InvestX Archives

Sep

2025

Navigating the IPO Lock-up Period

By Inyoung Hwang | Growing Wealth, invest, Investing | No Comments

Table of Contents

What Is an IPO Lock-up Period?
How the IPO Lock-Up Period Works
What Is the Purpose of a Lock-up Period?
What’s an Example of a Lock-up Period?
What Does the Lock-up Period Mean for Employees with Stock Options?
How Does the IPO Lock-Up Period Affect Investors?
FAQ

Following an initial public offering (IPO), there is frequently a lock-up period to prevent major stakeholders from selling their shares, which could potentially flood the market and cause the share price to drop.

IPO lock-up periods don’t pertain to all investors in an IPO, but they do apply to certain shareholders. Here’s what to know about lock-up periods and how they work in an IPO.

Key Points

• An IPO lock-up period is a period of time after a company goes public during which employees of the company and early investors are prohibited from selling their shares.

• Companies or investment banks impose the lock-up period, which usually lasts between 90 and 180 days.

• The purpose of the lock-up period is to stop company insiders and early investors from cashing out too quickly and to maintain a stable share price.

• Companies may use the lock-up period to avoid flooding the market with shares, create confidence in the company’s fundamentals, and help prevent insider trading.

• Investors may want to pay attention to the lock-up period when investing in IPOs, as it can affect the risk of investing in the company.

What Is an IPO Lock-up Period?

The IPO lock-up period is the time after a company goes public during which company insiders — such as founders, managers and employees — and early investors, including venture capitalists, are not allowed to sell their shares.

These restrictions are not mandated by the Securities and Exchange Commission (SEC), but instead are self-imposed by the company going public or they are contractually required by the investment banks that were hired as underwriters to advise and manage the IPO process.

Lock-up periods are usually between 90 and 180 days after the IPO. Companies may also decide to have staggered lock-up periods that end on different dates and allow various groups of shareholders to sell their shares at different times.

How the IPO Lock-Up Period Works

The IPO lock-up period is typically put into place by the company going public or the investment bank underwriting the IPO. An agreement is reached with company insiders and early investors specifying that they are prohibited from selling their shares for a specific period of time after the IPO.

The purpose of the lock-up period is to prevent a sudden flood of shares on the market that could reduce the stock price. The lock-up period also sends a signal to the market that company insiders are confident in the company’s prospects and committed to its success.

Once the lock-up period is over (typically in 90 to 180 days), insiders are allowed to sell their shares if they wish.

What Does “Going Public” Mean?

Going public with an IPO means that shares of a company are being offered on the public stock market for the first time. The company is shifting from a privately-held company to a publicly traded company.

When a company is private, ownership is limited and can be tightly controlled. But when a company goes public, investors can buy shares on the public market.

It’s worth noting that when a company first goes public, there may already be a series of shareholders in the company. Founders, employees, and even venture capitalists may already own shares or have stock options in the company.

💡 Quick Tip: Keen to invest in an initial public offering, or IPO? Be sure to check with your brokerage about what’s required. Typically IPO stock is available only to eligible investors.

What Is IPO Underwriting?

Before a company goes public, it generally goes through a process in which an underwriter — usually an investment bank — does IPO due diligence and helps come up with the valuation of the company, the share price of the stock, and the size of the stock offering on the market.

The underwriter also typically buys all of or a portion of the shares. They then allocate shares to institutional investors before the IPO.

The IPO underwriter will try to generate a lot of interest in the stock so that there will be high demand for it. This may lead to the stock being oversubscribed, which could lead to a higher trading price when it hits the market.

Recommended: How Are IPO Prices Set?

How IPO Lock-ups Get Used

A company or its underwriters might use the lock-up period as a tool to bolster the share price during the IPO, to prevent a sharp increase in shares from flooding the market, and to build confidence in the company’s future.

For instance, with tech startups, a great proportion of compensation may be paid out to employees through equity options or restricted trading units. In order to avoid flooding the market with shares when employees exercise these contracts, the lock-up restrictions prevent them from selling their stock until after the lock-up period is over.

