are typically actively managed, where a manager or team of professionals decides which securities to buy and sell, although some are passively managed, where the fund simply tracks an index like the S&P 500. The main differences among mutual funds typically come down to their investment objectives and the strategies they use to achieve them.

Key Points

•  Mutual funds pool money from many investors to build a diversified portfolio of securities.

•  Equity funds are higher risk, but have the potential to offer higher long-term growth; bond funds are typically lower risk, but may provide steady income.

•  Money market funds are structured to be highly illiquid and low risk, typically appropriate for short-term investments

•  Index funds passively track market indices, and may offer lower fees and tax efficiency.

•  Balanced funds have a (typically) fixed allocation of stocks and bonds, which may be suitable for moderate risk investors.

How Mutual Funds Work

Mutual funds pool money from many investors to buy a diversified mix of securities, known as a portfolio. These may include:

•  Stocks

•  Bonds

•  Money market instruments

•  Cash or cash equivalents

•  Alternative assets (such as real estate, commodities, or precious metals)

Mutual funds are typically open-end funds, which means shares are continuously issued based on demand, while existing shares are redeemed (or bought back). In contrast, a closed-end fund issues a set number of shares at once during an initial public offering.

You can buy mutual fund shares through a brokerage account, retirement plan, or sometimes directly from the financial group managing the fund. For example, you might hold mutual funds inside a taxable investment account, within an individual retirement account (IRA) with an online brokerage, or as part of your 401(k) at work.

One of the main advantages of mutual funds is the potential for diversification. If one holding underperforms or loses value, the other investments in the fund may help offset those losses, reducing overall portfolio risk.

💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.

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Explore trading funds that include commodities, private credit, real estate, venture capital, and more.

9 Types of Mutual Funds

Before adding mutual funds to your portfolio, it’s important to understand the different types. Some funds aim for growth, while others focus on steady income. Certain mutual funds may carry a higher risk profile than others, though they may offer the potential for higher rewards.

Knowing more about the different mutual fund options can make it easier to choose investments that align with your goals and tolerance for risk.

1. Equity Funds

•   Structure: Typically open-end

•   Risk Level: High

•   Goal: Growth or income

•   Asset Class: Stocks

Equity funds primarily invest in stocks to pursue capital appreciation and potential income from dividends. The types of companies an equity fund invests in will depend on the fund’s objectives.

For example, some equity funds may concentrate on blue-chip companies that tend to offer consistent dividends, while others may lean toward companies that have significant growth potential. Equity funds can also be categorized based on whether they invest in large-cap, mid-cap, or small-cap stocks.

Investing in equity funds can offer the opportunity to earn higher rewards, but they tend to present greater risks. Since the prices of underlying equity investments can fluctuate day to day or even hour to hour, equity funds tend to be more volatile than other types of mutual funds.

2. Bond (Fixed-Income) Funds

•   Structure: Typically open-end; some closed-end

•   Risk Level: Low

•   Goal: Steady income

•   Asset Class: Bonds

Bond funds invest in debt securities, such as government, municipal, or corporate bonds. They give investors a convenient way to access the fixed-income market without buying individual bonds. Some bond funds try to mirror the broad bond market and include short- and long-term bonds from a wide variety of issuers, while other bond funds specialize in certain types of bonds, such as municipal bonds or corporate bonds.

Generally, bond funds tend to be lower risk compared to other types of mutual funds, and bonds issued by the U.S Treasury are backed by the full faith and credit of the U.S. government. However, bonds are not risk-free. Bonds are typically sensitive to interest rate risk (meaning their market value fluctuates inversely with changes in interest rates), as well as credit risk (since a bond’s value is directly tied to the issuer’s ability to repay its debt).

3. Money Market Funds

•   Structure: Open-end

•   Risk Level: Low

•   Goal: Income generation

•   Asset Class: Short-term debt instruments

Money market funds invest in high-quality, short-term debt from governments, banks or corporations. This may include government bonds, municipal bonds, corporate bonds, and certificates of deposit (CDs). Money market funds may also hold cash and cash equivalent securities.

Money market funds can be labeled according to what they invest in. For example, Treasury funds invest in U.S. Treasury securities, while government money market funds can invest in Treasuries as well as other government-backed assets.

In terms of risk, money market funds are considered to be very low risk. That means, however, that money market mutual funds tend to produce lower returns compared to other mutual funds.

It’s also worth noting that money market funds are not the same thing as money market accounts (MMAs). Money market accounts are deposit accounts offered by banks and credit unions. While these accounts can pay interest to savers, they’re more akin to savings accounts than investment vehicles. While money market accounts may be covered by the Federal Deposit Insurance Corporation (FDIC), money market funds may alternatively be insured by the Securities Investor Protection Corporation (SIPC).

4. Index Funds

•   Structure: Open-end

•   Risk Level: Moderate

•   Goal: To replicate the performance of an underlying market index

•   Asset Class: Stocks, bonds, or both

Index funds are designed to match the performance of an underlying market index. For example, an index fund may attempt to mirror the returns of the S&P 500 Index or the Russell 2000 Index. The fund does this by investing in some or all of the securities included in that particular index, a process that’s typically automated. Because of this, index funds are considered passively managed, unlike actively managed funds where a manager actively trades to try to exceed a benchmark.

Because index funds need much less hands-on management and don’t require specialized research analysts, they’re generally lower cost than actively managed funds. They’re also considered to be more tax-efficient due to their potentially longer holding periods and less frequent trading, which may result in fewer taxable events. However, an index fund may include both high- and low-performing stocks and bonds. As a result, any returns you earn would be an average of them all.

5. Balanced Funds

•   Structure: Open-end

•   Risk Level: Moderate

•   Goal: Provide both growth and income

•   Asset Class: Stocks and bonds

Balanced funds, sometimes referred to as hybrid funds, typically contain a fixed allocation of stocks and bonds for investors interested in both income and capital appreciation. One common example of a balanced fund is a fund that invests 60% of its portfolio in stocks and 40% of its portfolio in bonds.

