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You probably know how easily you can tap to pay for items when shopping and click to send a friend money for your share of dinner. Why can’t most of your financial transactions be that easy?

They can be. You can be freed from much of the usual day-to-day account activity by automating your finances. Doing so can eliminate your wondering whether you have paid bills on time, allocated the right amount to savings, and more.

Automating your finances can be a smart money move that saves you on late fees and reduces financial stress. It may also help you make a budget and stick to it, as well as get on a path to growing your wealth.

Deciding where and when to automate personal finances need not be complicated. Here’s a guide sharing what it means to automate your finances, the different ways you can put your money management on autopilot, and tips for making the process super simple.

What Does It Mean to Automate Your Finances?

Automating your finances means you use today’s technology to preschedule and preapprove transfers of your funds. It’s a “set it and forget it” way to pay bills, move money from checking to savings, and even enrich your retirement account.

The beauty of doing so means you can avoid late fees (which many of us, no matter how responsible we are, get hit with sooner or later). You may also become more organized and free your mind to ponder better things. Worrying about when bills are due is so last decade, after all!

Check out our Money Management Guide.

This article is from SoFi’s guide on how to manage your money, where you can learn basic money management tips and strategies.

What Kind of Accounts Can You Automate?

If you’re wondering what kind of accounts you can automate, you’ll probably like this answer: almost any kind. Here’s a list of some of the most popular:

•   Credit cards

•   Rent or mortgage

•   Utilities

•   Investment accounts

•   Loans (car, personal, etc.)

•   Insurance

•   Savings (from short-term vacation funds to your emergency fund to retirement accounts).

Automating payments can spare you late fees and overdraft charges. It can also help you streamline the process of staying active and accountable on your accounts (a great way to avoid winding up with credit charge offs).

It may also help keep your credit score from being impacted by missed payments. In fact, payment history contributes 35% to your FICO® score. You want to protect those digits.

(BTW, it’s a good idea to scan for common credit report errors on an annual basis, just to make sure nothing is amiss.)

💡 Quick Tip: Want to save more, spend smarter? Let your bank manage the basics. It’s surprisingly easy, and secure, when you open a bank account online.

How to Automate Your Finances in 7 Easy Steps

When it comes to the set-up of automating personal finances, there are a few different techniques to try. Here, you’ll learn some of the most popular options so you can decide what’s right for you, whether it’s one method or a combination.

Step 1: Set Up Direct Deposit for Your Paycheck

An excellent way to automate and fund your personal finances is to set up direct deposit of your paycheck (the vast majority of salaried workers are paid this way). You’ll know your salary is getting sent to your bank account and when it hits. Some pointers:

•   You’ll likely need to share your bank account number and routing number with your employer in order to establish direct deposit.

•   You may also need a voided check to get the funds moving to the right place.

•   You can then schedule your automated payments for the right dates, when your balance is feeling especially flush.

•   A great hack to know about: Some bank accounts will allow you access to your paycheck funds a day or two early if you sign up for direct deposit with them. That’s another great way to keep abreast of those bills.

Step 2: Automate Fixed Monthly Bills and Utilities

Here’s how this works: Say your wifi provider or landlord of your rental apartment gives you an automatic bill payment option.

•   Through the company’s payment portal, you’ll set up an autopay schedule, connecting the service provider to your bank account. On the agreed-upon date (say, rent is due by the 7th of every month so you select to pay on the 5th), the company will automatically deduct the amount from your checking.

•   In some cases, you may be assessed a fee for this privilege; it varies with the provider.

•   When you opt into this kind of plan, you may be given the opportunity to have the payment charged to a credit card or deducted from an account other than your bank account. Look carefully, though; you may wind up paying additional fees for this.

Recommended: Guide to Automated Credit Card Payments

Step 3: Put Your Credit Card and Loan Payments on Autopilot

As you explore how to automate finances, you may find that some creditors don’t offer you the kind of convenience described above, but your bank may swoop in and help you pay automatically. Many major banks will issue payments on your behalf to a creditor or service provider, which can make your life infinitely easier. No more writing checks every month and digging around for stamps. Here are the steps to take:

•   Check with your bank about what it offers. Typically, your bank will need the name, account number, and potentially the address of the business you are paying.

•   You’ll also need to assess how long this process will take every month; it may not be instantaneous. You’ll want to make sure the money arrives on time and you are not charged any late fees so your credit score doesn’t suffer.

•   Then you’ll sign up for the series of payments to be handled by your bank.

