What Is a Calendar Spread Option?

What Are Calendar Spreads and How Do They Work?

Many options spread strategies consist of buying and selling call or put options that expire at the same time. Calendar spreads, on the other hand, are created by selling a short-dated option and buying a longer-maturity option with the same strike price. Rather than seeking favorable directional movement in the underlying stock, the calendar spread takes advantage of implied volatility and the way that it typically changes over time.

Like other option spread strategies, a calendar spread limits a trader’s potential losses, but it also caps their potential return. Calendar spreads are considered an advanced option trading strategy, so it’s important to have a handle on how they work and the potential risks. Read on to learn more about how to build calendar spreads and when to use them.

Calendar Spreads Defined

A calendar spread, also known as a horizontal spread, is created with a simultaneous long and short position in options on the same underlying asset and strike price but different expiration dates. Calendar spreads can be constructed using calls or puts. The longer-dated option is purchased and the shorter-dated option is sold. Typically, the option that is sold has a near-term expiration date.

How Calendar Spreads Work

Calendar spreads are typically established for a net debit, meaning you pay at the outset of the trade. This is because generally speaking, a longer-dated option will be more expensive than a shorter-dated one if the strike prices are the same.

Time decay is essential to how calendar spreads work. It tends to accelerate as an option’s expiration approaches, which means that all else equal, the short-dated option will lose more value due to time decay than the long-dated option over a given passage of time. If the stock price is at or near the strike price of the options at the time of the first expiration date, the trade should be profitable.

Calendar spreads function fairly similarly whether constructed with calls or puts. Depending on where the stock price is relative to the strike price selected at the outset of the trade, and whether calls or puts are used, a calendar spread can be neutral, slightly bearish, or slightly bullish.

Maximum Profit on Calendar Spread

A calendar spread strategy hits max profit when the stock price settles at the near-term strike price by that option’s expiration. That is not the end of the trade, however. The trader benefits when the stock price rises after the near-dated option’s expiration since they are long the later-date call option.

A rise in implied volatility after the front-month call expires also benefits the later-dated long options position. However, some traders might choose to close the later-dated option position when the near-dated option expires.

Maximum Loss on Calendar Spread

A calendar spread is considered a debit spread since the cost of the later-dated option is greater than the proceeds from the near-date option’s sale. So the trader can not lose more than the premium paid.

Breakeven

The precise breakeven calculation on a calendar spread option trade cannot be determined due to the two different option delivery dates. Traders must estimate what the value of the long-dated option contract will be on the near-dated option’s expiry.

One way to this is using online option strategy profit and loss calculator to estimate a breakeven price. Changing option Greeks – such as implied volatility levels and market interest rates – also make deriving a breakeven price difficult to pin down on this strategy.

Calendar Spread Example

An example helps to understand how calendar spread options work. Suppose XYZ stock is $100, and the trader believes the stock price will not change much in the next month. Based on that neutral thesis, the trader sells a $100 call option expiring in one month for $10 and buys a call at the same $100 strike price that expires in two months at a price of $15. The net debit is $5. The later-dated call option is more expensive because it has more time value than the near-dated call.

Over the next month, the stock fluctuates since the trade was executed, but settles back to $100 on the afternoon of the front-month’s option delivery date. Since time has passed and the stock has not drifted from $100, the near-dated call option has lost considerable time value. The short call expires worthless. The later-dated call is now worth $10.

The trade worked well. The trader exits the position by allowing the near-term call to expire worthless and selling to close the $10 later-dated long call. In essence, the trader made $10 on the short call and lost $5 on the long call for a profit of $5.

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Calendar Spread Payoff Diagram

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Source: https://www.warriortrading.com/calendar-spread-definition-day-trading-terminology/

Calendar Spread Risks

There are several risks that traders must keep in mind when using calendar spreads.