By holding both growth-oriented equities (stocks) and stability-focused, fixed-income securities (bonds) in one portfolio, these funds aim to provide a middle ground between the high-risk/high-return profile of equity funds and the low-risk/low-return profile of bond funds. Balanced funds automatically maintain their asset allocation and may make sense for moderately conservative, hands-off investors seeking long-term growth potential.

6. Income Funds

•   Structure: Open-end

•   Risk Level: Low to moderate

•   Goal: Provide steady income

•   Asset Class: Bonds, income-generating assets

Income funds are designed with the goal of providing investors with regular income through interest or dividends, rather than focusing mainly on long-term growth. Some income funds focus on bonds, such as government, municipal, or corporate bonds, while others mix equities with bonds to offer a diversified approach to income generation.

Though not risk-free, income funds are generally lower risk than funds that prioritize capital gains. This type of mutual fund can be appealing to investors who value stability and regular cash flow, such as retirees. Income funds may also help balance risk in any investor’s portfolio, especially in uncertain markets.

7. International Funds

•   Structure: Mostly open-end

•   Risk Level: High

•   Goal: Growth or income outside the U.S.

•   Asset Class: Global equities and bonds (excluding U.S. securities)

International mutual funds invest in securities and companies outside of the U.S. This sets them apart from global funds, which can hold a mix of both U.S. and international securities. Some international funds focus on developed economies, while others target emerging markets, which may offer higher growth but come with higher risk.

Adding international funds to a portfolio can increase diversification and access to global opportunities if you’ve primarily invested in U.S. companies or bonds so far. But keep in mind that international funds can carry unique risks, including the risk of currency volatility and changing economic or political environments, especially in emerging markets.

8. Specialty Funds

•   Structure: Open or closed-end

•   Risk Level: Varies

•   Goal: Thematic or sector-specific investing

•   Asset Class: Equities, bonds, alternatives

A specialty fund concentrates on a specific sector, industry, or investment theme, such as technology, health care, or clean energy. They allow investors to target specific opportunities and expand their portfolios beyond traditional stocks or bonds. Specialty funds can offer exposure to assets like real estate, commodities, or even precious metals. You could also use specialty funds to pursue specific investing goals, such as investing with environmental, social, and governance (ESG) principles in mind.

Because of their narrower focus, specialty funds frequently offer less diversification, which means they may come with higher potential risks. This type of mutual fund is generally best suited for investors with a deep understanding of the target market.

💡 Quick Tip: Spreading investments across various securities may help ensure your portfolio is not overly reliant on any one company or market to do well. For example, by investing in different sectors you can add diversification to your portfolio, which may help mitigate some risk factors over time.

9. Target Date Funds

•   Structure: Typically open-end

•   Risk Level: Declines over time

•   Goal: Retirement planning

•   Asset Class: Mix of stocks, bonds, and short-term investments

Target date funds are mutual funds that adjust their asset allocation automatically so the fund becomes more conservative as the target (typically retirement) date approaches. For example, if you were born in 2000 and plan to retire at 65, you would invest in a 2065 fund. As you get closer to retirement age, your target date fund will gradually become more conservative, increasing its allocations to bonds, cash, or cash equivalents.

Like mutual funds, target date funds are offered by nearly every investment company. In most cases, they’re recognizable by the year in the fund name. If you have a 401(k) at work, you may have access to various target date funds for your portfolio.

While target date funds offer a “set it and forget it” option for retirement planning, they are a one-size-fits-all solution that does not account for an individual’s unique financial situation, risk tolerance, or outside assets. Some investors may prefer a more aggressive or conservative allocation than the one the fund provides.

What’s the Difference Between Mutual Funds and ETFs?

It can be easy to confuse exchange-traded funds (ETFs) with mutual funds, since they have a number of similarities. Both are baskets of securities designed to provide diversification. And both can hold stocks, bonds, or a mix, or follow specific themes or strategies.

However, ETFs and mutual funds differ in several key ways:

•   Trading: ETFs trade throughout the day like stocks, while mutual funds are priced only once daily after the market closes.

•   Liquidity: Because they trade on exchanges throughout the day, ETFs are generally more liquid than traditional mutual funds.

•   Management: Most EFTs are passively managed, while mutual funds are typically actively managed.

•   Cost: Because they are largely passively managed, EFTs often carry lower expenses ratios.

The Takeaway

Mutual funds are among the most accessible and flexible investment options available. With choices ranging from conservative money market funds to aggressive equity and specialty funds, there’s a fund for nearly every type of investor.

The best mutual fund for you depends on your goals, time horizon, and tolerance for risk. Whether you’re seeking steady income, long-term growth, international exposure, or a hand-off retirement plan, understanding the different types of mutual funds can help you build a portfolio that supports your financial future.

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


Invest with as little as $5 with a SoFi Active Investing account.

FAQ

What are the four main types of mutual funds?

The four main types of mutual funds are equity funds, debt funds, money market funds, and hybrid funds.

Equity funds invest primarily in stocks and aim for long-term capital growth. Debt funds focus on fixed-income securities like bonds, offering relatively stable returns. Money market funds invest in short-term, low-risk instruments such as Treasury bills. Hybrid funds combine equity and debt securities in varying proportions to balance risk and reward. Each type suits different investor goals, risk tolerances, and time horizons.

What is the 7-5-3-1 rule in SIP?

The 7-5-3-1 rule in SIP (systematic investment plan) is a guideline for disciplined investing. The 7 suggests staying invested for at least seven years to reap the benefits of compounding and market growth. The 5 suggests diversifying your investments across at least five different mutual fund categories to help reduce risk. The 3 is about overcoming three common mental hurdles investors face (disappointment, frustration, and panic). The 1 suggests increasing your SIP amount every year to improve your return potential in the long term.

Which type of mutual fund is best?

The “best” type of mutual fund depends on your goals, risk tolerance, and time horizon. For long-term wealth creation, equity funds often provide the highest growth potential but come with more risk. For those prioritizing stable returns, debt funds or money market funds may be a favorable choice. Investors seeking balance may prefer hybrid funds. The best fund is one that is aligned with your unique financial objectives.

Photo credit: iStock/simonapilolla

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

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

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

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.

