• Understanding the difference between “in the money” and “out of the money” options is crucial for options traders to gauge potential profitability.
• Options classified as “in the money” have intrinsic value and can yield profits when exercised, while “out of the money” options lack intrinsic value and may expire worthless.
• The potential for profit from options depends on the relationship between the strike price and the current market price of the underlying asset.
• Higher volatility often leads to options being written “out of the money,” appealing to speculators due to lower premiums and potential for larger price swings.
• Decisions to buy “in the money” or “out of the money” options should align with an investor’s goals, risk tolerance, and confidence in the underlying asset’s future performance.
In options trading, knowing the difference between being “in the money” (ITM) and “out of the money” (OTM) allows the holder of a contract to know whether they’ll enjoy a profit from their option. The terms refer to the relationship between the options strike price and the market value of the underlying asset.
“In the money” refers to options that have profit potential if exercised today, while “out of the money” refers to those that do not. In the rare case that the market price of an underlying security reaches the strike price of an option exactly at the time of expiry, this would be called an “at the money option.”
What Does “In the Money” Mean?
In the money (ITM) describes a contract that would be profitable if its owner were to choose to exercise the option today. If this is the case, the option is said to have intrinsic value.
A call option would be in the money if the strike price is lower than the current market price of the underlying security. An investor holding such a contract could exercise the option to buy the security at a discount and sell it for a profit right away.
Put options, which are a way to short a stock, would be in the money if the strike price is higher than the current market price of the underlying security. A contract of this nature allows the holder to sell the security at a higher price than it currently trades for and pocket the difference.
In either case, an in the money contract has intrinsic value, so the options trader can exercise the option and make money doing so.
💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
Example of In the Money
For example, say an investor owns a call option with a strike price of $15 on a stock currently trading at $16 per share. This option would be in the money because its owner could exercise the option to realize a profit. The contract gives the holder the right to buy 100 shares of the stock at $15, even though the market price is currently $16.
The contract holder could take shares acquired through the contract for a total of $1,500 and sell them for $1,600, realizing a profit of $100 minus the premium paid for the contract and any associated trading fees or commissions.
While call options give the holder the right to buy a security, put options give holders the right to sell. For example, say an investor owns a put option with a strike price of $10 on a stock that is trading at $9 per share. This would be an in the money option. The holder could sell 100 shares of stock at a price of $10 for a total of $1,000, even though it only costs $900 to buy those same shares. The contract holder would realize that difference of $100 as profit, minus the premium and any fees.
What Does “Out of the Money” Mean?
Out of the money (OTM) is the opposite of being in the money. OTM contracts do not have intrinsic value. If an option is out of the money at the time of expiration, the contract will expire worthless. Options are out of the money when the relation of their strike prices to the current market price of their securities are opposite that of in the money options.
For calls, an option with a strike price higher than the current price of the underlying security would be out of the money. Exercising such an option would result in an investor buying a security for a price higher than its current market value.
For puts, an option with a strike price lower than the current price of its security would be out of the money. Exercising such an option would cause an investor to sell a security at a price lower than its current market value.
In either case, contracts are out of the money because they don’t have intrinsic value – anyone exercising those contracts would lose money.
Example of Out of the Money
Say an investor buys a call option with a strike price of $15 on a stock currently trading at $13. This option would be out of the money. An investor might buy an option like this in the hopes that the stock will rise above the strike price before expiration, in which case a profit could be realized.
Another example would be an investor buying a put option with a strike price of $7 on a stock currently trading at $10. This would also be an out of the money option. An investor might buy this kind of option with the belief that the stock will fall below the strike price before expiration.
💡 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.
What’s the Difference Between In the Money and Out of the Money?
The premium of an options contract involves two different factors: intrinsic value and extrinsic value. Options that have intrinsic value at the time they are written to have a strike price that is profitable relative to the current market price. In other words, such options are already in the money when written.
But not all options are written ITM. Those without intrinsic value rely instead on their extrinsic value. This value comes from speculative bets that investors make over a period of time. For this reason, assets with higher volatility often have their options contracts written out of the money, as investors expect there to be bigger price swings. Conversely, assets considered to be less volatile often have their options written in the money.
Options written out of the money are ideal for speculators because such contracts come with less expensive premiums and are often created for more volatile assets.
The answer to this question depends on an investor’s goals and risk tolerance. Options that are further out of the money can be more rewarding, but come with greater risk, uncertainty, and volatility. Whether an option is in or out of the money (and how far they’re out of the money), and the amount of time before the expiry of the option impacts the premium for that option, with riskier options typically costing more.
Whether to buy ITM or OTM options also depends on how confident an investor feels about the future of the underlying security. If a trader feels fairly certain that a particular stock will trade at a much higher price three months from now, then they might not hesitate to buy a call option with a very high strike price, making it out of the money.
Conversely, if an investor thinks a stock will fall in price, they can buy a put option with a very low strike price, which would also make the option out of the money.
Beginners and those with lower risk tolerance may prefer buying options that are only somewhat out of the money or those that are in the money. These options usually have lower premiums, meaning they cost less to buy. There are also generally greater odds that the contract will wind up in the money before expiration, as it will take a less dramatic move to make that happen.
Investors can also choose to combine multiple options legs into a spread strategy that attempts to take advantage of both possibilities.
In options trading, “in the money” refers to options that have profit potential if exercised immediately, while “out of the money” refers to those that don’t. Options contracts don’t have to be exercised to realize a profit. Sometimes investors buy contracts with the intent of selling them on the open market soon after they become in the money for quick gains.
In either case, it’s important to consider if an option is in the money or out of the money when buying or writing options contracts, as well as when deciding when to execute them. Options trading is an advanced investing strategy, and investors should know what they’re doing before engaging with it – or should speak with a financial professional for guidance.
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INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
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.
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.