Limited Upside

This is the main risk in calendar spread strategies, if the trade closes at the near-dated option’s expiry. The options trader benefits from time decay and increases in implied volatility. Once the short option expires or is bought to close, there is unlimited upside potential with the remaining long call. If the trader uses puts they have a significant upside if the stock price goes to zero.

Delivery Dates

Trader must make a choice when the near-dated option is on the precipice of expiring. The trader can let it expire if it is out of the money, but if it is in the money, then it might be worthwhile to buy to close the option.

Timing the Trade

Being correct about the near-term direction of the stock, as well as changes in implied volatility and time decay, can be challenging.

Types of Calendar Spreads

There are several types of calendar spreads. Here’s a look at some of the most popular strategies.

Put Calendar Spread

A calendar put spread option is a strategy in which a trader sells a near-dated put and buys a longer-dated put. A trader would put this trade on when they are neutral to bullish on the price change of the underlying stock in the near-term. Once again, this type of calendar spread options strategy aims to benefit from time decay or higher implied volatility.

Calendar Call Spread

A calendar call spread involves shorting a near-term call and buying a longer-dated call at the same strike. (This is the strategy outlined in the earlier example.) The near-term outlook on the underlying stock is neutral to slightly bearish while the trader might have a longer-term bullish view.

Diagonal Calendar Spread

A diagonal calendar spread uses different strike prices for the two options positions. This strategy still uses two options – either two calls or two puts – with different expiration dates. This strategy can be either bullish or bearish depending on how the trade is constructed. The term diagonal spread simply refers to the use of both a calendar spread (horizontal) and a vertical spread.

Short Calendar Spread

Traders can use a short calendar spread with either calls or puts. It is considered a “short” calendar spread options strategy because the trader buys the near-dated option while selling the longer-dated option. This is the opposite of a long calendar spread. A short calendar spread profits from a large move in the underlying stock.

Trading Stocks with SoFi

Calendar spreads are useful for traders who want to profit from changes in stock variables other than price direction. They’re an advanced strategy, however, that may not make sense for beginner investors.

However, you do not need to use any options at all to build a portfolio that helps you meet your goals. SoFi does not currently offer options, but it does provide an easy way to start building a portfolio. By opening an online brokerage account on the SoFi Invest® investment app, you can start trading in individual equities, fractional shares, and exchange-traded funds (ETFs) directly from your phone.

Photo credit: iStock/Tatomm


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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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Black Swan Events and Investing, Explained

Black Swan Events and Investing, Explained

The term “black swan event” is widely used in finance today to describe an unanticipated event that severely impacts the financial markets.

The name stems from the discovery of avian black swans by Dutch explorer De Vlamingh while exploring Australia in the late 1600s. Historians credit de Vlamingh with separating the “expected” (i.e., a white swan, which were plentiful at the time and also today) with the “unexpected” (i.e., a black swan, which was as rare a sighting in the 1600s as it is now).

Wall Street trader Nassim Nicholas Taleb popularized the financial theory of “black swan” events in his 2007 book The Black Swan: The Impact of the Highly Improbable.

“A black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences,” Taleb writes in his book. “Black swan events are characterized by their extreme rarity, their severe impact, and the widespread insistence they were obvious in hindsight.”

Taleb describes the occasional — but highly problematic — arrival of black swans on the investment landscape, and outlines what economists and investors could do to better understand those events and protect assets when they occur.

What Is a Black Swan Event?

According to Taleb, a black swan event is identifiable due to its extreme rarity and to its catastrophic potential damage to life and health, and to economies and markets. Taleb also notes that once a black swan landed and devastated everything in its path, it was obvious in hindsight to recognize the event occurred and should have been expected.

It can be a difficult concept for investors. Who, after all, would leave their finances unprotected from a black swan onslaught if they knew the event was imminent? By definition, predicting the arrival of a black swan is largely outside the realm of probability. All anyone needs to know, Taleb maintains, is that black swans occur and investors should not be surprised when they do happen.