Recommended: Guide to Tech IPOs

What Is the Purpose of a Lock-up Period?

A lock-up period typically has several different functions in an IPO, including the following:

Ensuring Share-Price Stability

Company insiders, like employees and angel investors, can own shares in a company before it goes public. Since share prices are set by supply and demand, extra shares can drive down the price of the stock. A lock-up period helps stabilize the stock price by preventing these extra shares from being sold for a certain amount of time.

Avoiding Insider Trading

To help avoid insider trading, company insiders may have extra restrictions regarding the lock-up period before selling their shares. That’s because company insiders might have information that is not available to the general public that could help them predict how their stock might do.

For example, if a company is about to report its earnings around the same time a lock-up period is set to end, insiders may be required to wait for that information to be public before they can sell any shares.

Public Image

Lock-up periods can also be a way for companies to build confidence in their future performance. When company insiders hold onto their shares, it can signal to investors that they have faith in the strength of the company.

On the other hand, if company insiders start to sell their stock, investors may get nervous and be tempted to sell as well. As demand falls, the price of the stock usually does, too, and the company’s reputation may be damaged.

The lock-up period can help keep this from happening while it’s in place.

💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.

What’s an Example of a Lock-up Period?

To give a hypothetical example of how a lock-up period could work, let’s say Business X — a unicorn company — went public with an IPO in March. The company set a lock-up period of four months. In July, the lock-up period ended and early investors and insiders sold up to 400 million shares of the company. As the new shares hit the market, the stock dropped by as much as 5%, but ended the day down just 1%.

What Does the Lock-up Period Mean for Employees with Stock Options?

Restrictions imposed during a lock-up period usually apply to any stock options employees have been given by the company before an IPO. Stock options are essentially an agreement that allows employees to buy stock in the company at a predetermined price.

The idea behind this type of compensation is that the company is trying to align employees’ incentives with its own. Theoretically, by giving employees stock options, the employees will have an interest in seeing the company do well and increase in value.

There’s usually a vesting period before employees can exercise their stock options, during which the value of the stock can increase. At the end of the vesting period, employees are generally able to exercise their options, sell the stock, and keep the profits.

If their stock options vest before the IPO, employees may have to wait until after the lock-up period to exercise their options.

How Does the IPO Lock-Up Period Affect Investors?

Most public investors that buy IPO stocks won’t be directly affected by the lock-up period because they didn’t own shares of the company before it went public. However, the lock-up period can reduce the supply of available shares on the market, keeping the stock price relatively stable.

But when the lock-up period ends, if a surge in shares suddenly hits the market, this could lead to volatility and cause the price of the shares to drop. Investors should be aware of these possibilities, do thorough research and due diligence, and carefully consider the risks before buying shares in an IPO.

Reading the IPO Prospectus

You can find information on a company’s lock-up period in its prospectus, the detailed disclosure document filed with the SEC as part of the IPO process. Investors can locate a company’s prospectus by using the SEC’s EDGAR database and searching for the company by name. Then, on the company’s filing page, look for Form S-1, which is the initial registration statement. The prospectus should be included in that filing.

Waiting to Buy Until After Lock-ups End

Investors considering investing in an IPO may choose to hold off until the lock-up period is over. The reason: When the lock-up ends and company insiders are free to sell their shares, the stock price may experience volatility as the new shares enter the market. This could potentially cause a drop in a stock’s price.

Some investors may want to take advantage of the dip that could occur when a lock-up period ends, especially if they believe the long-term fundamentals of the company are strong. However, this type of timing-the-market strategy can be very risky. It depends on a number of variables, including the company itself and market conditions. In other words, there is no guarantee that it will produce good results.

The Takeaway

A lock-up period can follow an IPO. It’s a period of time during which company insiders and early investors are prohibited from selling shares of the company. One of the main purposes of a lock-up period is to keep these stakeholders’ shares from flooding the market, and to help stabilize the stock price of a newly public company.