Step 4: Build Your Emergency Fund Automatically

Your emergency fund is another type of savings that can benefit from automated infusions of money. An emergency fund is a stockpile of easily accessed cash that can tide you over when unexpected setbacks hit. Perhaps you get a major car repair or medical bill or are laid off from your job. An emergency fund can let you pay bills without accessing a high-interest line of credit (say, ringing up too much debt on your credit card).

In terms of emergency funds, keep the following in mind:

•   It’s wise to have at least three to six months’ worth of basic living expenses in the bank. That means mortgage or rent, utilities, insurance payments, food, childcare, and other must-have goods and services, plus minimum debt payments.

•   Most people can’t create this fund with a single, lump-sum deposit. Making regular transfers into your account (even if it’s only $20 per paycheck or per month) will get you started. Any contribution is better than nothing!

•   Where to keep your emergency fund? Since you want it to be available almost immediately in urgent situations, a high-yield savings account or standard savings account can be a good option. Either way, you’ll earn some interest. A money market account, which combines some of the features of savings and checking accounts, may also serve this purpose.

Step 5: Direct Funds to Specific Savings Goals

Your non-retirement savings are another important account to automate. Again, if your salary hits your checking account, you may feel rich and go spend more than you should. By automating your savings and funneling money from your paycheck straight into an account, you may avoid going on shopping sprees. You’ll also foster the habit of paying yourself first — prioritizing saving for your future wants and needs.

This can be a very effective tool. In one study by financial psychologist Brad Klontz, people who visualized their goals and set up automatic withdrawals enjoyed a 73% increase in their savings after just one month.

Into what kind of account can you direct those funds? That’s up to you. Perhaps you want to have a few separate accounts that feed different goals. Think of them as separate vaults where you can save for your goals. You might have one account for a down payment fund, one for vacation savings, and one for a child’s educational expenses. You can direct how much and how often you want each transfer to be.

Of course, there are options about where exactly you keep your savings. Some possibilities to consider:

•   Standard savings accounts are good, but a high-yield savings account can be even better. These tend to pay a significantly higher annual percentage yield (APY) than a standard account.

•   Certificate of Deposit (CD) accounts can be another good option. These are time deposits, meaning you commit to keep the funds with the financial institution for a specific period of time, which may typically range from a few months to several years. In return, you are assured a specific interest rate. However, there may be penalties if you withdraw funds early.

•   A TreasuryDirect account can allow you to make recurring purchases of electronic savings bonds directly from your paycheck. You can learn more about this at the Treasury Direct website.

Step 6: Automate Your Retirement Plan Contributions

It’s all too easy to think, “I’ll get around to saving for retirement…someday.” Perhaps that’s why American households had a median balance of only $87,000 in retirement accounts, according to the Federal Reserve’s most recent survey. That’s probably not enough if your dream is moving to Hawaii at age 65 and spending your days with your toes in the sand.

That’s why learning how to automate your finances for retirement savings can be such a helpful practice. Many experts suggest depositing at least 15% of your pretax income into your retirement plan every paycheck. Some tips:

•   If your employer offers a retirement savings plan, you can authorize your HR or payroll department to automatically whisk away a certain amount of your pre-tax income every paycheck and put it toward retirement. You won’t miss what never hits your checking account, right?

•   Aim for the maximum amount allowed, or at least put in enough to get any company match that’s offered. Otherwise, you’re leaving free money on the table.

If you’re self-employed, you may be able to automate your savings with recurring transfers into such vehicles as a solo 401(k), SEP IRA, or SIMPLE IRA as you save for your future.

Step 7: Use an Automated Investing Account

If you currently have an investment portfolio or are planning to start investing in stocks, that’s another task that can be made simpler by technology. Automated investing can allow you to achieve consistency with minimal effort, which can help you build your net worth over time.

Some examples:

•   As noted above, you might set up recurring transfers into a retirement plan that invests the funds for you.

•   You may automate contributions to a 529 investment account, designed to help families save for future educational expenses, such as college.

•   You can automatically transfer money from your checking account into a brokerage account.

•   You might work with a robo-advisor that picks investments based on your needs and preferences and also rebalances your portfolio.

•   Investing apps are another possibility to help automate investing. These can be as simple as the ones that round up the price of purchases and then invest the change for you.

5 Tips for Successful Personal Finance Automation

Now that you have a good grounding in the benefits and how-to’s of automating personal finances, consider these strategies for success:

Create a Budget Based on the Balance You Get Paid

Look at where your money stands after you deduct your retirement and savings amounts. With the remaining funds, you can plan out ways to budget. There are various types of budgeting methods out there, like the 50-30-20 budget rule, among others. Do an online search and see what resonates with you.