Taleb outlines three indicators that signal the arrival of a black swan event. Each is meaningful in truly understanding a black swan scenario.

1.    Black swan events are outliers. No similar and prior event could predict the arrival of a particular black swan.

2.    Black swan events are severe, and they inflict widespread damage. That damage also has a severe impact on economies, cultures, institutions, and on families and communities.

3.    They’re usually seen in the rear view mirror. When black swans occur and eventually dissipate, recriminations take its place. While the specific black swan event wasn’t predicted, observers say the event could have and should have been prevented.

Black Swan Event Examples

It’s become common for politicians and investors to call any negative event a “black swan” event, whether or not it meets Tasam’s definition. However, history has no shortage of true black swan events, which led to large, unpredictable market corrections.

The following events are considered some of the most infamous among economists and historians.

The Soviet Union’s Historic Collapse

Economists consider the collapse of the Soviet Union in 1991 a major black swan. Only 10 years earlier, the Russian empire was considered a major global economic and military threat. A decade later, the Soviet Union was no more, significantly shifting the global geopolitical and economic stage.

The 9/11 Terrorist Attacks

In hindsight, the United States might have seen the attacks on the World Trade Center in New York and the Pentagon in Washington, D.C. coming. International terrorism had long been a big risk management issue for the U.S. government, but the severity of the attack left the world stunned – and plunged the U.S. into a serious economic decline. Stock lost $1.4 trillion in value the week after the attacks.

The Dot-com Bubble

In the late 1990s, investors were indulging in irrational exuberance and nowhere was that more clear than with the nation’s stock market — particularly with white-hot technology stocks. With an army of Internet stocks in the IPO pipeline, overvalued tech stocks plummeted, taking the entire stock market down in the process. The damage was staggering, with the Nasdaq Index losing 78% of its value between March 2000 and October 2002.

The 2008-2009 Financial Crisis

After a series of high-risk derivative bets by major banks, mounting losses in the U.S. mortgage market, and the collapse of Lehman Brothers, the U.S. economy teetered on the edge of disaster — a scenario it would take almost a decade to correct. Economists say that $10 billion in asset value disintegrated during the crisis, which created a bear market.

Why Do Black Swan Events Happen?

Since black swan events are virtually impossible to predict, there is no concrete answer as to why they happen. The world is complicated, with many different factors — political, financial, environmental, and social, among others — impacting one another and setting off chains of events that could potentially become black swan events in scope and magnitude.

Can You Predict a Black Swan Event?

By its very definition, it’s nearly impossible to predict a specific black swan event. This makes it hard to prepare for black swans as you would for other investment risks.

Instead, investors may want to focus on making sure they’re prepared, generally, for the unknown. Here’s how to do that:

•   Be pragmatic. Investors are better off knowing unanticipated bogeymen do exist and can arrive on their doorstep at any time. Keep in mind the possibility of black swans and consider building an expectation of stock volatility into your overall portfolio-management strategy.

•   Don’t get bogged down by long-term forecasts. Don’t rely solely on expert predictions or far-off investment outlooks, since unexpected events, including black swans can happen at any time and it’s normal for markets to fluctuate. Instead, consider building a more conservative element into your investment portfolio, one that relies more on protecting your assets, so you’re not tempted to make rash moves during a black swan event. Have a candid conversation with your financial advisor about how proper diversification can help build a portfolio that balances the need for performance with the need for protection.

•   Don’t panic when a black swan event happens. As tempting as it might be to try to get out of a market during a black swan event and get back in when it fades away, resist the urge to engage in market timing.

•   Look for opportunities. Putting money into the markets during a black swan event can be difficult, but investing in a down market can yield positive returns over the long-term. Rather than trying to time the market, consider using a dollar-cost averaging strategy, in which you make regular purchases — even during a black swan event.

