InvestGen Archives | Page 60 of 62

Feb

2022

Guide to Jade Lizards

By Dan Miller | Growing Wealth, invest, Investing | Comments Off

A Jade Lizard is an advanced options strategy that requires taking three different positions. It is a slightly bullish strategy typically used by traders who want to profit from high levels of market volatility.

Traders who use the Jade Lizard strategy must monitor their position and have a plan for exit to avoid the potential for significant losses. The maximum profit for a Jade Lizard strategy is the initial premium received when opening the trade.

What Is a Jade Lizard Option Strategy?

With a Jade Lizard trade, you will enter into three different options positions on the same underlying stock through your brokerage account. The first two positions require selling a call spread, which involves selling a call option at one strike price and buying a call option with the same expiration at a higher strike price. The third and final option position is a put at an even lower strike price.

With a Jade Lizard, these options are usually at out-of-the-money strike prices. The strikes should be selected such that the total premium received from selling the call spread and selling the put option are greater than the width of the call spread. Don’t worry — if it’s not clear what that means, we’ll illustrate in the example that follows.

How Does a Jade Lizard Work?

A Jade Lizard option trade is a neutral to bullish options strategy, which means that you should anticipate the price of your underlying stock to stay the same or go up. With a Jade Lizard options strategy, you are hoping to capture the premium that comes with higher levels of implied volatility, so the ideal environment to execute the trade is one where volatility is elevated.

Setting Up a Jade Lizard

When you set up a Jade Lizard, you should initially be collecting premium from both the call spread and put that you are selling. The key concept of setting up a Jade Lizard is that you want the total amount of premium that you collect initially to be more than the width of your call spread.

As an example, say that stock ABC is trading around $60. You could sell a 58/62/63 Jade Lizard, at these hypothetical prices, on options expiring in 30 days:

• Sell ABC 62 Call for 1.25

• Buy ABC 63 Call for 0.90

• Sell ABC 58 Put for 0.75

Your net credit is $1.10 ($1.25 minus $0.90 plus $0.75), so you collect $110 for each contract that you implement (since one contract typically controls 100 shares of the underlying stock). In our example, you have no risk should the stock move to the upside. To illustrate how, suppose the stock trades above 63 on expiration day. The put option expires worthless, and your maximum loss on the call spread is $100, which is less than the $110 you collected up front. On the other hand, you do have nearly unlimited downside risk if the underlying stock goes to 0. This is the main reason that the Jade Lizard options strategy only makes sense for stocks where you have a neutral to bullish outlook.

Maximum Profit

You will achieve your maximum profit if the options expire with the underlying stock having a price in between the strike price of your put option and the strike price of your lower call option. In our example above, if the stock closes between $58 and $62, then all three options expire worthless and your profit is the $1.10 in initial premium that you collected.

Maximum Loss

In a Jade Lizard strategy, you have nearly unlimited downside exposure, since you are selling a put option. A put option increases in value as the price of the underlying stock goes down. Since you are short the put option, as the stock price goes down you could be on the hook for the difference between the strike price of the put and the price of the underlying stock.

Breakeven Point

The breakeven point for a Jade Lizard on the downside is the difference between the strike price of the put option and the initial premium collected. In our earlier example, we collected $1.10 in net premium, so our breakeven point is $56.90 (the difference between $58.00 and $1.10).

There is also a potential breakeven point to the upside. Ideally with a Jade Lizard, you collect more in initial premium than the width of your call spread. In our example, we collected $1.10 in initial premium and our call spread is only $1 wide (between $62 and $63).

So if the stock closes anywhere above $63 when the options expire, your put will be worthless and your call spread will cost you $1 to close out, or $100 per set of contracts. That will leave you with a profit of $10 per set of contracts.

Exit Strategy

The exit strategy for a Jade Lizard involves purchasing back the options you sold using a buy to close order. When setting up the trade, it’s a good idea to set target profit at which you would buy back the options.

In our example, where we received $1.10 per share, you might look to close out the Jade Lizard when you could buy your options back for around $0.55 per share, 50% of the initial premium you received. The options may decline in value due to movement of the underlying stock, or time decay as the options get closer to their expiration.

Maintaining a Jade Lizard

A Jade Lizard is not a set-it-and-forget-it options strategy. Because of the unlimited downside risk, you’ll want to monitor your position, especially if the price of the underlying stock starts to go down. In that scenario, you may want to close out your position or roll down the strike prices of your short call spread.