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. Claw Promotion: Customer must fund their Active Invest account with at least $50 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
A security can refer to a number of different types of assets, including stocks, bonds, Treasury notes, derivatives, and more. Securities are fungible and can be traded via public as well as private markets.
The three main types of securities, broadly speaking, include: equity securities, where the investor owns a share in an organization; debt securities, where the investor loans capital and earns interest, and derivatives, which are contracts based on the value of an underlying asset.
Securities trading is regulated by the Securities and Exchange Commission, or SEC.
Key Points
• Securities is a broad term that refers to tradable financial instruments, including stocks, bonds, and derivatives.
• Equity securities represent ownership in a company, while debt securities (bonds) function as loans, where borrowers pay interest to lenders.
• Derivatives, such as futures and options, are higher-risk investments linked to underlying assets. These appeal mainly to experienced investors due to their complexity.
• Trading securities typically occurs on regulated exchanges, with investors using brokerage or retirement accounts to engage in buying and selling activities.
What is a Security?
A security is a tradable type of investment that traders can buy and sell on financial exchanges or other platforms, whether investing online or through a traditional brokerage. Securities have monetary value; buyers and sellers determine their value when trading them.
Securities include different types of asset classes. In general, investors earn money by buying securities at a low price and selling them at a higher one, but there are a range of investing strategies that can include profiting when the price of a security drops, as well as other means.
Here are some common security categories.
Equity Securities
These include stocks and stock mutual funds. Typically traded on exchanges, the price of equity securities rise or fall depending on the economy, the performance of the underlying company that offers the stock (or the companies in the fund), and the sector in which that company or fund operates.
This group includes bonds and other fixed-income vehicles, where lenders borrow money from investors and pay interest via periodic payments on the investment principal (also called the yield).
Investors can buy bonds from a variety of bond issuers, including: states, local and municipal governments, companies, and banks and other financial institutions. Typically, debt securities pay investors a specific interest rate paid usually twice per year until a maturity date, when the bond expires.
Some common debt securities include:
• Treasury bills. Issued by the U.S. government, T-Bills are considered among the safest securities.
• Corporate bonds. These are bonds issued by companies to raise money without going to the equity markets.
• Bond funds. These types of mutual funds allow investors to get exposure to the bond market without buying individual bonds.
Derivatives
This group of securities includes higher-risk investments like options trading and futures which offer investors a higher rate of return but at a higher level of risk.
Derivatives are based on underlying assets, and it’s the performance of those assets that drive derivative security investment returns.
For example, an investor can buy a call option based on 100 shares of ABC stock, at a specific price and at a specific time before the option contract expires. If ABC stock declines during that contract period, the call option buyer has the right to buy the stock at a reduced rate, thus locking in gains when the stock price rises again.
Derivatives allow investors to place higher-risk bets on stocks, bonds, and commodities like oil or gold, and currencies. Typically, institutional investors, such as pension funds or hedge funds, are more active in the derivative market than individual investors.
Hybrid Securities
A hybrid security combines two or more distinct investment securities into one security. For example, a convertible bond is a debt security, due to its fixed income component, but also has characteristics of a stock, since it’s convertible.
Hybrid securities sometimes act like debt securities, as when they provide investors with a floating or fixed rate of return, as bonds normally do. Hybrid securities, however, may also pay dividends like stocks and offer unique tax advantages of both stocks and bonds.
How Security Trading Works
Securities often trade on public exchanges where investors can buy or sell securities with the goal of making a financial profit.
Stocks, for example, are listed on global stock exchanges and investors can purchase them during market trading hours. Exchanges are highly regulated and expected to comply with strict fair-trading mandates. For example, U.S.-based stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq must adhere to the rules and regulations laid out by Congress and enforced by the U.S. Securities and Exchange Commission (SEC).
Each country has their own rules and regulations for fair and compliant securities trading, including oversight of stocks, bonds, derivatives, and other investment vehicles. Debt instruments, like bonds, usually trade on secondary markets while stocks and derivatives are traded on stock exchanges.
There are many ways for investors to engage in security trading. A few of the most common ones include:
Brokerage Accounts
Once an investor opens a brokerage account with a credentialed investment firm, they can start trading securities.
All a stock or bond investor has to do is fill out the required forms and deposit money to fund their investments. Investors looking to invest in higher-risk derivatives like options, futures, or currencies may have to fill out additional documentation proving their credentials as educated, experienced investors. They may also have to make larger cash deposits, as trading in derivatives is more complex and has more potential for risk.
Some qualified investors with a certain type of brokerage account can engage in margin trading, meaning that they trade securities using money borrowed from the broker. This is a high-risk strategy suitable only for experienced investors; most brokerages have strict rules about who can trade on margin.
Retirement Accounts
By opening a retirement account, through work or a bank or brokerage account, investors can invest in a range of securities, including stocks, mutual and index funds, bonds and bond funds, and annuities.
The type of securities you have access to will depend on the type of retirement account that you have. Workplace plans such as 401(k)s typically have fewer investment choices (but higher limits for tax-advantaged contributions) than IRAs, or Individual Retirement Accounts.
Risks and Considerations
There is always the risk of loss when investing in securities. That said, some securities are riskier than others.
Risk vs. Reward
• Equities, or stocks, tend to be higher risk investments. Stock markets are known to be volatile and unpredictable. That said, stocks offer the potential for returns; the average historic return of the stock market is about 9% or 10% (or 6% to 7% after inflation).
• Bonds, by contrast, are lower risk, and provide lower but steady returns versus stocks.
• Derivatives, like options and futures trading, can be very high risk and these strategies are meant for experienced investors.
When choosing securities for an investment portfolio, it’s important to take into account the risk/reward profile of your investments, as well as whether your asset allocation reflects your risk tolerance. For example, if your portfolio is heavily weighted to stocks, that is likely to increase your risk exposure.