Mutual Funds (MFs): 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 clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.

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 emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.

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

S&P 500 Index: The S&P 500 Index is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an investment product, but a measure of U.S. equity performance. Historical performance of the S&P 500 Index does not guarantee similar results in the future. The historical return of the S&P 500 Index shown does not include the reinvestment of dividends or account for investment fees, expenses, or taxes, which would reduce actual returns.
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. This should not be considered a recommendation to participate in IPOs 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 more information on the allocation process please visit IPO Allocation Procedures.

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

An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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

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Oct
14
2025
What Are Exotic Options? 11 Types of Exotic Options

What Are Exotic Options? 11 Types of Exotic Options

By | Growing Wealth, invest, Investing | Comments Off on What Are Exotic Options? 11 Types of Exotic Options

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

An option is a financial instrument that gives the buyer the right to purchase or sell an underlying security, such as a stock, during a set time period for an agreed-upon price. They are popular with some investors because they allow the investor to speculate on the price increase or decrease of a stock, without owning the stock itself.

Exotic options are a class of options that allow investors to take advantage of some features of options contracts to pursue other strategies. Exotic options are non-standard, customizable contracts that may trade over the counter (OTC) and differ in pricing from traditional options.

Key Points

•  Exotic options are complex financial instruments that can be customized using non-standard payoffs, expiration dates, and underlying assets.

•  These options help enable sophisticated investors to tailor risk exposure and implement unique strategies.

•  Exotic option strategies may involve higher or lower costs, and can offer more or less flexibility than traditional contracts, depending on the specific structure.

•  Types may include Asian, barrier, basket, Bermuda, and binary options, each with distinct characteristics.

•  Investors may benefit from financial advice when considering exotic options due to their complexity and high degree of risk.

What Is an Exotic Option?

Exotic options are hybrid securities that offer unique and often customizable payment structures, expiration dates, and strike prices. For those features, they may be priced higher or lower than traditional options, depending on the structure. University of California Berkeley professor Mark Rubinstein popularized the term “Exotic Options” in a 1990 paper about contracts.

To understand what makes an exotic option exotic, let’s review a traditional, plain-vanilla options contract and how it works. With a traditional option, the owner can buy or sell the underlying security for an agreed-upon price either before or at the option’s predetermined expiration date. The holder is not, however, obligated to exercise the option, hence the name.

An exotic option typically has all of those features, but with complex variations in the times when the option can be exercised, as well as in the ways investors may calculate the payoff.

Exotic options are typically traded in the over-the-counter (OTC) market, a smaller dealer-broker network. An exotic option may have underlying assets that differ from those offered by traditional options. Those underlying assets may include commodities like oil, corn and natural gas, in addition to stocks, bonds, and foreign currencies.

There are even exotic derivatives that allow for trading on things like the weather. Both institutional and sophisticated retail investors may use customized exotic options to match their own unique risk-management needs.

11 Types of Exotic Options

There are many types of exotic options that investors can purchase for exotic options trading. Here’s a look at some of them:

1. Asian Options

One of the most common forms of exotic options contract, the Asian option is a contract whose payoff to the holder is based on the average price of the underlying asset over one or more periods, rather than solely on the price at exercise. This makes it different from an American option, whose payout depends on the price of the underlying asset when the holder chooses to exercise it, and different from a European option, whose payoff depends on the price of the security at the time of the option’s expiration.

2. Barrier Options

These options may remain effectively dormant until activated (knock-in), or may terminate if a barrier is reached (knock-out), usually when the price of the underlying asset reaches a certain level.

3. Basket Options

Unlike traditional options, which typically have a single underlying asset, basket options contracts depend on the price movements of more than one underlying asset. For holders, the value of a basket option may be tied to the weighted average of the assets underlying the contract.

4. Bermuda Options

The main differentiator of Bermuda options is when the holder can exercise them. An investor can exercise a Bermuda option at its expiration date, and at certain set dates before then. This makes them different from American options, which holders can exercise at any point during the contract, and European options, which can only be exercised at expiration.

5. Binary Options

Sometimes called digital options, binary options are unique because they only provide a payout to the holder if a predetermined event occurs. This all-or-nothing investment may provide a predetermined payout or asset if the agreed-upon event occurs.

6. Chooser Options

With ordinary options contracts, the investor must decide upfront if they’re buying a call (right to buy the underlying security) or put (right to sell the underlying security) option. But with a chooser option, the holder can decide whether they want the option to be a put or call option at a predetermined date between when they buy the chooser option and when the contract expires.

7. Compound Options

These options, often called split-fee options, allow investors to buy an option on an option. Whether or not a compound option may result in a payout depends on the value or outcome of the underlying option. Investors in compound options have to make their decisions based on the expiration dates and strike prices of both the underlying option, as well as the compound option itself.

8. Extendible Options

The main advantage that extendible options offer is that they give an investor the ability to postpone the expiration date of the contract for an agreed-upon period of time. This can mean adding the extra time for an out-of-the-money option to potentially get into the money, a feature that’s priced into the original option contract.

Extendible options can be holder-extendible, meaning the purchaser can choose to extend their options. They can also be writer-extendible, meaning that the issuer has the right to extend the expiration date of the options contracts, if they so choose.

9. Lookback Options

Lookback options differ from most options because they do not necessarily come with a specified exercise price. Instead, depending on type, the strike (floating-strike) or the payoff (fixed-strike) is automatically determined by the most favorable price the underlying asset reached during the contract.

10. Spread Options

Unlike a traditional option, where the payout may reflect the difference between the contract’s strike price and the spot price of the underlying asset when the investor exercises the contract, a spread option may provide a return tied to the price difference between multiple assets.

11. Range Options

For highly volatile assets, some investors choose to use range options, because their payout is based on the size of the difference between the highest and lowest prices at which the underlying asset trades during the life of the range options contract.

Pros and Cons of Exotic Options

There are benefits and drawbacks to using exotic options.

Pros

•   Some exotic options may have lower premiums than comparable American-style options contracts.

•   Investors can potentially select and customize exotic options to fit very complex and precise strategies.