Pros and Cons of the Jade Lizard Strategy

Here are some pros and cons of the Jade Lizard strategy:

Pros of the Jade Lizard strategy	Cons of the Jade Lizard strategy
No risk of losses from upward price movement in the underlying	Significant risk of downward price movement in the underlying
Immediate collection of the net premium	Profits capped to the amount of premium initially received

Alternatives to Jade Lizards

One alternative to the Jade Lizard strategy is a strategy called the Big Lizard. With a Jade Lizard, you typically sell out-of-the-money options. With a Big Lizard strategy, the options that you sell are at-the-money, meaning that their strike price is close to the price of the underlying stock.

Investing With SoFi

The Jade Lizard strategy is an advanced strategy that options traders use when they have a bullish to neutral outlook on a stock. The strategy’s maximum upside is equal to the premium received when opening the trade, while the downside risk is essentially uncapped.

Learning about different options strategies can be a great way to further understand the stock market and how to invest. From there, you might consider an options trading platform like the one offered by SoFi. This platform has an intuitive and approachable design and allows investors to trade options from the mobile app or web platform. And if you aren’t done learning, there are educational resources about options available to explore.

Trade options with low fees through SoFi.

FAQ

How are Jade Lizards managed?

When opening a Jade Lizard options strategy, you want to make sure to keep an eye on the underlying stock until the options’ expiration date. Since a Jade Lizard comes with no upside risk, you should especially monitor negative moves in the stock price. In that case, you could close out your position or roll your call spread to a lower stock price, earning more premium.

How do reverse Jade Lizards differ from Jade Lizards?

In a reverse Jade Lizard, also known as a twisted sister option, you sell a put spread, being long the put option with the lower stock price. Additionally you sell a call with a higher strike price.

As the name suggests, a reverse Jade Lizard is the opposite of a regular Jade Lizard, and makes sense when you have a neutral to bearish outlook on a stock. You have risk of losses due to downard price movement and unlimited loss potential from upward price movement, due to the short call.

What is the maximum payoff of a Jade Lizard?

The maximum payoff or profit of a Jade Lizard is capped to the total initial premium that you receive when you open the position. This is equal to the amount you get for selling the put and short leg of the spread minus the amount of premium for the long leg of the call spread.

Photo credit: iStock/ipopba

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.
SOIN0122049

Feb

2022

What Are Calendar Spreads and How Do They Work?

By Mike Zaccardi, CMT, CFA | Growing Wealth, invest, Investing | Comments Off

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.

Calendar Spread Payoff Diagram

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

Jan

2022

A Guide to Box Spreads: What They Are and How They Work

By Paulina Likos | Growing Wealth, invest, Investing | Comments Off

A box spread, or long box, is an options strategy in which a trader buys a call and sells a put, which yields a similar trade profile of a long stock trade position. Depending on which strike prices the trader chooses, the spread will come close to the current market value of the stock.

The arbitrage strategy involves a combination of buying a stock at one strike price and selling stock on another strike price. These trade quotes, when connected form a box and make the difference between the two strike prices.

What Is a Box Spread in Options Trading?

A box spread is an arbitrage options trading strategy used by traders attempting to profit by taking little to no risk. To do this, they’re using both long and short strategies.

This options trade involves a four-legged spread, buying a bull call spread with the corresponding bear put spread with both vertical spreads having the same strike prices and expiration dates. The box spread trading strategy is a delta neutral strategy because the trader is neither bearish or bullish, rather the goal of the trade is to lock in a profit.

Traders using box trades are mostly professional traders such as market makers or institutional traders. Box spreads are not the best trading strategy for retail traders because they don’t yield high profits and transaction costs can impact potential returns. Large investment firms have the tools and resources to execute on box spread trades quickly and efficiently.

How Do Box Spreads Work?

To form a box spread, traders start out by buying a bull call spread and a bear put spread. These two options positions have the same strike prices and expiration dates. These trades must take place at the same time to execute a profit effectively.

The bear spread starts out with the trader taking a fixed profit, then after a period of time, the trader loses money then, the trader has a fixed loss. A bull spread is the opposite. Initially the trader incurs a fixed loss, then after a period time, the trader takes a fixed profit.

By taking both of these vertical spread positions, traders can lock in a profit that could potentially be risk free. In both corresponding positions there is either a fixed loss or fixed profit. This is why many traders see box spreads as a low risk trading option.