Types of Investments
Because many investors are less experienced at managing a portfolio for the long term, there are certain types of investments that can help investors to manage risk. This is especially true for those who are investing for retirement, and want to protect their savings while maximizing any potential growth. For example:
• Target-date funds are a type of mutual fund that are geared to be long-term investments, held until a target retirement date is reached. So a 2045 fund is designed to provide a balanced portfolio of securities for investors with a target retirement date in roughly 20 years.
The fund’s allocation of securities starts out more aggressive (tilted toward stocks), and automatically adjusts over time to become more conservative (tilted toward fixed income) to protect investors’ savings as they near retirement.
• Robo-advisors are automated portfolios that investors can select based on their personal goals, time horizon, and risk tolerance — the difference being that investors don’t select the securities in these portfolios. A robo portfolio is generally a pre-set mix of ETFs, and the allocation (or mix of securities) is determined by a sophisticated algorithm.
Because investors can’t change the securities themselves, this helps to prevent impulsive choices, and may mitigate risk over time.
Get Started With Securities Trading
To start trading securities, investors can set up a brokerage account or retirement account, and begin investing as they see fit.
Again, it’s best to start with the end in mind: Decide your investment goals, choose the amount you want to invest, do your due diligence in terms of researching various investment choices (bearing in mind risk levels and fees).
Once the account is funded, the investor can purchase a wide variety of securities in order to create an investment portfolio. Sometimes retirement account investment options can be more limited than a full-service brokerage account.
The Takeaway
There are many different types of securities that investors can purchase as part of their portfolio. Choosing which securities to invest in will depend on several factors, including your financial goals, current financial picture, and risk tolerance.
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FAQ
What are the four main types of securities?
The four types of securities are: equity securities (such as stocks), debt securities (bonds and Treasuries), derivatives (higher-risk investments like options), and hybrid securities (such as convertible bonds).
What is a securities investment?
A securities investment is an investment in a security such as stocks, bonds, or derivatives. A security is a tradable type of investment that investors can buy and sell.
What’s the difference between securities and shares?
Stocks, also known as equity shares, are a type of security. The term “securities” refers to a range of different investments, one of which is stocks, or shares in a company.
Are securities an asset?
Yes, securities are a type of financial asset because they hold monetary value.
What are Treasury securities?
Treasuries are debt securities — e.g., bills, bonds, and notes — issued by the U.S. government. Treasuries are considered low risk because the U.S. has never defaulted on its debts.
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SoFi Invest®
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.
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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. Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes. 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.
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.
Mutual funds are one option investors may consider when building a retirement portfolio. A mutual fund represents a pooled investment that can hold a variety of different securities, including stocks and bonds. There are different types of mutual funds investors may choose from, including index funds, target date funds, and income funds.
But how do mutual funds work? Are mutual funds good for retirement or are there drawbacks to investing in them? What should be considered when choosing retirement mutual funds?
Those are important questions to ask when determining the best ways to build wealth for the long term. Here’s what you need to know about mutual funds and retirement.
Key Points
• Mutual funds offer exposure to a wide range of asset classes, and thus may fit well in a retirement portfolio.
• Approximately 53.7% of U.S. households owned mutual funds in 2024, according to industry research.
• Target-date funds adjust their asset allocation as retirement approaches, offering a tailored solution.
• Income funds focus on generating steady income, and may be suitable for retirement needs.
• Potential drawbacks of mutual funds include high fees, portfolio overweighting, and tax inefficiency.
Understanding Mutual Funds
A mutual fund pools money from multiple investors, then uses those funds to invest in a number of different securities. Mutual funds can hold stocks, bonds, and other types of securities.
How a mutual fund is categorized depends largely on what the fund invests in and what type of investment strategy it follows. For example, index funds follow a passive investment strategy, as these funds mirror the performance of a stock market benchmark. So a fund that tracks the S&P 500 index would attempt to replicate the returns of the companies included in that index.
Target-date funds utilize a different strategy. These funds automatically adjust their asset allocation based on a target retirement date. So a 2050 target-date fund, for example, is designed to shift more of its asset allocation toward bonds or fixed-income and away from stocks as the year 2050 approaches.
How Mutual Funds Work
Mutual funds allow investors to purchase shares in the fund. Buying shares makes them part-owner of the fund and its underlying assets. As such, investors have the right to share in the profits of the fund. So if a mutual fund owns dividend-paying stocks, for example, any dividends received would be passed along to the fund’s investors.
• Understanding dividend payments. Depending on how the fund is structured or what the brokerage selling the fund offers, investors may be able to receive any dividends or interest as cash payments or they may be able to reinvest them. With a dividend reinvestment plan or DRIP, investors can use dividends to purchase additional shares of stock, often bypassing brokerage commission fees in the process.
• Understanding fund fees. Investors pay an expense ratio to invest in mutual funds. This reflects the annual cost of owning the fund, expressed as a percentage. Passively managed mutual funds tend to have lower expense ratios.
Actively managed funds, on the other hand, tend to be more expensive, but the idea is that higher fees may seem justified if the fund produces above-average returns.
It’s also important to know that mutual funds are priced and traded just once a day, after the market closes. This is different from exchange-traded funds, or ETFs, for example, which are similar to mutual funds in many ways, but trade on an exchange just like stocks, and typically require a lower initial investment than a mutual fund.
Investors interested in opening an investment account can learn more about how a particular mutual fund works, what it invests in, and the fees involved by reading the fund’s prospectus.
Types of Mutual Funds for Retirement
There are some mutual funds designed for people who are saving for retirement. These funds typically combine portfolio diversification, often with a greater emphasis on bonds and fixed income, and the potential for moderate gains.
For instance, retirement income funds (RIFs) are intended to be more conservative with moderate growth. RIFs may be mutual funds, ETFs, or annuities, among other products.
Target-rate funds, as mentioned, adjust their asset allocation based on an investor’s intended retirement date, and get more conservative as that date approaches. This automated strategy may help some retirement savers who are less experienced at managing their portfolios over time.