•   With exotic options, investors can potentially fine-tune the risk exposure of their portfolio.

•   Investors can use exotic options to seek opportunities in unique market conditions.

Cons

•   Many exotic options come with higher costs and less flexibility than traditional contracts.

•   There are no exotic options that guarantee a profit.

•   Because of their unique structures, exotic options may react to market moves in unexpected ways.

•   The complex rules mean that exotic options may carry a higher risk of ultimately becoming worthless.



💡 Quick Tip: Consider an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.

The Takeaway

Exotic options are complex financial instruments that allow investors to speculate on the price of an asset without owning that asset itself. Unlike traditional options, exotic options include customizable features that investors could use to pursue a specific options trading strategy.

As many investors may know, trading options — of all types — is relatively advanced and requires a good amount of background knowledge and understanding of intricate financial assets. For that reason, it may be advisable to speak with a financial professional before diving into options trading.

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

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

Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not support non-standard, exotic options trading at this time.

Photo credit: iStock/Pekic

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

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

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

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

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

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

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Oct
14
2025
How to Invest and Profit During Inflation

How to Invest During Inflation

By | Growing Wealth, invest, Investing | Comments Off on How to Invest During Inflation

While inflation is commonly associated with the rising cost of consumer goods, inflation also impacts investments like stocks, bonds, real estate, and more.

Just as inflation can reduce a consumer’s purchasing power overall, inflation can also impact the performance of different asset classes — particularly fixed-income assets such as bonds and cash — potentially reducing portfolio returns. It’s important for investors to understand how to invest during inflation, and which assets can provide a buffer against inflationary conditions.

After all, inflation doesn’t have to spell bad news for investors. SoFi’s 2025 investor survey reveals that despite inflation concerns this year, most investors are holding steady or increasing their investment contributions.

Key Points

•   Inflation affects purchasing power, and it can also take a toll on stocks, bonds, and other asset classes, impacting consumers and investors.

•   Inflation can impact the performance of some stocks and bond yields, making it advisable to reconsider some investment choices during inflationary periods.

•   During bouts of inflation, investors may want to consider inflation resistant assets, such as stocks of companies that can raise prices, commodities, TIPS, and I bonds.

•   Inflation doesn’t affect all sectors of the economy in the same way, so investors must consider a range of options when adjusting their portfolios.

•   Long-term investment plans may not need to be drastically changed due to temporary inflation spikes.

What Is Inflation and How Does It Affect Your Investments?

Inflation is defined as a steady rise in prices. When economic growth occurs, consumers and businesses have more money and tend to spend it. When cash flows through the economy, demand for goods and services grows, leading many companies to raise prices.

To some degree, inflation is a natural outcome of a growing economy. Historically, economic booms have come with an annual inflation rate of about 1% to 2%, a range that reflects solid consumer sentiment in a growing economy.

An inflation rate of 3%, 4%, 5% or more is associated with an overheated economy.

Conversely, prices fall when demand slides and supply is abundant; the inflation rate tumbles as economic growth wanes.

Key Measures of Inflation

The main barometer of inflation in the United States is the Consumer Price Index (CPI). The CPI encompasses the retail price of goods and services in common sectors such as housing, health care, transportation, food and beverage, and education, among other economic sectors.

The Federal Reserve uses a similar index, the Personal Consumption Expenditures Price Index (PCE), in its inflation-related measurements. Economists and investors track inflation on both a monthly and an annual basis.

Because investors may have less money to put into the markets when prices rise and their budgets become tighter, inflation may impact the people’s decision to buy stocks online or through a brokerage. Overall, it means there may be less liquidity in the markets. The relationship between investing and inflation may further be affected as interest rates are increased to combat rising prices, potentially affecting business profitability.

Recommended: Stock Market Basics

How Are Investors Responding to Inflation in 2025?

When facing a period of rising prices, deciding how to invest during inflation is top of mind for many investors. But as the 2025 SoFi Investor Insights Survey shows, many investors plan to stay the course. In fact, nearly two-thirds (65%) of respondents said they feel either optimistic or content about their investments over the past year.

A Steady Approach

Despite inflation concerns, most investors are holding steady or increasing their contributions. In fact, even given the potential impact of inflation, only 19% of investors wanted to invest less, while the remaining 82% planned to invest more or maintain their current strategy, including popular investments in 2025.

Donut chart: 46% left investments alone, 36% invested more, and 19% invested less due to inflation.
Source: SoFi 2025 Investor Insights Survey

This speaks to a mindset that can be beneficial when deciding how to invest during inflation or any time, but especially after you start an investing portfolio: It’s important to stick to your strategy — which is based on your financial goals and circumstances — and not make impulsive changes to your investments when there’s a temporary shift in the economy.

Which Investments Might Perform Well During Inflation?

Investing during inflation can be tricky, and it can be helpful to have a defensive investment strategy. It’s important to know that inflation impacts both stock and bond markets, but in different ways.

Inflation and the Stock Market

Inflation can have an indirect impact on stocks, partially reflecting consumer purchasing power. As prices rise, retail investors may have less money to put into the stock market, reducing market growth.

Also, when inflation rises, that puts pressure on investors’ stock market returns to keep up with the inflation rate. For instance, consider a stock portfolio that earns 5% before inflation. If inflation rises at a 6.0% rate, hypothetically, the portfolio may actually lose 1.0% on an inflation-adjusted basis, which can make it difficult to find high inflation investments.

Perhaps more importantly, high inflation may cause the Federal Reserve to raise interest rates to cool down the economy. Higher interest rates also make stock market investments less attractive to investors, as they can get higher returns in lower-risk assets like bonds.

However, some stocks and other assets can perform well in periods of rising prices, which can be a hedge against inflation. When inflation hits the consumer economy, companies often boost the prices of their goods and services to keep profits rolling, as their cost of doing business rises at the same time. In some cases, rising prices contribute to higher revenues, which may help boost a company’s stock price.

That said, rising inflation may raise the risk of an economic slowdown or recession. That scenario doesn’t bode well for strong stock market performance, as uncertainty about the overall economy tends to curb market growth.