A budget will guide your saving and spending and can reveal how you are doing in terms of setting financial goals and meeting them on other fronts, such as a vacation fund or a retirement account.

It will help you handle good vs. bad debt more effectively. All are terrific ways to avoid excessive debt and build wealth.

Be Aware of All Your Bill Due Dates

As you automate your finances, do pay careful attention to the due dates on your bills. Who wants to see their hard-earned cash get drained by late fees?

•   Look at the calendar; check when your paycheck hits and when certain bills are due. Some creditors may set your due date in stone; others may have some flexibility. Similarly, some autopay portals may allow you to set the payment date; others may have a specific date on which funds will be debited.

•   Note whether or not there’s any lag with automatic payments so that you can ensure that they will arrive on time.

•   It can be better to stagger autopayments so you don’t risk overdrawing your account. See what best suits your lifestyle and money style to keep your account in good shape.

Review Your Bank Account and Bank Statements Often to Stay on Top of Your Transactions

One of the pleasures of automating your finances is that you are freed from thinking and worrying about your money and your bills on a regular basis. However, daily life involves all kinds of money blips, from treating your bestie to a fancy birthday dinner to (ugh) having fraudulent charges appear on your credit card bill.

So do review your bank account and other statements regularly to make sure everything is as it should be and that your balance isn’t too low. Check in with your accounts often. Should you check your bank account every day? Not necessarily. A couple of times a week can be a good cadence.

Increase Your Contributions When It Makes Sense

While you’re checking your finances and bank balances, don’t overlook whether it’s time to increase your contributions to help meet your savings goals. If you’ve gotten a raise or paid off a student loan, you may have funds available to save more.

Or you might find that a chunk of change has accumulated in your checking account which could do more for your finances if used elsewhere. There are times when you may want to increase your transfers to reflect your positive financial status.

Leverage Budgeting Apps to Monitor Your Automated Finances

It’s easy to track your spending and saving right from your phone when you use a budgeting app to keep tabs on accounts. There are many out there. To decide what’s right for you, determine if you want to link your bank account(s) directly to the app or input data manually. (The latter is obviously more labor intensive; ask yourself if you’ll do the work regularly.) Some apps are free. Some allow you to share tracking with another person, such as a spouse. Think about the features you want before choosing.

The Takeaway

Automating your finances can be a great way to take control of your money and make bill paying and saving so much more convenient. That kind of organization can let you breathe easier when it comes to managing your money and be more successful in meeting your financial goals.

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

FAQ

What is the biggest mistake people make when automating finances?

The biggest mistake that occurs when people automate their finances is that they stop looking at their bills and bank statements. Costs can creep up and you may not notice that over time, more and more of your income is being eaten up by underused subscriptions. Or you could miss a case of fraud that depletes your account.

How often should I review and adjust my automated finances?

You should review your finances and automated transactions regularly to monitor your payments and balance, which for some people may mean a couple of times weekly; for others, it might be every other week. Also, it’s wise to check in when you have significant changes in your life, whether you got a raise, took out a mortgage, or moved to an area with a higher cost of living. You may want to recalibrate your automated transfers.

Is it safe to automate my finances?

By and large, it is safe to automate your finances. You should, however, check in regularly to make sure you are not overdrafting or getting close to it, and also to keep in touch with your money. It’s possible that a glitch could delay a payment and, unfortunately, it’s important to be aware of any potential signs of fraud when conducting any type of financial transaction.

What are the best tools or apps to use for automating my finances?

There are an array of tools and apps for automating your finances. A good place to start may be with your own financial institution. It may offer automated savings and investing products, roundup apps, and other tools to help you make the most of your money and grow your wealth.

Can I still make manual payments even if I have automatic payments set up?

In many cases, you will still be able to make a manual payment even if you have automated payments set up. This could occur when you have an additional bill for an account that is set on autopay, or when you have a credit and want to pay a lower amount. Check with your creditor or the financial institution handling the transfer for details on how to do this smoothly.

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

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SOBNK-Q226-140

Free margin is the capital in a trader’s account that isn’t reserved for margin or open positions and is available to be used to open new trades. Free margin is also the amount your existing holdings can decline before you face a margin call.

Changes in market values can impact this important margin balance, especially when trading foreign exchange (forex or FX) and other derivative instruments. For investors, free margin can be an important concept to understand, and an important metric to track.

What Is Free Margin?

Free margin is the equity in a leveraged trading account that isn’t currently tied up as collateral for open positions.

It’s also known as usable margin since you can open new positions with your free margin balance. Investors can use free margin as a safety buffer to absorb market fluctuations, or to open new trades.