Understanding how a lock-up period works — and how it might affect the price of a stock — can be helpful to investors who may be interested in buying shares of an IPO on the public market.

Whether you’re curious about exploring IPOs, or interested in traditional stocks and exchange-traded funds (ETFs), you can get started by opening an account on the SoFi Invest® brokerage platform. On SoFi Invest, eligible SoFi members have the opportunity to trade IPO shares, and there are no account minimums for those with an Active Investing account. As with any investment, it's wise to consider your overall portfolio goals in order to assess whether IPO investing is right for you, given the risks of volatility and loss.

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

FAQ

What is the purpose of a lock-up period?

The purpose of a lock-up period is to prevent company insiders and early investors from selling shares of stock right away, which could flood the market and cause the price of the stock to drop. A lock-up period can help stabilize the stock price and also send a message to the market that company insiders are committed to the company and confident in its future performance.

How do I know if an IPO has a lock-up period?

To find out if an IPO has a lock-up period, you can use the Securities and Exchange Commission’s EDGAR database. Search for the company by name, and on their listing page, look for a Form S-1, which is the company’s initial registration statement. In that filing, you should find the company’s prospectus, which will have information about the lock-up period if there is one.

What is the lock-up period for IPO employees?

A lock-up period is designed to prevent company insiders, including employees, from selling their stock quickly after a company goes public. That could cause the stock price to drop and might also signal that the employees don’t have confidence in the company. A lock-up period typically lasts 90 to 180 days.

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

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

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

Investing in an Initial Public Offering (IPO) involves substantial risk, including the risk of loss. Further, there are a variety of risk factors to consider when investing in an IPO, including but not limited to, unproven management, significant debt, and lack of operating history. For a comprehensive discussion of these risks please refer to SoFi Securities’ IPO Risk Disclosure Statement. This should not be considered a recommendation to participate in IPOs and investors should carefully read the offering prospectus to determine whether an offering is consistent with their investment objectives, risk tolerance, and financial situation. New offerings generally have high demand and there are a limited number of shares available for distribution to participants. Many customers may not be allocated shares and share allocations may be significantly smaller than the shares requested in the customer’s initial offer (Indication of Interest). For more information on the allocation process please visit IPO Allocation Procedures.

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

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.

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SOIN-Q325-068

Aug

2025

Should I Use a Dividend Reinvestment Plan?

Dividend Reinvestment Plans: How DRIP Investing Works

By Laurel Tincher | Growing Wealth, Investing | No Comments

Table of Contents

What Is Dividend Reinvestment?
What Is a Dividend Reinvestment Plan?
Types of Dividend Reinvestment Plans
DRIP Example
Pros and Cons of DRIPs
Cash vs Reinvested Dividends
Tax Consequences of Dividends
Should You Reinvest Dividends?
FAQ

When investors hold dividend-paying securities, they may want to consider using a dividend reinvestment plan, or DRIP, which automatically reinvests cash dividends into additional shares, or fractional shares, of the same security.

Using a dividend reinvestment strategy can help acquire more dividend-paying shares, which can add to potential compound gains. But companies are not obligated to keep paying dividends, so there are risks.

It’s also possible to keep the cash dividends to spend or save, or use them to buy shares of a different stock. If you’re wondering whether to use a dividend reinvestment program, it helps to know the pros and cons.

Key Points

• Dividend reinvestment plans (DRIPs) allow investors to reinvest cash dividends into more shares of the same securities.

• DRIPs can be offered by companies or through brokerages, with potential discounts on share prices, or no commissions.

• There are two types of DRIPs: company-operated DRIPs and DRIPs through brokerages.

• Reinvesting dividends through a DRIP may lead to greater long-term returns due to compounding.

• However, DRIPs have limitations, such as tying up cash, risk exposure, and limited flexibility in choosing where to reinvest funds.

What Is Dividend Reinvestment?

Dividend reinvestment plans typically use the cash dividends you receive to purchase additional shares of stock in the same company, rather than taking the dividend as a payout.