Recommended: How Do Interest Rates Impact Stocks?

Inflation and the Bond Market

Inflation may be a drag on bond market performance, as well. Most bonds offer a fixed rate of return, paid in the form of interest or coupon payments. As fixed-income securities offer stable, but fixed, investment returns, rising inflation can eat at those returns, further reducing the purchasing power of bond market investors.

Additionally, the Federal Reserve’s response to inflation — higher interest rates — can lower the price of bonds because there is an inverse relationship between bond yields and bond prices. So, bond investors and bond funds may experience losses because of high interest rates.

What to Consider Investing in During Inflation

Investors can take several steps to help protect their portfolios during periods of high inflation. Choosing how to invest during inflation is like selecting investments at any other time — you’ll need to evaluate the asset itself and how it fits into your overall portfolio strategy both now and in the future.

1. Real Estate and REITs

In some cases, investing in certain types of real property assets and real estate investment trusts (REITs) can be useful during inflationary periods, because this alternative asset class tends to move in the opposite direction of stocks (which may suffer during inflation).

REITs and some types of real estate tend to see higher prices at these times, and thus pay higher dividends or income to investors. REITs are required to pay 90% of their income as dividends.

2. Stocks in Companies With Pricing Power

Investors might consider stocks where the underlying company can boost prices in times of rising inflation. Retail stocks, like big box stores or discount retailers with a global brand and a massive customer base, can be potential investments during high inflation periods. In that scenario, the retailer could raise prices and not only cover the cost of rising inflation but also continue to earn profits in a high inflation period.

Think of a consumer goods manufacturer that already has a healthy portion of the market for certain everyday items, and doesn’t need excess capital as it’s already well-invested in its own business. Companies with low capital needs tend to do better in inflationary periods, as they don’t have to invest more cash into the business to keep up with competitors — they already have a solid market position and the means to produce and market their products.

During periods of inflation, popular investing trends may reflect increased interest in retail or consumer staple stocks.

3. Commodities

Investing in precious metals, oil and gas, and other commodities may also be considered for and an option for inflation hedges. The price growth of many commodities contributes to high inflation. So investors may see returns by investing in commodities during high inflationary periods.

Take the price of oil, natural gas, and gasoline. Businesses and consumers rely highly on oil and gas and will likely keep filling up the tank and heating their homes, even if they have to pay higher prices. That helps make oil — and other commodities — an asset worth considering when inflation is on the move.

4. Treasury Inflation-Protected Securities (TIPS)

Treasury Inflation-Protected Securities (TIPS) can be an option to hedge against inflation. By design, TIPS are like most bonds that pay investors a fixed rate twice annually. They’re also protected against inflation as the principal amount of the securities is adjusted for inflation.

5. I Bonds

During periods of high inflation, investors may consider investing in Series I Savings Bonds, commonly known as I Bonds. I Bonds are indexed to inflation like TIPS, but the interest rate paid to investors is adjustable. With an I bond, investors earn both a fixed interest rate and a rate that changes with inflation. The U.S. Treasury sets the inflation-adjusted interest rate on I Bonds twice a year.

General Strategies for Investing in an Inflationary Environment

Aside from considering some of the above investments when investing for inflation, there are some strategies that may also be beneficial to consider.

Stay Focused on Your Long-Term, Diversified Plan

While there are some investing strategies that are exclusively focused on short-term results, most investors plan to invest for the long term — an approach that allows for greater stability over time.

An important tenet of long-term investing is to “buy and hold” investments so they have a chance to grow over the target period of time, weathering the markets’ ups and downs. This approach enables investors to maintain a plan that’s based on their financial values, and which matches their circumstances and helps them reach their goals. It also helps investors avoid making needless changes out of fear or other market reactions.

Another component of a long-term investment strategy is to employ the principles of diversification, which means holding a range of different asset types in your portfolio, in order to help manage risk factors.

Consider Dollar-Cost Averaging to Manage Volatility

Dollar-cost averaging is a strategy that helps manage price volatility, which can be a factor during an inflationary period. With DCA, you pick the securities you want to invest in, and the dollar amount you want to invest on a regular basis (e.g., weekly, monthly, etc.). Typically, people invest the same amount each time, to end up buying more when prices are lower — and less when they’re higher.

Over time, however, the average cost of investments tends to be lower, which may yield potential returns.

Using the DCA method may keep your investment strategy on track — and investors may be less likely to react impulsively or emotionally in response to certain events or headlines, which can increase the risk of loss.

The Takeaway

Investors may want to proceed with caution when inflation rises. It may be tempting to readjust your portfolio because prices are rising. Periods of high inflation usually wane, so throwing a long-term investment plan out the window just because inflation is moving upward may knock you off course to meet your long-term financial goals.

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

Invest with as little as $5 with a SoFi Active Investing account.

FAQ

Which investments tend to perform poorly during inflation?

Inflation erodes the value of cash, and as such it can impact a range of securities, including long-term fixed-rate bonds, certain types of stocks, and cash as well as low-interest cash accounts.

Are investors making impulsive decisions in 2025?

The tendency to make impulsive choices can occur at any time. According to SoFi’s 2025 investor survey, however, it does seem that the majority of investors are staying the course.

Is gold a good hedge against inflation?

Some investors believe that gold can be a way to hedge against inflation, because gold has intrinsic (i.e., tangible) value, a limited supply, and the price of gold has been known to rise when inflation-wary investors put more money into this precious metal. That said, the price of gold can fluctuate, and there is always a risk with any investment.

Should I stop investing when inflation is high?

Historically, many long-term investors maintain their established strategy during periods of high inflation. Some investors may consider defensive positions, such as rotating into inflation-protected assets or consumer staples, depending on their risk tolerance.

How can interest rate changes by the Fed affect my investments?

When the Federal Reserve raises or lowers interest rates, that can impact stocks and bonds in different ways. When the Fed lowers rates, that lowers the cost of loans, which can boost company performance and stock prices. Bonds with lower yields may be less appealing. When the Fed raises rates, that increases borrowing costs, which can put a damper on stocks, but raise bond yields.