The bear spread bets that the stock price will decline while the bull spread bets that the stock price will increase. By combining both positions, the profit and loss offset one another, leaving the trader with a small profit, known as the box spread.

How to Use the Box Spread Strategy

Traders make money on a box spread based on the difference between the two strike prices. When executed correctly, this is worth the difference in strike prices at expiration. This means, if a trader purchases a $100/$110 vertical spread, that trade would be worth ten dollars at expiration, no more, no less.

This is a guaranteed profit regardless of market volatility or whether the stock price increases or decreases. Traders execute on box spreads when an options contract is mispriced, or more specifically when spreads are underpriced.

If traders believe the outlook of the stock market will change in the future, they may take advantage of a scenario where put options are less expensive than call options, a perfect set up for box spreads.

When the trader believes the spreads are overpriced in relation to their value at expiration, the trader would employ a short box spread, selling a bull call spread with its corresponding bear put spread with the same prices and expiration dates. If the trade yields an amount higher than the combined expiration value of the spreads for selling these two spreads, that’s the trader’s profit.

Box Spread Risks

Many sophisticated investors think of box spread options trading as a risk-free trading strategy but in reality there is no such thing as a risk-less trade. When asset prices are misplaced, this is the ideal time to execute on a box spread. However, the market moves fast and prices can change quickly, so these trades can be difficult to fill and hard to identify in the first place.

Profits from box spreads tend to be small. Traders also need to consider expenses associated with these trades like brokerage fees, taxes, and transaction costs, which could eat at overall returns. This is why box spreads typically make the most sense for institutional traders who are able to do a high volume of trades and manage other expenses.

Another risk for traders to consider is early exercise. This is when a trader decides to exercise an option before expiration. If traders are in a box spread and exercise one of their positions early, they are no longer in a box spread and their risk/reward profile has changed. When employing a box spread trading strategy, early exercise could impact the initial desired outcome.

Box Spread Example

To execute on a box spread, traders buy the call spread at the lower strike price and the put spread at the higher strike price. By making these positions traders are “buying the box.” A lower strike call and a higher strike put have to be worth more to secure a profit.

For example, a trader takes two strike prices $95 and $100 and buys a long $95 call and sells the short $100 call, this is a long $95/$100 vertical spread. To form the box spread, the trader would have to buy the $95/$100 put spread. This means buying the $100 put and selling the $95 put.

These trading positions are synthetic, meaning, the trader copies a position to mimic another position so they have the same risk and reward profile.

For this example, at the $95 strike price, the trader is synthetically long and for the $100 strike, the trader is synthetically short. In other words, the trader in these positions is buying shares at $95 and selling them at $100 and the most the trader can make is $5 at expiration.

Start Trading Stocks with SoFi

The best time to use a box spread is when a trader believes the underlying spreads are underpriced relative to their value at expiration. While considered a low-risk, low-reward trading strategy, box trades may not be the best trading strategy for the retail investor. Still, understanding box spreads can be beneficial to understand the relationship between how different options can work together.

For market participants who want to start trading options, SoFi’s options trading platform is a great way to get started. The platform offers an intuitive, user-friendly design, as well as access to a slew of educational resources about options. Investors can trade options from the mobile app or the web platform.

Trade options with low fees through SoFi.

Photo credit: iStock/MicroStockHub

SoFi Invest®

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

Jan

2022

Covered Calls: The Basics of Covered Call Strategy

By Samuel Becker | Growing Wealth, invest, Investing | Comments Off

With most things in life, it helps to be covered — by a coworker, an insurance policy, or a roof over your head. In investing, it can also pay to be covered. When it comes to options contracts, a covered call is an option trading strategy worth knowing about.

Here’s all you need to know about putting together a covered call strategy, when to consider it, and how it may — or may not — pay off.

What is a Covered Call?

A covered call is an options trading strategy that opens up an additional avenue to generate income. In a covered call transaction, an investor sells call options on a security they own. This strategy can be beneficial to the investor if they don’t expect the value of the stock price to move much in either direction during the terms of the option.

Call Options Recap

A “call” is a type of option (you may be familiar with calls versus puts), that allows investors to buy shares of an underlying asset or stock at a specific, prearranged price, called the strike price. Usually, an investor dealing with call options holds a long position — that is, they think that the underlying stock is going to appreciate.