Margin works differently in forex versus stock trading. Margin in stock trading means you trade with borrowed funds using your stock holdings as collateral, and owe interest on the loan. Margin in forex is simply a deposit set aside to cover the potential for losses when you trade large amounts of currency. Free margin in forex tells you how much wiggle room you have on your current holdings before you get hit with a margin call. Each broker is different, but a margin call can occur when your account’s margin level dips below 100%.

You may also potentially face a stop-out call, which is a forced sale of the assets in your account, when your margin percentage falls below a broker-defined, margin-based threshold.

Free margin also indicates how much you can withdraw from your account if you have no hedged positions.

How Does Free Margin Work?

In general, margin can be categorized as used or free.

Used margin is the total amount of all the required margin from all your open positions. Free margin is the difference between equity and used margin — the available margin not taken up by current positions. You can use free margin to open new positions in the forex market if sufficient margin is available.

Within the forex market, free margin is a constantly changing balance. The prices of currency pairs move throughout the day, so the free margin on your account will also fluctuate. Traders must constantly monitor their margin levels during the trading day. The forex market trades 24 hours a day for five-and-a-half days a week, so changes can also occur overnight.

Recommended: Active vs Passive Investing: Differences Explained

Calculating Free Margin

This is the formula for calculating free margin:

Free margin = Equity – Used Margin

One similar element in investment accounts is excess margin — the collateral held in a margin account in excess of the minimum to maintain the account’s good standing.

Excess Margin = Total Account Equity – Minimum Maintenance Requirement

Free Margin Example

Let’s say you have a forex trading account with 100:1 leverage. Your margin deposit is $100. That means you can trade an amount up to $10,000. Now, say you take a $20 position at 100:1 leverage. Your position size controls $2,000 of currency value. That $20 position is locked by your broker. The remaining $80 is your free margin. You may theoretically use up to that amount to trade more currency pairs in the FX market.

If the market moves to your benefit, your portfolio’s equity increases. You will have more free margin available as your holdings move in your favor. Free margin declines when the market moves against you, though.

Be aware that having free margin available also provides a cushion to absorb losses in the case of market volatility. Letting your free margin fall too low could potentially result in a margin call.

Free Margin vs Used Margin

There are some key differences to know between free margin and used margin:

Margin vs Free Margin

Similarly, there are some differences to understand between margin and free margin:

Free Margin in Forex

Free margin is important to understand in forex trading. Volatility in your balances can be high due to the amount of leverage employed. Some traders have leverage ratios up to 500:1, while risk-averse traders can simply trade with only their margin. Trading with only your margin means you’re not using leverage.

Free margin in forex tells a trader how much more money they can use to open new positions. It’s also a risk management indicator, in that it can be seen as a kind of buffer amount before a margin call or forced liquidation is issued.

One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.

The Takeaway

Free margin is the equity in a trader’s account that is not reserved in margin for open positions. It’s considered the margin available to use for new trades and the amount your current positions can move against you before you get a margin call or automated stop out.

Free margin is an important term to know when trading in the forex market, as well. Forex, with its often high degree of leverage and wide trading hours, can be more complicated than trading stocks and exchange-traded funds (ETFs).

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

FAQ

Can you withdraw free margin?

In a general margin account, you can withdraw free margin or take a margin loan against your securities. Investors often withdraw free margin for personal expenses like taxes, purchases, or debt consolidation.

In a forex account, you can withdraw your equity minus margin hedges.

Is margin money free?

Margin is your good-faith deposit used as collateral to open and maintain leveraged trading positions. It allows you to control a larger position size than your account balance by using leverage rather than paying the full value upfront. Margin isn’t free money but is split into “used” or “free,” and when you have open positions, not all of your margin is available.

What happens when your free margin runs out?

When your margin runs out, you can no longer open new trades. Further, your broker may issue a margin call, which would require you to deposit additional funds to secure your position, or trigger a stop-out, which automatically closes your open trades to prevent a negative balance.

Photo credit: iStock/kupicoo

SOIN-Q126-143

Intrinsic value and time value are two major determining factors of the value of the premium of an options contract. An option’s intrinsic value is the payoff the buyer would receive per share if they exercised the option right away, before the premium paid and other costs. Intrinsic value represents how in-the-money the option would be based on the difference between the contract’s strike price and the market value of the underlying security.

An option’s time value is not quite as straightforward. Time value is based on a formula that includes the expected volatility of the underlying asset, as well as the amount of time until the option contract expires.

What Is the Intrinsic Value of an Option?