Photo credit: iStock/pondsaksit

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

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

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

Dollar Cost Averaging (DCA): Dollar cost averaging is an investment strategy that involves regularly investing a fixed amount of money, regardless of market conditions. This approach can help reduce the impact of market volatility and lower the average cost per share over time. However, it does not guarantee a profit or protect against losses in declining markets. Investors should consider their financial goals, risk tolerance, and market conditions when deciding whether to use dollar cost averaging. Past performance is not indicative of future results. You should consult with a financial advisor to determine if this strategy is appropriate for your individual circumstances.

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

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

An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.

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14
2025
Covered Calls: The Basics of Covered Call Strategy

Covered Calls: The Basics of Covered Call Strategy

By | Growing Wealth, invest, Investing | Comments Off on Covered Calls: The Basics of Covered Call Strategy

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

With most things in life, it helps to be covered — by a coworker, an insurance policy, or a roof over your head. In investing, it can also be helpful to have coverage through specific strategies. A covered call is an options trading strategy that involves selling call options on stocks you already own, with the goal of potentially generating income.

Here’s a breakdown of how a covered call strategy works, when to consider it, and how it may — or may not — perform depending on market positions.

Key Points

•  A covered call strategy involves selling call options on owned assets to try to generate income, with limited upside if the stock’s price surges.

•  Using covered calls may provide additional income from stock holdings through the premiums received.

•  Premiums from covered calls may offer limited protection against stock price declines, which could help offset potential losses.

•  Capped gains risk occurs if the stock price rises sharply above the call option’s strike price.

•  Employing covered calls restricts the ability to sell stocks freely, as the call option must be honored if exercised.

What Is a Covered Call?

A covered call is an options trading strategy used to generate income by selling call options on a security an investor already owns. This strategy can be beneficial to the investor if they expect the stock’s price to experience limited movement or remain neutral, though it may limit potential gains if the stock rises sharply above the strike price.

Call Options Recap

A call is a type of option that gives purchasers the right, but not the obligation, to buy shares of an underlying asset or stock at a specific, prearranged price, called the strike price. A call is in contrast to a put option, which gives buyers the right, but not the obligation, to sell the underlying asset at the strike price.

An investor who purchases a call option holds a long position in the option — that is, they anticipate that the underlying stock may appreciate. For example, an investor who anticipates a stock’s price increase might buy shares, hold them, wait for appreciation, and — assuming they do appreciate — sell them to potentially realize a gain.

Call options allow options buyers to pursue a similar strategy without buying the underlying shares. Instead, a premium is paid for the right to buy the shares at the strike price, allowing buyers to profit if the market price rises above the strike price.

Call option writers (or sellers), on the other hand, typically sell call options when they anticipate that the price of the underlying asset will decline, allowing them to keep the premium, or price paid for the option, when the option expires worthless.

What’s the Difference Between a Call and a Covered Call?

The main difference between a regular call and a covered call is that a covered call is “covered” by an options seller who holds the underlying asset. That is, if an investor sells call options on Company X stock, it would be “covered” if they already own an equivalent number of shares in Company X stock. Conversely, if an investor does not own any Company X stock and sells a call option, they’re executing what’s known as a “naked” option, which carries a much higher risk because losses can theoretically be unlimited if the stock rises sharply.

In a covered call, the seller’s maximum profit is limited to the premium plus any stock appreciation up to the call’s strike price, while the maximum loss equals the price paid for the stock minus the premium received. This same structure can be helpful to clarify gains and losses.

It’s worth noting that losses, overall, could be substantial if the price of the stock purchased falls to zero and becomes worthless, though the premium received from the call option sold may cushion the loss to a certain extent.

Example of a Covered Call

The point of selling covered calls is typically to generate income from existing stock positions. If, for example, you have 100 shares of Company X stock and were looking for ways to pursue additional income, you might consider selling covered calls to other investors.

Here’s what that might look like in practice:

Your 100 shares of Company X stock are worth $50 each or $5,000 at the current market value. To make a little extra money, you decide to sell a call option with a $10-per-share premium at a strike price of $70. Since standard options contracts typically represent 100 shares, you receive a total of $1,000 for the option.

Let’s say that Company X stock’s price only rises to $60, and the buyer doesn’t exercise the option, so it expires. In this scenario, you’ve earned a total of $1,000 by the selling covered call option, and your shares have also appreciated to a value of $6,000. So, you now have a total of $7,000.

The ideal outcome in this strategy is that your shares rise in value to near the strike price, (say, $69) but the buyer doesn’t exercise the option. In that scenario, you still own your shares (now worth $6,900) and get the $1,000 premium.

But the risk of selling covered call options is that you might forgo higher gains if the stock significantly exceeds the strike price.

So, if Company X stock rises to $90 and the call buyer executes their option, you would then be obligated to sell your 100 shares, which are now worth $9,000 on the open market. You would still get the $1,000 premium, plus the value of the shares at the predetermined strike price of $70 (or $7,000) — bringing the total trade value to $8,000. Effectively, you’ve turned a holding valued at $5,000 into $8,000, though doing so caps your upside and forfeits potential gains beyond the strike price.

On the other hand, had the covered call never been initiated, your shares could be worth $9,000. This illustrates the trade-off involved in selling covered calls: capped upside in exchange for income.

Recommended: How to Sell Options for Premium

When and Why Should You Do a Covered Call?

There is no single correct time to use a covered call strategy — it depends on weighing potential risks and evaluating the market environment.

Some investors may choose to write covered calls when the market is expected to climb moderately — or at least stay neutral. Since market outcomes are uncertain, investors should be ready and willing to sell their holdings at the agreed strike price.

As for why an investor might use covered calls? The goal is often to generate income from existing stock holdings. Another potential reason to use covered calls, for some investors, is to offset some risk using the premium received.

Pros and Cons of Covered Calls

Using a covered call strategy could serve specific purposes for income generation or risk management. But there are pros and cons to consider.

Covered Call Pros

The benefits of utilizing covered calls include the potential to receive added income and offset downside risk.

•   Investors can potentially pad their income by keeping the premiums they earn from selling the options contracts. Depending on how often they sell covered calls, this can lead to recurring income opportunities.