This opens up the opportunity to profit from their position. If you thought that a stock’s price was going to increase, you might want to buy that stock, hold onto it, allow the price to increase, and then sell it in order to generate a profit.

Call options allow investors to do more or less the same thing, but without having to buy or pay the full price for the underlying shares. Instead, a premium is paid for the right to execute the trade at the strike price.

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

The main difference between a regular call and a covered call is that a covered call is “covered” by an investor holding an actual position. That is, if an investor sells call options on Company X stock, it would be “covered” if the investor actually owns, or holds a position, on Company X stock.

Conversely, if an investor does not hold a position on, or own any Company X stock and sells a call option, they’re selling a regular call option. This is also known as a “naked” option.

Example of a Covered Call

The point of selling covered calls to other investors is to boost your own investment income. If, for example, you have 100 shares of Company X stock, and were looking for ways to potentially increase your annual return from that holding, you could try selling covered calls to other investors.

Here’s what that might look like in practice:

Your 100 shares of Company X stock are worth $50 each: $5,000 total, at current market value. To make a little extra money, you decide to sell call options to your friend Harris, at a strike price of $70. Harris pays you $10 for the premium.

Let’s say that Company X stock’s price only rises to $60, and Harris doesn’t execute the option, so it expires. You keep the $10, plus your 100 shares. You’ve turned a profit of $10 selling call options, and your shares have appreciated to a value of $6,000. So, you now have a total of $6,010.

For all intents and purposes, the best-case scenario, for you, is that your shares rise in value to near the strike price, (say, $69) but Harris doesn’t exercise the option. In that scenario, you still own your shares (now worth $6,900) and get the $10 premium Harris paid you.

But the risk of buying call options is that you could lose out on bigger potential gains.

So, if Company X stock rises to $90 and Harris executes his option, you would then be obligated to sell your 100 shares to him, which are now worth $9,000. You would still get the $10 premium, plus the value of the shares at the predetermined strike price of $70 — netting you $7,010. Effectively, you’ve turned a holding valued at $5,000 into $7,010. Not bad!

On the other hand, had Harris not exercised his option, your shares could be worth $9,000. That’s the risk you run when selling covered calls.

Recommended: How to Sell Options for Premium

When and Why Should You Do a Covered Call?

There is no definite right answer in terms of the right time to use a covered call strategy — it involves weighing the risks involved and doing a bit of reading the tea leaves in terms of the market environment.

It’s generally best to write covered calls when the market is expected to climb — or at least stay neutral. Nobody knows what’s going to happen in the future, and investors might want to be ready and willing to sell their holdings at the agreed strike price.

As for why an investor might use covered calls? The goal is to increase the income they see from their investment holdings. Another potential reason to use covered calls, for some investors, is to offset a portion of a stock’s price drop, if that were to occur.

Pros and Cons of Covered Calls

Using a covered call strategy can sound like a pretty sweet deal on its face. But as with everything, there are pros and cons to consider.

Covered Call Pros

The benefits of utilizing covered calls are pretty obvious.

• Investors can potentially pad their income by keeping the premiums they earn from selling the options contracts. Depending on how often they decide to issue those calls, this can lead to a bit of income several times per year.

• Investors can determine an adequate selling price for the stocks that they own. If the option is exercised, an investor profits from the sale (as well as the premium). And since the investor is receiving a premium, that can potentially help offset a potential decline in a stock’s price. So, there’s limited downside protection.

Covered Cons

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

• Investors could miss out on potential profits if a stock’s price rises, and continues to rise, above the strike price. But that just goes with the territory. As does the possibility of an option holder executing the option, and an investor losing a stock that they wanted to keep.

• An investor can’t immediately sell their stocks if they’ve written a call option on it. This limits the investor’s market mobility, so to speak.

• Investors need to keep in mind that there could be capital gains taxes to pay.

The Takeaway

A covered call may be attractive to some investors as it’s an opportunity to try and make a little more profit off a trade. That said, as with all trading strategies, it may pay off in your favor, and it may not. There are no guarantees.

Calls, puts, and options trading can get complicated, and fast. That’s why it’s helpful if your options trading platform isn’t more complicated than it needs to be. SoFi’s options trading platform has an intuitive and approachable design. You can trade options from the mobile app or web platform, and reference the offered educational resources about options.

Trade options with low fees through SoFi.