When you initially buy a share of dividend-paying stock, or shares of a mutual fund that pays dividends, you typically have the option of choosing whether you’d want to reinvest your dividends automatically to buy stocks or more shares, or take them as cash.

Numerous companies, funds, and brokerages offer DRIPs to shareholders. And reinvesting dividends through a DRIP may come with a discount on share prices, for example, or no commissions.

What Is a Dividend Reinvestment Plan?

Depending on which securities you invest in, you may have the option to enroll in a Dividend Reinvestment Plan or DRIP. This type of plan, offered by numerous companies and brokerages, allows you to automatically reinvest dividends as they’re paid out into additional shares of stock.

Note that some brokerages offer what’s called synthetic DRIPs: meaning, even if the company itself doesn’t offer a dividend reinvestment program, the brokerage may enable you to reinvest dividends automatically in the same company stock.

How DRIPs Help Build Wealth Over Time

Reinvesting dividends can, in some cases, help build wealth over time.

• The shares purchased using the DRIP plan are bought without a commission, and sometimes at a slight discount to the market price per share, which can lower the cost basis and potentially add to gains.

• Using a dividend reinvestment plan effectively offers a type of compounding, because buying new shares will provide more dividends as well, which can again be reinvested.

That said, shares bought through a DRIP plan cannot be traded like other shares in the market; they must be sold back to the company.

In that sense, investors should bear in mind that participating in a dividend reinvestment plan also benefits the company, by providing it with additional capital. If your current investment in the company is aligned with your financial goals, there may be no reason to reinvest dividends in additional shares, and risk being overweight in a certain company or sector.

💡 Quick Tip: Investment fees are assessed in different ways, including trading costs, account management fees, and possibly broker commissions. When you set up an investment account, be sure to get the exact breakdown of your “all-in costs” so you know what you’re paying.

Types of Dividend Reinvestment Plans

There are two main types of dividend reinvestment plans. They are:

Company DRIPs

With this type of plan, the company operates its own DRIP as a program that’s offered to shareholders. Investors who choose to participate simply purchase the shares directly from the company, and DRIP shares can be offered to them at a discounted price.

Some companies allow investors to do full or partial reinvestment, or to purchase fractional shares.

DRIPs through a brokerage

Many brokerages also provide dividend reinvestment as well. Investors can set up their brokerage account to automatically reinvest in shares they own that pay dividends.

Partial DRIPs

In some cases a company or brokerage may allow investors to reinvest some of their dividends and take some in cash to be used for other purposes. This might be called a partial DRIP plan.

DRIP Example

Here’s a dividend reinvestment example that illustrates how a company-operated DRIP works.

If you own 20 shares of a stock that has a current trading value of $100 per share, and the company announces that it will pay $10 in dividends per share of stock, then the company would pay you $200 in dividends that year.

If you choose to reinvest the dividends, you would own 22 shares of that stock ($200 in dividends/$100 of current trading value = 2 new shares of stock added to your original 20). These new shares would also pay dividends.

If, instead, you wanted cash, then you’d receive $200 to spend or save, and you’d still have the initial 20 shares of the stock.

If you wanted to reinvest part of your dividends through the DRIP plan, you might be able to purchase one share of stock for $100, and take $100 in cash. Again, not all companies offer flexible options like this, so it’s best to check.

Long-Term Compounding With DRIPs

Again, reinvesting dividends in additional company shares can create a compounding effect: The investor acquires more shares that also pay dividends, which can then be taken as cash or reinvested once again in more shares of the same company.

That said, there are no guarantees, as companies are not required to pay dividends. In times of economic distress, some companies suspend dividend payouts.

In addition, if the value of the stock declines, or it no longer makes sense to keep this position in your portfolio, long-term compounding may seem less appealing.

Pros and Cons of DRIPs

If you’re wondering whether to reinvest your dividends, it’s a good idea to weigh the advantages and disadvantages of DRIPs.

Pros of Dividend Reinvestment Plans

One reason to reinvest your dividends is that it may help to position you for higher long-term returns, thanks to the power of compounding returns, which may hold true whether investing through a company-operated DRIP, or one through a brokerage.