An investor who purchases an options contract buys the right, but not the obligation, to buy or sell the option’s underlying asset at an agreed-upon price, known as the strike price. Options are considered derivatives because they are tied to the value of the underlying security. The contract may allow the investor to purchase or sell a security at that strike price at any point up until and on the contract expiration date (for American-style options) or solely on the expiration date (for European-style options).

There are two main kinds of options: calls and puts. The purchaser of a call option buys the right (though not the obligation) to purchase the underlying asset at a given price until a particular date.

The buyer of a put option purchases the right (though not the obligation) to sell the underlying asset at a given price until a particular date.

Important terms: In the Money, At the Money, Out of the Money

There are a few more key options investing terms to know: in the money, at the money, and out of the money.

In the Money

An option is considered to be in the money (ITM) if exercising it would result in positive intrinsic value. For a call option, that means that the price of the underlying asset is higher than the strike price specified in the options contract. For a put option to be ITM, the price of the underlying asset would have to be lower than the strike price in the contract.

At the Money

If an option is at the money (ATM), the price of the underlying security is equal to the strike price in the contract, and it’s not considered profitable since it has no intrinsic value. However, an ATM option could potentially be sold for profit.

Out of the Money

If an option is out of the money (OTM), the strike is above the market price for a call option or below the market price for a put option. The contract has no intrinsic value. If the option expires OTM, it will essentially expire worthless. In those instances, the buyer takes a loss on the premium they paid to enter into the options contract, while the seller, or writer, of the contract collects the premium.

Recommended: Popular Options Trading Terminology to Know

Formula for the Intrinsic Value of an Options Contract

Here are the formulas for calculating intrinsic values of call and put options.

Intrinsic value formula for a call option:

Call Option Intrinsic Value = Underlying Stock’s Current Price – Call Strike Price​

Intrinsic value formula for a put option:

Put Option Intrinsic Value = Put Strike Price – Underlying Stock’s Current Price​

Example of Intrinsic Value Calculation

Imagine that hypothetical XYZ stock is selling at $48.00. A call option for XYZ with a strike price of $40 would have an intrinsic value of $8.00 ($48 – $40 = $8). In this example, the option holder could exercise the option to buy XYZ shares at $40, then immediately sell them for a $8.00 profit per share, less the premium paid.. The contract would be in the money at $8.

But what if the strike price is higher than the $48.00 market price of XYZ stock? Let’s say the call option strike is $50 ($48 – $50 = –$2.00. The option would be considered out of the money and worth zero, because the intrinsic value of an option can never be negative.

What if it’s a put option? In this scenario, with an underlying price of $48.00 for XYZ stock, a put option with a strike price of $44.00 would have an intrinsic value of zero ($44 – $48 = –$4.00), again because the value of an option cannot fall below zero.

But a put option with a strike price of $50 would be considered in the money, and have an intrinsic value of $2 ($50 – $48 = $2).

Investors should remember when calculating options strategies that an option’s intrinsic value does not include the premium the investor has to pay in order to buy the options contract in the first place. To get a better sense of the profit of an options trade, it’s important to include that initial premium, along with any other trading commissions and fees charged by the broker.

What Is the Time Value of an Option?

Premiums are typically based on an option’s intrinsic value, plus its extrinsic value, also called time value. Time value is the portion of an option’s premium above its intrinsic value, reflecting the possibility the option becomes in the money before expiration.

While volatility is one factor that influences an option’s extrinsic value, time plays a large role as well. The more time an investor in an options contract has, the better their chances of being able to exercise that option in the money, simply because the underlying security has a greater chance of moving in the desired direction. Longer time periods may increase the possibility that the option becomes profitable.

Conversely, as an options contract gets closer to expiring, its value may go down. The reason is that there is less time for the security underlying the options contract to make profitable moves.

An option tends to decline at an accelerating rate as expiration approaches. This phenomenon is known as the time decay of options. It’s a critical concept for options investors because the closer the option gets to expiration, the more the underlying security must move to impact the price of the option.

The intrinsic value of the option plays a role in how fast the time value decays. An ITM option faces less dramatic time decay, but for an OTM option, time decay is more dramatic since the option will be entirely worthless if it expires out of the money.

Formula for the Time Value of an Options Contract

The formula for the time value of an options contract is as such:

Time Value = Option Premium− Intrinsic Value​

How Does Volatility Impact Time Value?

Another important factor that can impact time value is the volatility of the underlying asset. Volatility cuts both ways: it can help generate gains or lead to losses.