FAQ

There are a lot of details and terms regarding options, and it can be hard to keep track of everything. Here are a few common questions about covered calls.

Are covered calls free money?

Covered calls are not “free money”. But covered calls can provide a boost to one’s investment earnings — though an investor does have to assume some risks associated with selling options.

The strategy is more of a game of risk and reward, and there’s always the risk that the strategy could end up backfiring, particularly if your stock’s value increases much more than you anticipated.

Are covered calls profitable?

They have the potential to be profitable: If you’re selling call options on your holdings, then you should be receiving a premium in return. In that sense, you’ve turned a profit. After all, the entire point of selling calls on your holdings is to increase your profits, too.

But how profitable the strategy is, and the risks involved, will depend on a number of factors, such as the underlying stock, market conditions, and the specifics of the call option.

What happens when you let a covered call expire?

If you’ve sold a covered call option to someone else and it expires, nothing happens — you keep the premium, and nothing changes.

Because an option is only that — an option to execute a trade at a predetermined price for a select period of time — the option holder’s reluctance to execute during the time period means that the option will expire worthless.

Can you make a living selling covered calls?

Living strictly off of income derived from covered calls is theoretically possible, but you’d need a big portfolio (against which to sell those options) to make it work. There are a lot of things to consider, too, like the fact that a lot of the income your covered calls do generate is going to be taxed as capital gains, and that the market isn’t always going to be in a favorable environment for selling covered calls.

Photo credit: iStock/millann

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.

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

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

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.
SOIN0821348

Jan

2022

What Are Binary Options? How to Trade Binary Options

What Is Binary Options Trading? How to Trade Binary Options

By Samuel Becker | Growing Wealth, invest, Investing, Terminology | Comments Off

Binary options are a type of trading option in which investors either end up making up to $100 or they make nothing. Once the investor enters into the options contract, they don’t have to do anything else.

Below, we’ll give you the full rundown about binary options, including what they are, how they work, how to trade binary options, how to make money with binary options, and finally, why it’s so important to understand their ins and outs before making any moves.

What Are Binary Options?

A traditional binary option is a type of options contract, in which investors bet whether the price of the underlying stock will be above or the option’s strike price. In industry terms, they’re either “in the money,” or “out of the money.” Prices, of course, can be hard to predict, which is what makes binary options something of a gamble.

Here’s a fairly straightforward example: You think that the price of Stock X will be $10 or more on January 4, at 4 PM ET. You acquire a binary option contract with that stipulation — the other party on the contract holds the other position, that the price of Stock X, on the agreed upon time and day, will be less than $10.

When the clock strikes 4 pm ET on January 4, Stock X’s price is either $10, or it’s less than $10. Depending on what it is, one person is “victorious.” There’s no middle ground.

International traders may offer other variations of binary options as well.

How Binary Options Work

The inner workings of traditional binary options requires a baseline knowledge of their key elements. That includes a few things:

• The strike price. This is the price at which the option will execute, and when it comes to binary options, is the fulcrum point at which traders must choose a position — above, or below.

• The underlying asset, security, or market. This is the security (stock, commodity, etc.) upon which the options contract is based. Since options are derivatives, they’re tied to an underlying asset.

• The expiration date. The day and time when the contract executes.

• The expiration price. The price of the underlying asset when the contract executes.

These elements (along with a few other minor ones) comprise a basic binary options contract. Now, as far as how the option actually works, it’s pretty simple.

In effect, an options trader buys a binary option contract from another party who has taken the opposite position. That is, if you were to buy a contract with the position that the option’s underlying asset will exceed the strike price on the agreed expiration day and time, the other trader would have the equal and opposite position — they’re betting that the underlying asset’s value will not exceed the strike price when it expires.

When the clock does strike midnight, so to speak, on the expiration date, one of the two positions will have made the correct choice. The value of the underlying asset will either be above or below the strike price. The successful trader then receives a payout.

That payout is either $100, or nothing, regardless of how much higher or lower the value of the security is compared to the strike price. It’s like betting $100 on a World Cup match — your team either wins, in which you get your buddy’s $100, or your team loses, and you have to fork over $100.

Like all options, pricing on binary options reflects the time value of money, and their price, though always less than $100, will fluctuate depending on their current price and the length until expiration.