The Takeaway

For long-term investors, the prudent stance on black swan events is to acknowledge their existence, build some protection into your investment portfolio to mitigate potential damage, and be ready to take full advantage of the inevitable market upturn once the black swan flies away. Continuing to invest during a recession can pay off in the long run.

Ready to get started building your portfolio? Open a brokerage account with SoFi Invest. An active investing account allows you to take a hands-on approach to investing, choosing among individual stocks, ETFs, and fractional shares to build a personalized portfolio.

Find out how to start trading with SoFi Invest.

Photo credit: iStock/by Martin Nancekievill


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.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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


Stock Bits
Stock Bits is a brand name of the fractional trading program offered by SoFi Securities LLC. When making a fractional trade, you are granting SoFi Securities discretion to determine the time and price of the trade. Fractional trades will be executed in our next trading window, which may be several hours or days after placing an order. The execution price may be higher or lower than it was at the time the order was placed.

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What Is Extrinsic Value?

What Is Extrinsic Value?

What is Extrinsic Value?

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

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

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

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

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

How Extrinsic Value Works

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

Factors that Affect Extrinsic Value

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

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

1. Length of Contract

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

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

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

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

Recommended: Guide to Options Spreads: Definitions and Types

2. Implied Volatility

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

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

3. Others Factors

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

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

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

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

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

Extrinsic Value Example

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

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

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

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

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

Extrinsic vs Intrinsic Value

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

Extrinsic Value Factors (Call Option)

Intrinsic Value Factor (Call Option)

Length of Contract Stock Price Minus Strike Price
Implied Volatility

Extrinsic Value and Options: Calls vs Puts

Both call options and put options can have extrinsic value.

Calls

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

Puts

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

Start Investing Today with SoFi

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

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

Photo credit: iStock/alvarez


SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

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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What is a Glide Path?

Guide to Glide Paths for 401k

Asset managers use a “glidepath” to determine who the asset allocation of a target-date retirement fund will change based on the number of years until the fund’s target date. Each target-date fund has its own glide path, though they typically begin with a more aggressive allocation that gets more conservative over time.

The idea behind most target date fund glide paths is that investors with a longer-term time horizon should have a higher percentage of their portfolio in riskier assets, like stocks, since they have time to recover from short-term volatility. As their retirement date approaches (or once they’ve started retirement), they likely will benefit from a more conservative portfolio that protects the assets they’ve already accumulated.

What Is a Glide Path?

The glide path is the formula that asset managers choose when they put together a target-date mutual fund that determines how and when that portfolio will adjust its asset allocation over time.

Target-date funds (and their glide paths) are common investment choices in 401(k) accounts, as well as in other types or retirement accounts, such as a Roth or traditional IRA purchased through a brokerage account.

Recommended: What’s the Difference Between a 401(k) and an IRA?

A key component to saving for retirement is having a suitable mix of investments that allow for portfolio diversification. Early on, most glide paths focus on stocks that offer the greatest potential to grow in value over time and shifts to bonds and other fixed-income investments according to the investors risk tolerance to manage volatile price swings as retirees or those who are approaching retirement grow older.

Understanding Glide Path

The glide paths within target-date funds create a set-it-and-forget-it investing option for retirement savers, who can get diversification based on their time horizon within a single fund. Investors who are younger and have 20 to 30 years until retirement typically need to maximize their portfolio growth, which requires a much higher allocation toward stocks.

By comparison, someone who has already retired may need to scale back on their portfolio risk. Glide path investing automatically reallocates the latter investor’s portfolio toward bonds which are typically lower risk investments with lower returns compared to stocks but provide portfolio stability. That also means that younger investors in a target-date fund will typically have higher 401(k) returns than older investors.

Types of Glide Paths for Retirement Investing

There are different glide path strategies depending on an investor’s risk tolerance and when they plan to retire. Typically, target-date funds have a declining glide path, although the rate at which it declines (and the investments within its allocation vary depending on the fund).