Stocks with higher volatility typically have the potential for greater price movements — and thus related options may have a higher probability of expiring in the money, though outcomes are never guaranteed. That’s one reason why time value, as reflected by the option’s premium, is typically higher when the underlying asset is more volatile.

With stocks and other assets that have lower volatility, and are therefore not expected to show big price fluctuations, time value and the option premium may be lower.

Recommended: Implied Volatility: What It Is & What It’s Used for

How Can Intrinsic and Time Value Help Traders?

When calculating the value of the options contracts that they’re buying and selling, intrinsic value and time value can help traders gauge the potential risks and rewards of the options trade. Intrinsic value is easy to assess, but it only tells part of the story. Traders need to understand the extrinsic or time value of options as well in order to gauge how profitable the option is likely to be. Investors use this deeper understanding to inform which options trading strategies they may choose.

When it comes to the profitability of an options trade, investors also need to take into account the premiums they pay to buy an option, along with related commissions and fees. There are also other factors that play a role in the pricing of an options contract, such as the option’s implied volatility. This is the aspect of options pricing that takes into account the market sentiment as to the future volatility of an option’s underlying security, and can have a major influence on the price of an option as well.

💡 Quick Tip: In order to profit from purchasing a stock, the price has to rise. But an options account offers more flexibility, and an options trader might gain if the price rises or falls. This is a high-risk strategy, and investors can lose money if the trade moves in the wrong direction.

The Takeaway

Understanding how options are priced can be complicated. Knowing its two main components — intrinsic value and time value — is essential. Intrinsic value represents the amount the buyer would receive if they exercised the option immediately, while time value reflects the additional premium attributed to time remaining and volatility. Typically the more volatility and the more time to the option’s expiry date, the higher the premium or value of the option.

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.

Frequently Asked Questions

How does time value work with options?

Time value represents the “extrinsic” portion of an option’s price that accounts for the potential of the underlying asset to move profitably before expiration, a value that diminishes daily through a process called time decay.

What is the meaning of intrinsic value?

For options, intrinsic value is the in-the-money (ITM) amount based on the difference between the underlying asset’s price and the strike price.

Which option has the highest time value?

An at-the-money (ATM) option with the longest possible time until expiration typically has the highest time value. This is because these options carry the maximum uncertainty and potential for the stock price to move significantly in either direction before the contract expires.

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There are two common ways to use margin in a trading account: cross margin and isolated margin. Cross margin involves margin that is shared between open positions. Isolated margin, on the other hand, is margin assigned to a single position that is restricted from being shared.

Cross margin may help prevent quick liquidations and has a better capability to withstand portfolio losses. Isolated margin offers better flexibility in that other portfolio holdings will not be affected if a single position is liquidated.

What Is Cross Margin?

Cross margin was introduced in the late 1980s as a way to reduce systematic risk in the market and to help traders better manage their portfolios when engaging in margin trading.

At the institutional level, cross margin offsets the value of hedged positions maintained by firms at multiple clearinghouses. Cross margining recognizes intermarket hedged positions, thus allowing for reduced initial margin requirements, fewer margin variations, and smaller net settlements.

For individual traders, cross margin provides more leeway in how open positions in a portfolio move. Cross margin takes excess margin from one margin account and gives it to another to satisfy maintenance margin requirements. That sharing of margin allows the trader to use all available margin balances across their accounts.

How Does Cross Margin Work?

Cross margin is not a simple calculation, and it runs on sophisticated algorithms. By sharing margin across accounts, traders can access more exposure without depositing more capital. Clearinghouses, central counterparties, and brokers determine cross margin amounts and automatically move margin between accounts that have registered for the service.

Traders might prefer cross margining, as a single losing position might not be liquidated quickly when market conditions change. Excess margin is transferred from another account to meet a minor shortfall in minimum maintenance. Cross margin helps to avoid quick margin calls and forced liquidations.

💡 Quick Tip: One of the advantages of using a margin account, if you qualify, is that a margin loan gives you the ability to buy more securities. Be sure to understand the terms of the margin account, though, as buying on margin includes the risk of bigger losses.

How to Use Cross Margin

Cross margin is best used when a trader has multiple margin trading accounts. A cash account and margin account work differently, and cross vs. isolated margin only applies to the latter type. For traders concerned about a single position being stopped out, it is generally better for them to use cross margin vs. isolated margin, as the former is a tool to help prevent unnecessary forced liquidations. So, a trader must trade with a broker who offers this service.

Volatile markets demonstrate the benefits of cross vs. isolated margin. With cross margin, when there are extreme movements in single securities, it is hard to keep a handle on individual positions’ margin requirements. Cross margining can calculate amounts automatically and move excess margin to other accounts that need it.