Mutual funds are arguably one of the most popular investment options for retirement planning. According to the Investment Company Institute, 53.7% of U.S. households totaling approximately 121.6 million individual investors owned mutual funds in 2024. Fifty-three percent of individuals who own mutual funds are ages 35 to 64 — in other words, those who may be planning for retirement — the research found.
There are also many investors living in retirement who own mutual funds. According to the Investment Company Institute, 58% of households aged 65 or older owned mutual funds in 2024.
So are mutual funds good for retirement? Here are some of the pros and cons to consider.
Pros of Using Mutual Funds for Retirement
Investing in mutual funds for retirement planning could be attractive for investors who want:
• Convenience
• Basic diversification
• Professional management
• Reinvestment of dividends
Investing in a mutual fund can offer exposure to a wide range of securities, which could help with diversifying a portfolio. And it may be easier and less costly to purchase a single fund that holds hundreds of stocks than to purchase individual shares in each of those companies.
The majority of mutual funds are actively managed (and sometimes called active funds). Actively managed mutual funds are professionally managed, so investors can rely on the fund manager’s expertise and knowledge. And if the fund includes dividend reinvestment, investors can increase their holdings automatically which can potentially add to the portfolio’s growth.
Cons of Using Mutual Funds for Retirement
While there are some advantages to using mutual funds for retirement planning, there are also some possible disadvantages, including:
• Potential for high fees
• Overweighting risk
• Under-performance
• Tax inefficiency
As mentioned, mutual funds carry expense ratios. While some index funds may charge as little as 0.05% in fees, there are some actively managed funds with expense ratios well above 1%. If those higher fees are not being offset by higher than expected returns (which is never a guarantee), the fund may not be worth it. Likewise, buying and selling mutual fund shares could get expensive if your brokerage charges steep trading fees.
While mutual funds generally make it easier to diversify, there’s the risk of overweighting one’s portfolio — owning the same holdings across different funds. For example, if you’re invested in five mutual funds that hold the same stock and the stock tanks, that could drag down your portfolio.
Something else to keep in mind is that an actively managed mutual fund is typically only as good as the fund manager behind it. Even the best fund managers don’t always get it right. So it’s possible that a fund’s returns may not live up to your expectations.
You may also have to contend with unexpected tax liability at the end of the year if the fund sells securities at a gain. Just like other investments, mutual funds are subject to capital gains tax. Whether you pay short- or long-term capital gains tax rates depends on how long you held a fund before selling it.
If you hold mutual funds in a tax-advantaged retirement account, then capital gains tax doesn’t enter the picture for qualified withdrawals
Pros of Mutual Funds
Cons of Mutual Funds
• Mutual funds offer convenience for investors
• It may be easier and more cost-effective to diversify using mutual funds vs. individual securities
• Investors benefit from the fund manager’s experience and knowledge
• Dividend reinvestment may make it easier to build wealth
• Some mutual funds may carry higher expense ratios than others
• Overweighting can occur if investors own multiple funds with the same underlying assets
• Fund performance may not always live up to the investor’s expectations
• Income distributions may result in unexpected tax liability for investors
Investing in Mutual Funds for Retirement Planning
The steps to invest in mutual funds for retirement are simple and straightforward.
1. Start with an online brokerage account, individual retirement account (IRA) such as a traditional IRA, or a 401(k). You can also buy a mutual fund directly from the company that created it, but a brokerage account or retirement account is usually the easier way to go.
2. Set your budget. Decide how much money you can afford to invest in mutual funds. Keep in mind that the minimum investment can vary for different funds. One fund may allow you to invest with as little as $100 while another might require $1,000 to $3,000 or even more to get started. In some cases, setting up automatic contributions may lower the required minimum.
3. Choose funds. If you already have a brokerage account or an IRA like a SEP IRA, this may simply mean logging in, navigating to the section designated for buying funds, selecting the fund or funds and entering in the amount you want to invest.
4. Submit your order. You may be asked to consent to electronic delivery of the fund’s prospectus when you place your order. If your brokerage charges a fee to purchase mutual funds, that amount will likely be added to the order total. Once you submit your order to purchase mutual funds, it may take a few business days to process.
Tips for Selecting Retirement-Ready Mutual Funds
If you’re considering investing in mutual funds for retirement, here are some strategies to keep in mind.
• Determine your risk tolerance and retirement goals. As discussed previously, the closer you are to retirement, the more conservative you may want to be. For example, you might want to consider target-date or bond funds.
• Analyze the fund’s performance. You can look for funds that have a history of consistent returns for the past three, five, and 10 years.
• Check out expense ratios. If a mutual fund’s fees are high, you may want to consider other funds instead.
• Evaluate the possible tax implications. Mutual funds are subject to capital gains tax, as mentioned. Index funds may be more tax efficient. You can read more about this below.
Determining If Mutual Funds Are Right for You
Whether it makes sense to invest in mutual funds for retirement can depend on your time horizon, risk tolerance, and overall investment goals. If you’re leaning toward mutual funds for retirement planning, here are a few things to consider.
Investment Strategy
When comparing mutual funds, it’s important to understand the overall strategy the fund follows. Whether a fund is actively or passively managed may influence the level of returns generated. The fund’s investment strategy may also determine what level of risk investors are exposed to.
For example, index funds are designed to mirror the market. Growth funds, on the other hand, typically have a goal of beating the market. Between the two, growth funds may produce higher returns — but they may also entail more risk for the investor and carry higher expense ratios.
Choosing funds that align with your preferred strategy, risk tolerance, and goals matters. Otherwise, you may be disappointed by your returns or be exposed to more risk than you’re comfortable with.
Cost
Cost is an important consideration when choosing mutual funds for one reason: Higher expense ratios can eat away more of your returns.
When comparing mutual fund expense ratios, it’s important to look at the amount you’ll pay to own the fund each year. But it’s also important to consider what kind of returns the fund has produced historically. A low-fee fund may look like a bargain, but if it generates low returns then the cost savings may not be worth much.