•   Investors can determine an adequate selling price for the stocks that they own. If the option is exercised, an investor can potentially realize a profit from the sale (as well as the premium).

•   The premium the investor receives for the sold call can potentially help offset a potential decline in a stock’s price. This provides limited downside protection, though losses can still occur.

Covered Call Cons

There are also a few drawbacks to using a covered call strategy:

•   Investors could miss out on potential profits if a stock’s price rises, and continues to rise, above the strike price. This is an inherent trade-off of the strategy. There is also the risk that the option is exercised and the investor must sell a stock — although, investors should typically only consider covered calls for assets that they’re prepared to sell.

•   An investor may be unable to sell their stocks on the market if they’ve written a call option on the shares. This limits the investor’s flexibility to respond to price movements.

•   Investors need to keep in mind that covered call gains may be subject to capital gains taxes.

The Takeaway

A covered call may be attractive to some investors as it’s a way to potentially generate additional income from a stock position. That said, as with all trading strategies, outcomes may vary based on market conditions and timing. There are no guarantees, and the strategy involves trade-offs between income potential and capped gains.

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

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

Explore SoFi’s user-friendly options trading platform.

FAQ

Are covered calls free money?

Covered calls are not “free money.” They may generate income if the option expires worthless, but they can also limit upside potential if the stock’s value increases significantly or the option is exercised when the price rises toward the strike.

Are covered calls profitable?

Covered calls may be profitable, but results depend on the performance of the underlying stock and the terms of the option contract. If the option expires unexercised, the seller keeps the premium and the stock. The strategy tends to work best in neutral to moderately bullish markets, and profitability can depend on strike selection and timing.

What happens when you let a covered call expire?

If a covered call expires without being exercised, nothing happens: the option just expires worthless. The seller keeps the premium received, which can be a benefit of the strategy. Because an option is only that — an option to execute a trade at a predetermined price for a select period of time — the option holder’s reluctance to execute during the time period means that the option will expire worthless.

Can you make a living selling covered calls?

Living strictly off income from covered calls may be theoretically possible, but it would likely require a large portfolio to make it work. There are other factors to consider, too, like potential capital gains taxes and the fact that the market won’t always be in a favorable environment for the strategy to work.

Photo credit: iStock/millann

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

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

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

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

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

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

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

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Oct
14
2025
What Is Gamma in Options Trading?

What Is Gamma in Options Trading?

By | Growing Wealth, invest, Investing, Terminology | Comments Off on What Is Gamma in Options Trading?

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

Gamma measures how much an option’s delta changes for every $1 price movement in the underlying security. You might think of delta as an option’s speed, and gamma as its acceleration rate.

Gamma expresses the rate of change of an option’s delta, based on a $1 price movement — or, one-point movement — of the option’s underlying security. Traders, analysts, portfolio managers, and other investment professionals use gamma — along with delta, theta, and vega — to quantify various factors in options markets.

Key Points

•   Gamma measures the rate of change in an option’s delta for every $1 movement in the underlying security’s price.

•   Delta provides insight into how much an option’s price might move relative to its underlying security.

•   Understanding gamma is essential for risk management, as it allows traders to gauge the risk in their options holdings.

•   Traders may balance positive and negative gamma in their portfolio to manage the risk of rapid price movements.

•   High gamma may make long options more responsive to price movements, potentially amplifying gains, but increases risks for short options near expiration.

What Is Gamma?

Gamma is an important metric for pricing contracts in options trading. Gamma can show traders how much the delta — another metric — will change concurrent with price changes in an option’s underlying security.

An option’s delta measures its price sensitivity, and gamma provides insight into how that sensitivity may change as the underlying asset’s price shifts.

Expressed as a ratio: Gamma quantifies the rate of change in an option’s delta relative to changes in the underlying asset’s price. As an options contract approaches its expiration date, the gamma of an at-the-money option increases; but the gamma of an in-the-money or out-of-the-money option decreases.

Gamma is one of the Greeks of options trading, and can help traders gauge the rate of an option’s price movement relative to how close the underlying security’s price is to the option’s strike price. Put another way, when the price of the underlying asset is closest to the option’s strike price, then gamma is at its highest rate. The further out-of-the-money a security goes, the lower the gamma rate is — sometimes nearly to zero.

Recommended: What Is Options Trading? A Guide on How to Trade Options

Calculating Gamma

Calculating gamma precisely is complex, and it requires sophisticated spreadsheets or financial modeling tools. Analysts usually calculate gamma and the other Greeks in real-time, and publish the results to traders at brokerage firms. However, traders may approximate gamma using a simplified formula.

Gamma Formula

Here is an example of how to calculate the approximate value of gamma. This formula approximates gamma as the difference between two in delta values divided by the change in the underlying security’s price.

Gamma = (Change in Delta) / (Change in Underlying Security’s Price)

Or

Gamma = (D1 – D2) / (P1 – P2)

Where:

•   D1 represents the initial delta value.

•   D2 represents the final delta value after a price change.

•   P1 represents the initial price of the underlying security.

•   P2 represents the final price of the underlying security.

Example of Gamma

For example, suppose there is an options contract with a delta of 0.5 and a gamma of 0.1, or 10%. The underlying stock associated with the option is currently trading at $10 per share. If the stock increases to $11, the delta would increase to 0.6; and if the stock price decreases to $9, then the delta would decrease to 0.4.

In other words, for every $1 that the stock moves up or down, the delta changes by .1 (10%). If the delta is 0.5 and the stock price increases by $1, the option’s value would rise by $0.50. As the value of delta changes, analysts use the difference between two delta values to calculate the value of gamma.

How to Interpret Gamma

Gamma is a key risk-management tool. By figuring out the stability of delta, traders can use gamma to gauge the risk in trading options. Gamma can help investors discern what will happen to the value of delta as the underlying security’s price changes.

Based on gamma’s calculated value, investors can see the potential risk involved in their current options holdings; then decide how they want to invest in options contracts. If gamma is positive when the underlying security increases in value in a long call, then delta will become more positive. When the security decreases in value, then delta will become less positive.