How Binary Options Trading Works

If you have any experience investing online, it should be pretty easy to get started. But before you do that, of course, you’ll want to make sure that you know what you’re getting into. That means doing some homework about how binary options work, the risks involved, and considering whether binary options trading jives with your overall strategy.

With all of that in mind, actually trading options contracts is almost as simple as trading stocks. You’ll want to find a binary options broker (which are usually specialized brokers such as
Nadex , Pocket Option , and BinaryCent ), open and fund an account, and from there, start executing trades.

Pros and Cons of Binary Options Trading

As with any type of investment or trade, binary options have pros and cons. Here’s a quick look at them:

Binary Options: Pros and Cons

Pros	Cons
Risks are capped	Rewards are capped
Fast and efficient	Highly speculative
Known payouts	Fraud Concerns

Pros of Binary Options

There are some positives to trading binary options.

• Limited risks. Traders can only lose so much if they end with the short straw.

• Efficient process. Binary options trading is usually a fast, efficient, and easy process, and they expire quickly.

• Known payouts. Since binary options are capped at $100, you know in advance what’s at stake. It’s always nice to know where things might land, right?

Cons of Binary Options

There are also some potential disadvantages to trading binary options.

• Limited gains. There’s only so much “winning” a trader can do with a given binary options contract.

• Speculative nature. You may get the feeling that you’re simply placing a bet at the roulette table when trading binary options, so prepare for that.

• Unregulated markets. Some brokerages and exchanges that offer binary options operate outside of the United States, and away from regulators. That could increase the risk of fraud.

3 Potential Binary Options Frauds to Watch For

The risk of fraud is a bit more pronounced in the binary options sphere because many platforms and brokerages that allow traders to trade binary options are unregulated. That means they’re not conducting business under the authority of the Securities and Exchange Commission (SEC) or other regulators.

It’s worth noting that if you trade with a well-regarded broker, your chances of getting scammed are probably pretty slim. Even so, here are a few types of fraud that you may run into when trading binary options.

1. Identity Theft

You’re likely familiar with identity theft, and some traders have lodged complaints with regulators that certain online trading platforms have been collecting personal data (credit card numbers, etc.) and then using it as they will.

How might this play out in the wild? Let’s say you want to do some binary options trading, and after a bit of Googling, find a platform that looks fun and easy to use. You sign up, fork over some personal information, and start trading.

A while later, you might get alerts that your credit has been compromised, or something similar. This could be a sign of identity theft, and it may all stem back to when you gave your personal information to that trading platform.

It’ll require some investigation to get to the culprit (if it’s even possible), but the point is that some sites play fast and loose with personal information. Or, they may not do a good job of securing it.

As a rule, it’s generally a good idea to keep your personal data to yourself, and not upload it to unfamiliar platforms.

2. Trade Manipulation

You can’t win if the game is rigged, right? This is another common complaint lodged against certain brokerages. Specifically, some traders say the exchanges manipulate the software used to execute trades to ensure the trader ends up on the wrong side of the trade.

In effect, this would be a case of the dealer taking a peek at the next card in the deck during a game of Blackjack, seeing that you’re going to hit “21,” and replacing the winning card with another.

3. Refusing to Credit Accounts

Another common complaint is that some platforms accept customer deposits, but then don’t allow them to withdraw the funds. Platforms may cancel withdrawal requests, or ignore them, leaving traders unable to access their money.

If this happens and the brokerage or platform you’ve been dealing with is in a foreign country (or its location is unknown), you might be out of luck. Again, stick to well-known brokerages or platforms, and you’re less likely to run into these types of issues.

Binary Option Fees

The fees for trading differ depending on the platform or brokerage you’re using, so that’s something to keep in mind when deciding where you want to execute trades.

Some platforms make money through commissions, and as such, will incorporate fees into contract spreads. Others simply charge a per-contract fee. Check your preferred platform or brokerage’s pricing guidelines to make sure you’re comfortable with any applicable fees.

The Takeaway

Whether you’re interested in trading binary options or stocks and bonds, it’s important to do your homework first. That means understanding a financial instrument, be it a binary option, or a vanilla stock, before you add it to your portfolio.

An options trading platform like SoFi’s can make it easier to understand what you’re getting into, thanks to its library of educational resources about options. The platform’s intuitive and approachable design allows you to trade options through the mobile app or the web platform, depending on what you prefer.

Trade options with low fees through SoFi.

Photo credit: iStock/dinachi

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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.
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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.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

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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