It’s possible, however, to find plenty of low-cost index funds that produce solid returns year over year. Likewise, you shouldn’t assume that a fund with a higher expense ratio is guaranteed to outperform a less expensive one.
Fund Holdings
It’s critical to look under the hood, so to speak, to understand what a particular mutual fund owns and how often those assets turn over. This can help you to avoid overweighting your portfolio toward any one stock or sector.
Reading through the prospectus or looking up a stock’s profile online can help you to understand:
• What individual securities a mutual fund owns
• Asset allocation for each security in the fund
• How often securities are bought and sold
If you’re interested in tech stocks, for example, you may want to avoid buying two funds that each have 10% of assets tied up in the same company. Or you may want to choose a fund that has a lower turnover rate to minimize your capital gains tax liability for the year.
Tax Efficiency of Mutual Funds in Retirement
As mentioned, when held in a taxable account mutual funds are subject to capital gains tax. Dividend income from mutual funds is also taxed. When mutual funds are held in a tax-advantaged retirement account, investors need to consider the tax treatment of those accounts rather than capital gains.
With actively managed mutual funds, fund managers typically need to constantly rebalance the fund by
selling securities to reallocate assets, among other things. Those sales may create capital gains for investors. While mutual fund managers usually use tax mitigation strategies to help diminish annual capital gains, this is a factor for investors to consider.
Index funds tend to have less turnover of assets than actively managed funds and thus may generally be more tax efficient.
Managing Risk with Mutual Funds in a Retirement Portfolio
Generally speaking, mutual funds offer diversification and less risk compared to some other investments. That’s why they are often part of a retirement portfolio. However, it’s important to remember risk is inherent in investing whether you’re investing in mutual funds or another asset class.
Investors can select mutual funds that align with their risk tolerance, financial goals, and the amount of time they have before retirement (the time horizon). A younger investor may choose funds that potentially offer higher growth but also have higher risk like stock funds. Those closer to retirement age may opt for more conservative options, such as bond funds, and they might want to consider target rate funds that automatically adjust their asset allocation to be in sync with an investor’s retirement date.
Performance of Mutual Funds Compared to Other Retirement Investments
When considering mutual funds, it’s important to look at a fund’s performance over time. Not all funds hit their benchmarks or deliver consistent returns over the long term.
In 2024, according to Morningstar, of the nearly 3,900 actively managed equity funds tracked, only 13.2% beat the S&P 500 SPX index. The average gain was 13.5% compared to the 25% return of the S&P 500.
Historically, index funds have generally performed better overall than actively managed funds.
Other Types of Funds for Retirement
Mutual funds, and target date funds in particular, are one of the ways to save for retirement. But there are other options you might consider. Here’s a brief rundown of other types of funds that can be used for retirement planning.
Real Estate Investment Trusts (REITs)
A real estate investment trust isn’t a mutual fund. But it is a pooled investment that allows multiple investors to own a share in real estate. REITs pay out 90% of their income to investors as dividends.
An investor might consider a REIT, which is considered a type of alternative investment, if they’d like to reap the potential benefits of real estate investing without actually owning property.
Exchange-Traded Funds (ETFs)
Exchange-traded funds are another retirement savings option. Investing in ETFs — for instance, through a Roth or traditional IRA — may offer more flexibility compared to mutual funds. They may carry lower expense ratios than traditional funds and be more tax-efficient if they follow a passive investment strategy.
Income Funds
An income fund is a specific type of mutual fund that focuses on generating income for investors. This income can take the form of interest or dividend payments. Income funds could be an attractive option for retirement planning if an individual is interested in creating multiple income streams or reinvesting dividends until they’re ready to retire.
Bond Funds
Bond funds focus exclusively on bond holdings. The type of bonds the fund holds can depend on its objective or strategy. For example, you may find bond funds or bond ETFs that only hold corporate bonds or municipal bonds, while others offer a mix of different bond types. Bond funds could potentially help round out the fixed-income portion of your retirement portfolio.
IPO ETFs
An initial public offering or IPO represents the first time a company makes its shares available for trade on a public exchange. Investors can invest in multiple IPOs through an ETF. IPO ETFs invest in companies that have recently gone public so they offer an opportunity to get in on the ground floor. However, IPO ETFs are relatively risky and are generally more suitable for experienced investors.
The Takeaway
Mutual funds can be part of a diversified retirement planning strategy. Regardless of whether you choose to invest in mutual funds, ETFs or something else, the key is to start saving for your pos-work years sooner rather than later. Time can be one of your most valuable resources when investing for retirement.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
Invest with as little as $5 with a SoFi Active Investing account.
FAQ
Are mutual funds safer than individual stocks for retirement?
Generally speaking, mutual funds tend to carry less risk than individual stocks for retirement. Mutual funds provide diversification by investing in a mix of stocks, bonds, and other assets, which may help reduce overall risk. Individual stocks, on the other hand, depend on the performance of one company, which makes them riskier.
What percentage of my retirement portfolio should be in mutual funds?
There is no one single approach to asset allocation. The percentage of your portfolio that’s in mutual funds depends on your individual goals, risk tolerance, and time horizon. Younger investors with retirement far in the future may want to consider a more aggressive strategy that’s heavier on stocks, with more possibility for growth, but also involves more risk. Conversely, an investor near retirement age will likely want to be more conservative, and they might choose less risky options such as fixed income and bond funds.
How often should I review my mutual fund holdings?
There is no fixed rule for how often to review mutual fund holdings. Some investors may prefer biannual or annual reviews, while others might feel more comfortable with quarterly reviews. Reviewing a portfolio can help you monitor mutual fund performance, track your returns, and manage risk, so choose the schedule you are most comfortable with.
Can mutual funds provide steady income in retirement?