Generally, if a company pays the same dividend amount each year and you take your dividends in cash, then you’ll keep getting the same amount in dividends each year (assuming you don’t buy any additional shares).

But if you take your dividends and reinvest them through a DRIP, then you’ll have more shares of stock next year, and then more the year after that. Over a period of time, the dividend amount you might receive during subsequent payouts could also increase.

An important caveat, however: Stock prices aren’t likely to stay exactly the same for an extended period of time.

Plus, there’s no guarantee that dividends will be paid out each period; and even if they are, there is no way to know for sure how much they’ll be. The performance of the company and the general economy can have a significant impact on company profitability and, therefore, typically affect dividends given to shareholders.

There are more benefits associated with DRIPs:

• You may get a discount: Discounts on DRIP shares can be anywhere from 1% to 10%, depending on the type of DRIP (company-operated) and the specific company.

• Zero commission: Most company-operated DRIP programs may allow you to buy new shares without paying commission fees. However, many brokerages offer zero-commission trading outside of DRIPs these days, too.

• Fractional shares: DRIPs may allow you to reinvest and purchase fractional shares, rather than whole shares that may be at a pricier level than you wish to purchase. This may be an option with either a company-operated or brokerage-operated DRIP.

• Dollar-cost averaging: Dollar-cost averaging is a strategy investors use to help manage price volatility, and lower their cost basis. You invest the same amount of money on a regular basis (every week, month, quarter) no matter what the price of the asset is.

Cons of Dividend Reinvestment Plans

Dividend reinvestment plans also come with some potential negatives.

• The cash is tied up. First, reinvesting dividends puts that money out of reach if you need it. That can be a downside if you want or need the money for, say, home improvements, a tuition bill, or an upcoming vacation.

• Risk exposure. There are a few potential risk factors of reinvesting dividends, including being overweight in a certain sector, or locking up cash in a company that may underperform.

If you’ve been reinvesting your dividends, and the stock portion of your portfolio has grown, using a DRIP could inadvertently put your allocation further out of whack, and you may need to rebalance your portfolio.

• Flexibility concerns. Another possible drawback to consider is that when your dividends are automatically reinvested through a DRIP, they will go right back into shares of stock in the company or fund that issued the dividend.

Though some company-operated DRIPs do give investors options (such as full or partial reinvestment), that’s not always the case.

• Less liquidity. When you use a company-operated DRIP, and later wish to sell those shares, you must sell them back to the company or fund, in many cases. DRIP shares cannot be sold on exchanges. Again, this will depend on the specific company and DRIP, but is something investors should keep in mind.

💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.

Cash vs Reinvested Dividends

Should I reinvest dividends or take cash instead? How you approach this question can depend on several things, including:

• Your short-term financial goals

• Long-term financial goals

• Income needs

Taking dividends in cash can provide you with ongoing income. That may be important to you if you’re looking for a way to supplement your paychecks during your working years, or for other income sources if you’re already retired.

As mentioned earlier, you could use that cash income to further a number of financial goals. For instance, you might use cash dividend payouts to pay off debt, fund home improvements or put your kids through college. Or you may use it to help pay for long-term care during your later years.

Cash may also be more attractive if you’re comfortable with your current portfolio configuration and don’t want to purchase additional shares of the dividend stocks you already own.

On the other hand, reinvesting dividends automatically through a DRIP could help you to increase your savings for retirement. This assumes, of course, that your investments perform well and that the shares you own don’t decrease or eliminate their dividend payout over time.

Tax Consequences of Dividends

One thing to keep in mind is that dividends — whether you cash them out or reinvest them — are not free money. Dividend income is taxed in the year they’re paid to you (unless the dividend-paying investment is held in a tax-deferred account such as an IRA or 401(k) retirement account).

• Qualified dividends are taxed at the more favorable capital gains rate.

• Non-qualified, or ordinary dividends are taxed as income.

Each year, you’ll receive a tax form called a 1099-DIV for each investment that paid you dividends, and these forms will help you to determine how much you owe in taxes on those earnings.