Declining Glide Path

A declining glide path reduces the amount of risk that a target-date fund takes over time. In general, it makes sense for retirees or those approaching retirement to reduce their investment risk with a more conservative portfolio as they age. A decreasing glide path is the more common approach used which involves a higher equity risk allocation which steadily declines as retirement approaches.

Static Glide Path

Some target-date funds may have a static glide path during some years. During this time, the investment mix would remain at a set allocation, such as 60% stocks and 40% bonds. Managers maintaining portfolios that have a static glide path rebalance them regularly to maintain this allocation.

Rising Glide Path

Some researchers believe that the glide path should begin to rise again once an investor reaches retirement age, taking on more risk over time.This argument holds that by increasing risk in a retiree’s portfolio could reduce volatility in the early stages of retirement when the portfolio is at risk of losing the most wealth in the event of a stock market decline.

An increasing glide path may work for retirees with pension benefits or higher withdrawal rates or who is working in retirement. If a retiree is comfortable taking on more risk, this strategy may make sense, however, generally speaking, the rising glide path is the least utilized method for retirement planning.

Choosing the Right Glide Path

If you’re saving for retirement in a 401(k), there may only be one target-date option available to you based on your target-retirement age. However, if you have choices within your 401(k) or you’re choosing a target-date fund within an individual retirement account or another investment vehicle, you’ll want to look for a target-date fund with a strategy that aligns with your investment view.

One rule of thumb uses “rule of 100,” which subtracts the investor’s age from 100 to determine the percentage of your portfolio that should be in stocks. However, some managers use glide paths that decline more or less quickly than that.

Some target-date funds also incorporate alternative assets, such as private equity or real estate, in addition to traditional stocks and bonds.

”To” or “Through” Retirement

When glide paths reach retirement date, they can take one of two approaches, either a “To” or “Through” approach. A “To” retirement glide path is a target-date fund strategy that reaches its most conservative asset allocation when retirement starts. This strategy holds lower exposure to risk assets during the working phase and at the target retirement date. This means, at retirement, it reduces exposure to riskier assets, like equalities, and moves into more conservative assets, like bonds.

“Through” glide paths tend to maintain a higher allocation toward riskier assets as investors accumulate savings, at their target retirement date and years into retirement. This means exposure to equities in retirement tends to be higher, at least in the first few years of retirement.

In making which path is best suited for each investor, you must determine your risk preference and how aggressive or conservative you are able to be. This includes deciding how much exposure to equities you can afford to have. Decreasing exposure to stocks means investors don’t have to worry about a portfolio that fluctuates in value, whereas, an increased exposure to equities may mean a portfolio with more volatility but over time, it has potential for greater gains.

The Takeaway

Glide paths are formulas that investment managers create to determine the level of risk in a target-date fund. This allows investors in those funds to take a hands-off approach with a portfolio that automatically adjusts itself based on risk tolerance that changes as investors age.

SoFi does not currently offer target-date funds, but it does provide an opportunity to open an IRA account through the SoFi Invest® online brokerage. SoFi Automated investing offers automated, algorithm-driven financial planning that creates and rebalances a portfolio on your behalf.

FAQ

What does glide path approach mean?

A glide path refers to a formula that asset managers use to determine the allocation mix of assets in a target-date retirement portfolio and how it changes over time. A target-date retirement portfolio tends to become more conservative as the investor ages, but there are multiple glide paths to take account to a retiree’s risk tolerance.

What is a retirement glide path?

A retirement glide path is the approach within a target-date fund that includes a diversified portfolio of stocks and bonds. Retirement glide paths typically start out with a more aggressive mix of investments and get more conservative over time.

Which type of mutual fund follows a glide path?

Target-date retirement funds are the most common type of mutual fund that follows a glide path. However managers may also use glide paths for other time-focused, long-term investments, such as 529 retirement accounts.