Certain types of mutual funds, such as retirement income funds (RIFs), are designed to provide a steady source of income in retirement. Ideally, an investor may want to have a mix of stocks, bonds, and cash investments that provide streams of income and growth in retirement and help preserve their money.
What are the tax implications of mutual fund investments in retirement?
Mutual funds are subject to capital gains tax when held in a taxable account. Actively managed funds must report capital gains every time a share is sold or purchased and may result in more capital gains tax. Index funds tend to have less turnover of assets and are generally more tax efficient. However, you may wish to consult a tax professional about your specific situation.
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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.
Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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 https://sofi.app.link/investchat. 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. Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
In options trading, delta measures the sensitivity of an option’s price relative to changes in the price of its underlying asset. Delta is a risk metric that compares changes in a derivative’s underlying asset price to the change in the price of the derivative itself.
In short, delta measures the sensitivity of a derivative’s price to a change in the underlying asset. Using delta as part of an option’s assessment may help investors make better trades.
Key Points
• Delta measures how option prices change in response to the underlying asset’s price.
• Call options have a delta between 0 and 1; put options have a delta between 0 and -1.
• Delta-neutral strategies balance portfolios by offsetting price movements.
• Delta offers a probabilistic estimate of price movement, not a guaranteed outcome.
What Is Delta?
Delta is one of “the Greeks,” a set of trading tools denoted by Greek letters. Some in options trading refer to the Greeks as risk sensitivities, risk measures, or hedge parameters. The delta metric is a commonly used Greek for measuring risk; the other four are gamma, theta, vega, and rho.
Delta Example
For each $1 that an underlying stock moves, the derivative’s price changes by the delta amount. Investors typically express delta as a decimal value or percentage. For example, let’s say there is a long call option with a delta of 0.40. If the option’s underlying asset increased in price by $1.00, the option price would increase by $0.40.
Because delta changes alongside underlying asset changes, the option’s price sensitivity also shifts over time. Various factors impact delta, including asset volatility, asset price, and time until expiration.
For call options, delta increases toward 1.0 as the underlying asset price rises. For put options, delta moves toward -1.0 as the underlying asset’s price falls.
Analysts calculate delta using the following formula with theoretical pricing models:
Δ = ∂V / ∂S
Where:
• ∂ = the first derivative
• V = the option’s price (theoretical value)
• S = the underlying asset’s price
The formula Δ = ∂V / ∂S represents how small changes in the underlying price (S) affects the option’s value (V).
Some analysts may calculate delta with the more complex Black-Scholes model that incorporates additional factors. This model is a widely used theoretical pricing model that factors in volatility, time decay, and interest rates to estimate an investment’s delta. Traders generally don’t calculate the formula themselves, as trading software and exchanges do it automatically.
💡 Quick Tip: Did you know that opening a brokerage account typically doesn’t come with any setup costs? Often, the only requirement to open a brokerage account — aside from providing personal details — is making an initial deposit.
How to Interpret Delta
Delta is a ratio that compares changes in the price of derivatives and their underlying assets. The direction of price movements will determine whether the ratio is positive or negative.
Bullish options strategies have a positive delta, and bearish strategies have a negative delta. It’s important to remember that unlike stocks, buying or selling options does not necessarily indicate a bullish or bearish strategy.
Traders use delta to gain an understanding of whether an option will expire in the money or not. The more an option is in the money, the further the delta value will deviate from 0, towards either 1 or -1.
The more an option goes out of the money, the closer the delta value gets to 0. Higher delta means higher sensitivity. An option with a 0.9 delta, for example, will change more if the underlying asset price changes than an option with a 0.10 delta. If an option is at the money, the underlying asset price is the same as the strike price, so there is a 50% chance that the option will expire in the money or out of the money.
For call options, delta is positive, indicating that the option’s price will increase as the underlying asset increases. Delta’s value for calls range from 0 to 1. When a call option is at the money (i.e. the asset price equals the strike price), the delta is near 0.50, meaning it has an equal probability of being out-of-money or in-the-money. As the underlying asset’s price increases, delta moves closer to 1. This signals that the option has demonstrated a high price sensitivity.
• For long call positions, delta increases toward 1 as the underlying asset’s price rises, signaling greater price sensitivity.
• For short call positions, delta is negative, meaning the position loses value as the asset price increases
Puts: Long and Short
For put options, delta is negative, indicating that the option’s price will increase when the underlying asset’s price decreases. Delta’s value for puts ranges from 0 to -1. As with call options, when a put option is at the money, the delta is near -0.50, representing an equal probability that the put could expire in or out of the money. If an underlying asset’s price decreases, the delta would move closer to -1, which would indicate an option has high price sensitivity to price changes in its underlying asset.
• For long put positions, delta moves closer to -1 as the underlying asset’s price decreases, indicating greater price sensitivity.
• For short put positions, delta is positive, meaning the position loses value as the asset price declines.
How Traders Use Delta
In addition to assessing option sensitivity, traders look to delta as a probability that an option will end up in or out of the money.
Every investor has their own risk tolerance, so some might be more willing to take on a risky investment if it has a greater potential reward. When considering Delta, traders recognize that the closer it is to 1 or -1, the greater the option’s sensitivity is to movements in the underlying asset.
If a long call has a Delta of 0.40, traders often interpret this as a 40% chance of expiring in the money. So if a long call option has a strike price of $30, the owner has the right to buy the stock for $30 before the expiration date. There is believed to be a 40% chance that the stock’s price will increase to at least $30 before the option contract expires. These outcomes are not guaranteed, however.
Traders may also use Delta to hedge against risk. One common options trading strategy, known as Delta neutral, is to hold several options with a collective Delta near 0.
The strategy reduces the risk of the overall portfolio of options. If the underlying asset price moves, it will have a smaller impact on the total portfolio of options than if a trader only held one or two options.
One example of this is a calendar spread strategy, in which traders use options with various expiration dates in order to get to Delta neutral.