What Is Isolated Margin?

Isolated margin is margin assigned to a single position that is restricted to a specific amount. When the allocated margin drops below an unrealized profit and loss threshold or the maintenance margin requirement, the trader may face a margin call or potentially a liquidation of their assets.

The upshot is that other positions in the account are not affected. Isolated vs. cross margin tends to offer better flexibility because it can divide the trader’s funds, but stop-outs can happen quickly in volatile markets. Isolated margin vs. cross margin are different from each other, and both are used in crypto trading. It’s important to know what decentralized exchanges are when using either margin type when buying and selling crypto.

How Does Isolated Margin Work?

Isolated margin works by setting aside a margin amount for a single position. Volatile and speculative positions are sometimes good candidates for the use of isolated margin. It can be helpful when you don’t want other portfolio holdings to be impacted by a change in the value or margin requirements from that single position.

How to Use Isolated Margin

Traders have the flexibility to adjust their isolated margin amounts, which can be useful when managing their portfolio positions. You should consider isolated margin when you want more flexibility with a single position and seek to restrict the risk of potential loss to only a small piece of your account. Isolated vs. cross margin can also require more nimble attention to the market, as you might need to actively adjust the isolated margin amount.

Cross vs Isolated Margin Compared

Let’s review the similarities and differences in cross vs. isolated margin. In general, cross margin is preferable for long-term strategies, as market- and single-asset volatility could always strike. Cross margin helps portfolios endure volatility with fewer automated stop-outs. The downside is that if there is an extremely volatile event, and liquidations occur, then total portfolio losses could be severe.

Similarities

Initial and maintenance margin rules apply to your account whether you use cross margin or isolated margin. The two strategies help to reduce the risk that your overall portfolio will experience fast liquidations.

Differences

The key difference between the two is that cross margin shares margin between positions and accounts. This can be a helpful feature for long-term investors and during periods of market volatility. Overall, cross margin may be a better risk-management tool for complex portfolios that consist of multiple positions or options and other derivatives.

Advantages and Disadvantages of Cross Margin

There are advantages and disadvantages of cross margin:

Advantages and Disadvantages of Isolated Margin

Similarly, there are upsides and drawbacks to isolated margin:

The Takeaway

Cross margining is a feature that increases a firm’s or individual trader’s liquidity and trading capability by allowing excess margin to collateralize across separate positions or accounts. In doing so, cross margining can distribute risk across different assets and utilize capital from assets more efficiently. Isolated margin is margin assigned to just one position — if it is liquidated, other account positions are not affected. Isolated margin is assigned to a single position and restricted from being shared.

It’s important that traders who engage in margin trading understand the concept of cross vs. isolated margin. If you feel like you’re in over your head while trading on margin, it may be a good idea to consult with a financial professional for guidance.

If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.

FAQ

How is cross margin calculated?

In options trading, cross margin is calculated by clearinghouses and their clearing members, including prime brokerages that offer margin services. They use the proprietary System for Theoretical Analysis and Numerical Simulations (STANS) developed by the Options Clearing Corporation of Chicago (OCC). At the end of each trading day, hedged positions held at separate clearinghouses are combined into a single portfolio to calculate the real risk of leveraged and hedged positions.

Is isolated margin the same as isolated leverage?

Isolated margin and isolated leverage are similar concepts. While isolated margin is the margin allocated to a single position, isolated leverage refers to the multiplier you’re using to borrow money for that position, or the degree to which you’re using leverage. For example, you may be using margin to increase your buying power by 2x.

What is the main benefit of cross margin?

Cross margin is when excess margin is transferred to another margin position or account to satisfy maintenance margin requirements. It allows traders to use their available margin balances across all their accounts. It makes it possible to have more exposure without the extreme risk of liquidation should the market move against the trader.

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Time decay, as it relates to options trading, has to do with an option contract’s loss of value as it nears its expiration date. There are numerous variables in the mix when it comes to time decay, but knowing the basics of what the terms means, and how it can affect an investment strategy, can be important for investors.

What Is Time Decay?

Time decay is the loss of an option’s value as it gets closer to expiration. An option’s time value refers to the extent to which time factors into the value — or the premium — of the option. Time decay accelerates, or declines more quickly, as the expiration date gets closer because investors have less time to exercise the contract.

For options traders, understanding time decay can be important whether you’re buying call options or put options. Here are the basics you need to know.