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How to Find Portfolio Beta

Beta is a popular metric that investors use to measure a portfolio’s risk, or its sensitivity to price swings in the broader market. While past performance does not indicate future returns, knowing a portfolio’s Beta can help investors understand the price variability of their stocks, or how much their holdings may move if there’s stock volatility or big gains in a benchmark index like the S&P 500.

Investors often consider Beta a measure of systematic risk, or risk that stems from the entire market and that investors can not diversify away. Macro events such as interest-rate or economic changes often fall into the category of systematic risk, while idiosyncratic, stock-specific risk includes events like a change in company management, new competitors, changed regulation, or product recalls.

Calculating a portfolio’s Beta coefficient involves determining the weighted Betas of all the individual stocks in a portfolio and adding up the values.

How to Calculate Beta of a Portfolio

The Beta of a portfolio formula requires relatively simple math, as long as investors know the Beta for each stock that they hold and the portion of your portfolio that each stock comprises.

Here are the steps you’d follow to calculate the Beta of a hypothetical portfolio:

1.    Calculate the total value of each stock in the portfolio by multiplying the number of shares that you own of the stock by the price of its shares:

Stock ABB: 500 shares X $20 a share each = $10,000.

2.    Figure out what proportion each stock in their portfolio represents by dividing the stock’s total value by the portfolio’s total value:

Stock ABB’s total value of $10,000/Portfolio’s total value of $80,000 = 0.125.

3.    Multiply each stock’s fractional share by its Beta. This will calculate the stock’s weighted beta:

Stock ABB’s beta of 1.2 X its fractional portfolio of 0.125 = 0.15.

4.    Add up the individual weighted betas.

Here is the whole hypothetical portfolio with a total beta of 1.22, benchmarked to the S&P 500. That means when the index moves 1%, this portfolio as a whole is 22% more risky than the index.

Stock

Value

Portfolio Share

Stock Beta Weighted Beta
ABB $10,000 0.125 1.20 0.15
CDD $30,000 0.375 0.85 0.319
EFF $15,000 0.1875 1.65 0.309
GHH $25,000 0.3125 1.42 0.44375
Sum 1.22

4 Ways to Characterize Beta

Investors always measure a portfolio’s Beta against a benchmark index, which they give a value of 1. Stocks that have a Beta higher than one are more volatile than the overall market, and those with a Beta of less than one are less volatile than the overall market.

Understanding Beta is part of fundamental stock analysis. Once you know the Beta of your portfolio, you can make changes in order to increase or decrease its risk based on your overall investment strategy by changing your asset allocation.

There are four ways to characterize Beta:

High Beta

A high beta stock — one that tends to rise and fall along with the market often — has a value of greater than 1. So if a stock has a beta of 1.2 and is benchmarked to the S&P 500, it is 20% more volatile than the broader measure.

If the S&P 500 rises or falls 10%, then the stock would conversely rise or fall 12%. The same would be true for portfolio beta. While there’s more downside risk with high-beta stocks, they can also generate bigger returns when the market rallies – a principle of Modern Portfolio Theory.

Low Beta

A low beta stock with a Beta of 0.5 would be half as volatile as the market. So if the S&P 500 moved 1%, the stock would post a 0.5% swing. Such a stock may have less volatility, but it also may have less potential to post large gains as well.

Still, investors often prefer lower volatility securities. Low Beta investment strategies have shown strong risk-adjusted returns over time, too.

Negative Beta

Stocks or portfolios with a negative beta value inversely correlate with the rest of the market. So when the S&P 500 rises, shares of these companies would go down or vice versa.

Gold, for instance, often moves in the opposite direction as stocks, since investors tend to turn to the metal as a haven during stock volatility. Therefore, a portfolio of gold-mining companies could have a negative beta.

So-called defensive stocks like utility companies also sometimes have negative Beta, as investors buy their shares when seeking assets less tied to the health of the economy. A downside to negative Beta is that expected returns on negative beta securities tend to be weak – even less than the risk-free interest rate.