Delta Spread
With a delta spread strategy, traders buy and sell various options to create a portfolio that offsets so the overall delta is near zero. With this strategy the trader hopes to make a small profit off of some of the options in the portfolio.
Using Delta Along With Other Greeks
Delta measures an option’s directional exposure. It is just one of the Greek measurement tools that traders use to assess options. There are five Greeks that work together to give traders a comprehensive understanding of an option. The Greeks are:
• Delta (Δ): Measures the sensitivity between an option price and the price of the underlying security.
• Gamma (Γ): Measures the rate at which delta is changing.
• Theta (θ): Measures the time decay of an option. Options become less valuable as the expiration date gets closer.
• Vega (υ): Measures how much implied volatility affects an option’s value. Higher implied volatility generally leads to higher option premiums.
• Rho (ρ): Measures an option’s sensitivity to changing interest rates. Rho is most suited for long-dated options because changes in interest rates have a larger effect on their value.
The Takeaway
Delta provides an estimate of how much the price of an option may change relative to a $1 change in the price of its underlying security. Delta is a useful metric for traders evaluating options and can help investors determine their options strategy. Traders often combine it with other tools and ratios during technical analysis.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
What does a 10 delta option mean? Or a 30 delta option?
A 10 delta option means the option’s price is expected to change by $0.10 for every $1.00 change in the underlying asset’s price. A 30 delta option would change by $0.30 for the same price movement.
What is the ideal delta for a covered call?
The ideal delta for a covered call is typically between 0.30 and 0.40. This range balances earning a decent premium while minimizing the risk of the call being exercised too quickly.
Do you want high or low delta options?
It depends on your strategy. High delta options are more sensitive to price changes in the underlying asset and are closer to being in the money. Low delta options are less sensitive but cost less and are generally further out of the money.
How accurate is delta in options trading?
Delta is an estimate, not a guarantee. It’s generally accurate for small price changes in the underlying asset, but may become less reliable for larger movements since delta itself changes over time (as it’s influenced by gamma).
Why is delta negative for put options?
Delta is negative for put options because their value increases as the underlying asset’s price decreases. The negative delta reflects this inverse relationship.
Does delta increase with volatility?
Not directly. Delta measures price sensitivity, while volatility impacts vega (which reflects changes in option prices due to implied volatility). Higher volatility can push options further in or out of the money, however, indirectly influencing delta.
Photo credit: iStock/PeopleImages
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. 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.
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Gamma measures how much an option’s delta changes for every $1 price movement in the underlying security. You might think of delta as an option’s speed, and gamma as its acceleration rate.
Gamma expresses the rate of change of an option’s delta, based on a $1 price movement — or, one-point movement — of the option’s underlying security. Traders, analysts, portfolio managers, and other investment professionals use gamma — along with delta, theta, and vega — to quantify various factors in options markets.
What Is Gamma?
Gamma is an important metric for pricing contracts in options trading. Gamma can show traders how much the delta — another metric — will change concurrent with price changes in an option’s underlying security.
An option’s delta measures its price sensitivity, and gamma provides insight into how that sensitivity may change as the underlying asset’s price shifts.
Expressed as a ratio: Gamma quantifies the rate of change in an option’s delta relative to changes in the underlying asset’s price. As an options contract approaches its expiration date, the gamma of an at-the-money option increases; but the gamma of an in-the-money or out-of-the-money option decreases.
Gamma is one of the Greeks of options trading, and can help traders gauge the rate of an option’s price movement relative to how close the underlying security’s price is to the option’s strike price. Put another way, when the price of the underlying asset is closest to the option’s strike price, then gamma is at its highest rate. The further out-of-the-money a security goes, the lower the gamma rate is — sometimes nearly to zero.
Calculating Gamma
Calculating gamma precisely is complex, and it requires sophisticated spreadsheets or financial modeling tools. Analysts usually calculate gamma and the other Greeks in real-time, and publish the results to traders at brokerage firms. However, traders may approximate gamma using a simplified formula.
Gamma Formula
Here is an example of how to calculate the approximate value of gamma. This formula approximates gamma as the difference between two in delta values divided by the change in the underlying security’s price.
Gamma = (Change in Delta) / (Change in Underlying Security’s Price)
Or
Gamma = (D1 – D2) / (P1 – P2)
Where:
• D1 represents the initial delta value.
• D2 represents the final delta value after a price change.
• P1 represents the initial price of the underlying security.
• P2 represents the final price of the underlying security.
Example of Gamma in Options
For example, suppose there is an options contract with a delta of 0.5 and a gamma of 0.1, or 10%. The underlying stock associated with the option is currently trading at $10 per share. If the stock increases to $11, the delta would increase to 0.6; and if the stock price decreases to $9, then the delta would decrease to 0.4.
In other words, for every $1 that the stock moves up or down, the delta changes by .1 (10%). If the delta is 0.5 and the stock price increases by $1, the option’s value would rise by $0.50. As the value of delta changes, analysts use the difference between two delta values to calculate the value of gamma.
How to Interpret Gamma
Gamma is a key risk-management tool. By figuring out the stability of delta, traders can use gamma to gauge the risk in trading options. Gamma can help investors discern what will happen to the value of delta as the underlying security’s price changes.
Based on gamma’s calculated value, investors can see the potential risk involved in their current options holdings; then decide how they want to invest in options contracts. If gamma is positive when the underlying security increases in value in a long call, then delta will become more positive. When the security decreases in value, then delta will become less positive.
In a long put, delta will decrease if the security decreases in value; and delta will increase if the security increases in value.
Traders use a delta hedge strategy to maintain a hedge over a wider security price range with a lower gamma.
💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.
How Traders Use Gamma
Hedging strategies can help professional investors reduce the risk of an asset’s adverse price movements. Gamma can help traders discern which securities to purchase by revealing the options with the most potential to offset losses in their existing portfolio.