Recommended: Options Trading: A Beginner’s Guide

How Time Decay Works

The rate of change in the time value of an option is known as theta. For traders who buy options with the intention of holding them until expiration, theta usually isn’t of great concern. That’s because traders who hold contracts until the expiry date are hoping that the underlying security moves so far in their favor that the reward in terms of intrinsic value will outweigh any loss in extrinsic value.

But traders who want to close their options position prior to expiration may be more concerned about time decay. Because the security will have less time to move in their favor, the potential profit from intrinsic value is reduced, and the potential loss of extrinsic value becomes greater.

While both intrinsic and extrinsic value are important for options traders of all kinds, the type of options trading strategy a trader is using can influence which factors they put more emphasis on.

Understanding Options Pricing

Time decay isn’t a difficult options trading concept, but it does require a quick refresher about how options are traded and priced.

Four of the main variables that impact the price of an option are:

1.    The underlying price and strike price

2.    Time left until expiration

3.    Implied volatility

4.    Interest rates

The underlying price, strike price, and expiration date of the options contract are the main factors that determine its intrinsic value, while implied volatility and time to expiration are the factors that determine its extrinsic value.

•   Intrinsic value. An option’s intrinsic value refers to the option’s value if exercised immediately, which depends on the price of its underlying security relative to the strike price of the contract. In other words, whether the option is in the money, out of the money, or at the money.

•   Extrinsic value. Extrinsic value refers to how time and implied volatility can impact the option’s value, i.e., its premium. As the expiration date of the options contract approaches, there’s less time for an investor to profit from the option, so time decay or theta, accelerates and the option loses value.

Interest rates can also affect options prices, but this is more of a macro factor that doesn’t have to do with the specific contract itself.

Thus, time value represents the added value an investor has to pay for an option above the intrinsic value. Options are sometimes referred to as depreciating or wasting assets because they tend to lose value over time, since the closer the option is to expiration, the faster its time value erodes.

Recommended: Popular Options Trading Terminology to Know

How to Calculate Time Decay

The rate of an option’s time decay is measured by theta. An option with a theta of -0.05 (theta is expressed as a negative value) would be expected to fall about $0.05 each day until expiration, but this may accelerate during the days and weeks leading up to the expiry date.

Greek values like theta are constantly changing, and can therefore be one of the most difficult factors to take into account when trading options.

Example of Time Decay of Options

Imagine an investor is thinking about buying a call option with a strike price of $40. The current stock price is $35, so the stock has to rise by at least $5 per share for the option to be in the money. The expiration date is two months in the future, and the contract comes with a $5 premium.

Now imagine a similar contract that also has a strike price of $40 but an expiration date that is only one week away and comes with a premium of just $0.50. This contract costs much less than the $5 contract because the stock would need to gain almost 15% in value in one week to reach profitability, which is unlikely.

Thus, the extrinsic value of the second option contract is lower than the first, because of time decay.

How Does Time Decay Impact Options?

Option time decay is pretty straightforward in principle. Things can be more complicated in practice, but in general, options lose value over time. The more time there is between now and the expiry date of the option, the more extrinsic value the option will have. The closer the expiry date is to the current date, the more time decay will have taken effect, reducing the option’s value.

The basic idea is that because there’s less time for a security to move one way or the other, options become less valuable the closer they get to their expiration dates. This isn’t a linear process though. The rate of time decay accelerates over time, with the majority of decay occurring in the final month before expiration.

The Takeaway

If you think about it, the time value of an option is similar to other things that have a value which is time dependent. A fresh loaf of bread, a new car, a newly built home — these items carry inherent value, but you might also pay a premium when they’re at full value.

As time passes, though, consumers may pay less for a loaf of bread that isn’t fresh — or a car or home that’s older — because time has eroded some of the value. Similarly, as an option gets closer to its expiration date, it too loses value owing to the effects of time decay or theta.

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.

FAQ

How does time decay work on options?

Time decay, also called theta, is the gradual erosion of an option’s extrinsic value as its expiration date approaches. Decay typically accelerates in the final weeks before expiration.

What happens to an option’s value as it approaches expiration?

As expiration approaches, an option’s extrinsic value declines while its intrinsic value — if any — remains tied to the underlying asset’s price. Options that are out of the money will lose value rapidly in the final days before expiration and may expire worthless.

How does moneyness affect time decay?

At-the-money options tend to experience the most significant time decay, as they carry the highest amount of extrinsic value relative to their price. In- and out-of-the-money options decay differently, with deep out-of-the-money options often losing value quickly as expiration nears.

What time of day do options decay?

Theta decay is generally calculated and applied at the close of each trading session rather than continuously throughout the day. That said, options positions can be more vulnerable to price swings during the open and close, when volatility tends to spike.

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