Zero Beta

A stock or portfolio can also have a beta of zero, which means it’s uncorrelated with the market. Some hedge funds seek a market-neutral strategy. Being market-neutral means attempting to perform completely indifferent to how an index like the S&P 500 behaves.

How to Calculate an Individual Stock’s Beta

For investors, calculating the Beta of all their stock holdings can be time consuming, and typically, financial data or brokerage firms offer Beta values for stocks.

But if you wanted to calculate Beta for an individual stock, you’d divide a measure of a stock’s returns relative to the broader market over a given time frame by a measure of the market’s return by its mean, also over a specific time frame. Here is the formula:

Beta = covariance/variance

Covariance is a measure of a security’s returns relative to the market’s returns.

Variance is a measure of the market’s return relative to its mean or average.

💡 Recommended: What Is Covariance and How Do You Calculate It?

Alpha vs Beta vs Smart Beta

Beta is one of the Option Greeks, terminology frequently used by traders to refer to characteristics of specific securities or derivatives in the market. Another commonly used Greek term is Alpha. While Beta refers to an asset’s volatility relative to the broader market, Alpha is a measure of outperformance relative to the rest of the market.

Beta also comes up a lot in the exchange-traded fund or ETF industry. Smart Beta ETFs, are funds that incorporate rules- or factor-based strategies.

What Impacts Beta?

A variety of factors impact an asset’s Beta. In general, stocks seen as riskier than average typically feature higher betas. Stock-specific factors such as debt levels, aggressive management, bold projects, volatile cash flows, and even ESG factors can influence a stock’s idiosyncratic risk. Higher business risk, while stock-specific, can lead to a more volatile stock price than the overall market, hence a higher beta.

Higher Betas often appear in particular sectors. There are even investment fund strategies that play on Beta – you can buy funds that exclusively own high Beta or low Beta stocks. A stock’s sector, industry, geographic location, and market cap size all impact a stock’s volatility and beta.

Cyclical and growth sectors like energy, industrials, information technology, and consumer discretionary often feature high Betas. Utilities, consumer staples, real estate, and much of the healthcare sector typically have low Beta.

Small caps and stocks domiciled in emerging-market economies also often have a higher Beta (compared to the U.S. large-cap S&P 500).

Important Things to Know About Beta

1.    A stock’s beta may change over time. Because beta relies on historical price data, it is subject to change.

2.    Beta is not a complete measure of risk. It can be a useful way for investors to estimate short-term risk but it’s less helpful when it comes to considering a long-term investment because the macroeconomic environment and company’s fundamentals may change. In some cases, Beta is not the best measure of a stock or a portfolio’s risk.

3.    Beta is an input when investors are using the Capital Asset Pricing Model (CAPM) — a way to measure the expected return of assets taking into account systematic risk. It’s a method that also looks at the cost of capital for investors.

4.    The estimated Beta of a stock will be less helpful for companies that do not trade as frequently. Thin liquidity for a stock may bias its Beta value since there is less robust historical price data.

5.    Beta does not offer a complete picture of a stock’s risk profile as it’s linked to systematic risk. Investors must also consider stock-specific risk when managing their portfolios.

The Takeaway

Knowing stock holdings’ betas can be important information when you’re building your portfolios.You can calculate their portfolio Beta using simple math as long as you’re able to obtain the individual betas for your stock holdings. While beta is a helpful tool to try to gauge potential volatility in a portfolio, its reliance on historical data makes it limited in measuring the complete risk profile of an asset or portfolio.

If you’re ready to start building a portfolio, a great way to get started is by opening an online brokerage account on the SoFi Invest® investment app. You can use the platform to purchase stocks, exchange-traded funds, and IPOs directly from your phone.

Open a SoFi Invest account and start diversifying today.


SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.

Active Investing—The Active Investing platform is owned by SoFi Securities LLC. Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above, please visit https://www.sofi.com/legal/.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

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.
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