Gamma hedging helps traders manage the risk of rapid delta changes by offsetting gamma exposure in their portfolio. This is typically done by holding a combination of options with positive and negative gamma.
If any of the trader’s assets are at risk of making strong negative moves, investors could purchase other options to hedge against that risk, especially when close to options’ expiration dates.
In gamma hedging, investors generally purchase options that oppose the ones they already own in order to create a balanced portfolio. For example, if an investor already holds many call options, they might purchase some put options to hedge against the risk of price drops. Or, an investor might sell some call options at a strike price that’s different from that of their existing options.
Benefits and Risks of Using Gamma
Gamma plays a crucial role in managing options positions, influencing how delta changes in response to price movements. While it can enhance trading strategies, it may also introduce certain risks.
Benefits of Gamma
Gamma in options Greeks is popular among investors in long options. All long options, both calls and puts, have a positive gamma that is usually between 0 and 1, and all short options have a negative gamma between 0 and -1.
Higher gamma means the option is sensitive to movements in the underlying security’s price. For every $1 increase in the underlying asset’s price, a higher gamma suggests that delta will change more significantly, potentially amplifying gains or losses depending on the trade’s direction.
When delta is 0 at the contract’s expiration, gamma is also 0 because the option is worthless if the current market price is better than the option’s strike price. If delta is 1 or -1 then the strike price is better than the market price, so the option is valuable.
Risks of Gamma
While gamma can potentially benefit long options buyers, for short options sellers it can potentially pose risks. For short options, a high gamma near expiration increases the risk of substantial losses if the underlying asset’s price moves sharply, since delta changes rapidly and can result in significant margin requirements or losses.
Another risk of gamma for option sellers is expiration risk. The closer an option gets to its expiration date, the less probable it is that the underlying asset will reach a strike price that is very much in-the-money — or out-of-the-money for option sellers. This probability curve becomes narrower, as does the delta distribution. The more gamma increases, the more theta — the cost of owning an options contract over time — decreases. Theta is a Greek that shows an option’s predicted rate of decline in value over time, until its expiration date.
For options buyers, this can mean greater returns, but for options sellers it can mean greater losses. The closer the expiration date, the more gamma increases for at-the-money options; and the more gamma decreases for options that are in- or out-of-the-money.
How Does Volatility Affect Gamma?
When a security has low volatility, options that are at-the-money have a high gamma and in- or out-of-the-money options have a very low gamma. This is because the options with low volatility have a low time value; their time value increases significantly when the underlying stock price gets closer to the strike price.
If a security has high volatility, gamma is generally similar and stable for all options, because the time value of the options is high. If the options get closer to the strike price, their time value doesn’t change very much, so gamma is low and stable.
Start Investing With SoFi
Gamma and the Greeks indicators are useful tools for understanding derivatives and creating options trading strategies. However, trading in derivatives, like options, is primarily for advanced or professional investors.
If you’re ready to invest, an options trading platform like SoFi’s is worth exploring. This user-friendly platform features an intuitive design, as well as the ability to trade options from either the mobile app or web platform. You can also access a library of educational resources to keep learning about options.
Using Gamma Along With Other Options Greeks
Gamma is a key metric in options trading, providing insight into how delta changes as the underlying asset’s price fluctuates. It is one of the five primary Greeks that traders use to manage risk and develop options strategies. Each Greek helps measure different aspects of an option’s behavior, offering a more comprehensive view of market exposure. The Greeks are:
• Gamma (Γ): Measures the rate of change in delta as the underlying security’s price moves. Higher gamma means delta shifts more quickly, increasing both potential gains and risks.
• Delta (Δ): Measures an option’s sensitivity to changes in the underlying asset’s price. Delta helps traders understand how much an option’s price might move relative to its underlying security.
• Theta (θ): Represents time decay, indicating how an option loses value as it nears expiration. A higher theta means the option’s value declines more rapidly over time.
• Vega (ν): Reflects the impact of implied volatility on an option’s price. Higher vega suggests that increased volatility leads to larger option price swings.
• Rho (ρ): Gauges an option’s sensitivity to interest rate changes. Rho is more relevant for long-dated options, as interest rate fluctuations can significantly impact their value.
Understanding gamma alongside the other Greeks allows traders to refine their strategies and manage risk more effectively in the options market.
The Takeaway
Gamma and the Greeks indicators are useful tools in options trading for understanding derivatives and creating options trading strategies. However, trading in derivatives, like options, is primarily for advanced or professional investors.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
A “good” gamma depends on the trading strategy. High gamma is beneficial for short-term traders who want quick delta changes, as it makes options more responsive to price movements. Lower gamma is preferred for longer-term strategies or hedging, as it provides more stability and reduces the need for frequent adjustments.
Should gamma be high or low when trading options?
Whether gamma should be high or low depends on your strategy and risk tolerance. High gamma is ideal for short-term trades or when expecting significant price moves, as it amplifies delta changes and potential gains but also increases risk. Low gamma, common in deep in-the-money or far out-of-the-money options, provides more stability and slower delta changes, making it better suited for longer-term strategies or conservative approaches.
How do you trade options using gamma?
Trading options using gamma helps traders assess delta changes, identify opportunities, and manage risk. High gamma options, often at-the-money and near expiration, allow for rapid delta shifts, benefiting short-term trades. Gamma hedging helps balance exposure by offsetting positive and negative gamma, reducing volatility in a portfolio.
What is the best gamma ratio?
A “good” gamma depends on the trading strategy. High gamma is beneficial for short-term traders who want quick delta changes, as it makes options more responsive to price movements. Lower gamma is preferred for longer-term strategies or hedging, as it provides more stability and reduces the need for frequent adjustments.
What happens to gamma when volatility increases?
When volatility increases, gamma decreases for at-the-money options and stays relatively stable for in- and out-of-the-money options. Higher volatility smooths delta changes, making gamma less sensitive, while lower volatility increases gamma, leading to sharper delta shifts.
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