In a long put, delta will decrease if the security decreases in value; and delta will increase if the security increases in value.
Traders use a delta hedge strategy to maintain a hedge over a wider security price range with a lower gamma.

💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.

How Traders Use Gamma

Hedging strategies can help professional investors reduce the risk of an asset’s adverse price movements. Gamma can help traders discern which securities to purchase by revealing the options with the most potential to offset losses in their existing portfolio.

Gamma hedging helps traders manage the risk of rapid delta changes by offsetting gamma exposure in their portfolio. This is typically done by holding a combination of options with positive and negative gamma.

If any of the trader’s assets are at risk of making strong negative moves, investors could purchase other options to hedge against that risk, especially when close to options’ expiration dates.

In gamma hedging, investors generally purchase options that oppose the ones they already own in order to create a balanced portfolio. For example, if an investor already holds many call options, they might purchase some put options to hedge against the risk of price drops. Or, an investor might sell some call options at a strike price that’s different from that of their existing options.

Benefits and Risks of Using Gamma

Gamma plays a crucial role in managing options positions, influencing how delta changes in response to price movements. While it can enhance trading strategies, it may also introduce certain risks.

Benefits of Gamma

Gamma in options Greeks is popular among investors in long options. All long options, both calls and puts, have a positive gamma that is usually between 0 and 1, and all short options have a negative gamma between 0 and -1.

Higher gamma means the option is sensitive to movements in the underlying security’s price. For every $1 increase in the underlying asset’s price, a higher gamma suggests that delta will change more significantly, potentially amplifying gains or losses depending on the trade’s direction.

When delta is 0 at the contract’s expiration, gamma is also 0 because the option is worthless if the current market price is better than the option’s strike price. If delta is 1 or -1 then the strike price is better than the market price, so the option is valuable.

Risks of Gamma

While gamma can potentially benefit long options buyers, for short options sellers it can potentially pose risks. For short options, a high gamma near expiration increases the risk of substantial losses if the underlying asset’s price moves sharply, since delta changes rapidly and can result in significant margin requirements or losses.

Another risk of gamma for option sellers is expiration risk. The closer an option gets to its expiration date, the less probable it is that the underlying asset will reach a strike price that is very much in-the-money — or out-of-the-money for option sellers. This probability curve becomes narrower, as does the delta distribution. The more gamma increases, the more theta — the cost of owning an options contract over time — decreases. Theta is a Greek that shows an option’s predicted rate of decline in value over time, until its expiration date.

For options buyers, this can mean greater returns, but for options sellers it can mean greater losses. The closer the expiration date, the more gamma increases for at-the-money options; and the more gamma decreases for options that are in- or out-of-the-money.

How Does Volatility Affect Gamma?

When a security has low volatility, options that are at-the-money have a high gamma and in- or out-of-the-money options have a very low gamma. This is because the options with low volatility have a low time value; their time value increases significantly when the underlying stock price gets closer to the strike price.

If a security has high volatility, gamma is generally similar and stable for all options, because the time value of the options is high. If the options get closer to the strike price, their time value doesn’t change very much, so gamma is low and stable.

Using Gamma Along With Other Options Greeks

Gamma is a key metric in options trading, providing insight into how delta changes as the underlying asset’s price fluctuates. It is one of the five primary Greeks that traders use to manage risk and develop options strategies. Each Greek helps measure different aspects of an option’s behavior, offering a more comprehensive view of market exposure. The Greeks are:

•   Gamma (Γ): Measures the rate of change in delta as the underlying security’s price moves. Higher gamma means delta shifts more quickly, increasing both potential gains and risks.

•   Delta (Δ): Measures an option’s sensitivity to changes in the underlying asset’s price. Delta helps traders understand how much an option’s price might move relative to its underlying security.

•   Theta (θ): Represents time decay, indicating how an option loses value as it nears expiration. A higher theta means the option’s value declines more rapidly over time.

•   Vega (ν): Reflects the impact of implied volatility on an option’s price. Higher vega suggests that increased volatility leads to larger option price swings.

•   Rho (ρ): Gauges an option’s sensitivity to interest rate changes. Rho is more relevant for long-dated options, as interest rate fluctuations can significantly impact their value.

Understanding gamma alongside the other Greeks allows traders to refine their strategies and manage risk more effectively in the options market.

The Takeaway

Gamma and the Greeks indicators are useful tools in options trading for understanding derivatives and creating options trading strategies. However, trading in derivatives, like options, is primarily for advanced or professional investors.

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

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

Explore SoFi’s user-friendly options trading platform.

FAQ

What is a good gamma for options?

A “good” gamma depends on the trading strategy. High gamma is beneficial for short-term traders who want quick delta changes, as it makes options more responsive to price movements. Lower gamma is preferred for longer-term strategies or hedging, as it provides more stability and reduces the need for frequent adjustments.

Should gamma be high or low when trading options?

Whether gamma should be high or low depends on your strategy and risk tolerance. High gamma is ideal for short-term trades or when expecting significant price moves, as it amplifies delta changes and potential gains but also increases risk. Low gamma, common in deep in-the-money or far out-of-the-money options, provides more stability and slower delta changes, making it better suited for longer-term strategies or conservative approaches.

How do you trade options using gamma?

Trading options using gamma helps traders assess delta changes, identify opportunities, and manage risk. High gamma options, often at-the-money and near expiration, allow for rapid delta shifts, benefiting short-term trades. Gamma hedging helps balance exposure by offsetting positive and negative gamma, reducing volatility in a portfolio.

What is the best gamma ratio?

A “good” gamma depends on the trading strategy. High gamma is beneficial for short-term traders who want quick delta changes, as it makes options more responsive to price movements. Lower gamma is preferred for longer-term strategies or hedging, as it provides more stability and reduces the need for frequent adjustments.

What happens to gamma when volatility increases?

When volatility increases, gamma decreases for at-the-money options and stays relatively stable for in- and out-of-the-money options. Higher volatility smooths delta changes, making gamma less sensitive, while lower volatility increases gamma, leading to sharper delta shifts.

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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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