Dividends are considered taxable whether you take them in cash or reinvest them through a DRIP. The value of the reinvestment is considered taxable.

The exception to that rule is for funds invested in retirement accounts, such as an online IRA, as the money invested in these accounts is tax-deferred. If you have received or believe you may receive dividends this year, it can make sense to get professional tax advice to see how you can minimize your tax liability.

How DRIPs Affect Cost Basis

When dividends are reinvested to buy more shares of the same security, the DRIP creates a new tax lot. This can make calculating the total cost basis of your share holding more complicated. It may be worth considering working with a professional in that case, to ensure that you end up paying the right amount of tax when you sell shares.

The complexity around calculating the cost basis is another reason some investors reinvest dividends within tax-deferred accounts. In this case, the overall cost basis doesn’t matter, as withdrawals from a tax-deferred account — such as a traditional IRA or 401(k) — would be simply taxed as income.

Should You Reinvest Dividends?

Reinvesting dividends through a dividend reinvestment plan is partly a short-term decision, and mostly a long-term one.

Factors to Consider Before Reinvesting

If you need the cash from the dividend payouts in the near term, or have doubts about the market or the company you’d be reinvesting in (or you’d rather purchase another investment), you may not want to use a DRIP.

If on the other hand you don’t have an immediate need for the cash, and you can see the value of compounding the growth of your shares in the company over the long haul, reinvesting dividends could make sense.

If taxes are a concern, it might be wise to consider the location of your dividend-paying shares.

The Takeaway

Using a dividend reinvestment plan (DRIP) is a strategy investors can use to take their dividend payouts and purchase more shares of the company’s stock. However, it’s important to consider all the scenarios before you decide to surrender your cash dividends to an automatic reinvestment plan.

While there is the potential for compound growth, and using a DRIP may allow you to purchase shares at a discount and with no transaction fees, these dividend reinvestment plans are limiting. You are locked into that company’s stock during a certain market period, and even if you decided to sell, you wouldn’t be able to sell DRIP shares on any exchange but back to the company.

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

How do you set up a dividend reinvestment plan?

There are two ways to set up a dividend reinvestment plan. First, you can set up an automatic dividend reinvestment plan with the company or fund whose shares you own. Or you can set up automatic dividend reinvestment through a brokerage. Either way, all dividends paid for the stock will automatically be reinvested into more shares of the same stock.

Can you calculate dividend reinvestment rates?

There is a very complicated formula you can use to calculate dividend reinvestment rates, but it’s typically much easier to use an online dividend reinvestment calculator instead.

What’s the difference between a stock dividend and a dividend reinvestment plan?

A stock dividend is a payment made from a company to its shareholders (people who own shares of their company’s stock). A dividend reinvestment plan allows investors to reinvest the cash dividends they receive from their stocks into more shares of that stock.

Are dividend reinvestments taxed?

Yes, dividend reinvestments are taxed as income in the case of ordinary dividends. Qualified dividends are taxed at the more favorable capital gains rate. Dividends are subject to tax, even when you don’t take the cash but reinvest the payout in an equivalent amount of stock.

What are the benefits of using DRIPs for long-term investing?

One potential benefit of using a DRIP long term is that there may be a compounding effect over time, because you’re buying more shares, which also pay dividends, which can also be reinvested in more shares. This strategy could prove risky, however, if the company suspends dividends or if you become overweight in that company or sector.

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

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

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

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

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SOIN-Q325-059

Aug

2025

The Risks and Rewards of Naked Options

By Colin Dodds | Financial Independence, Growing Wealth, invest, Investing, Terminology | Comments Off

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.

Table of Contents

What Is a Naked Option?
The Pros and Cons of Naked Options
How to Use Naked Options
FAQ

A naked (or uncovered) option is an option that is issued and sold without the seller owning the underlying asset or reserving the cash needed to meet the obligation of the option if exercised.

While an options writer (or seller) collects a premium upfront for naked options, they also assume the risk of the option being exercised. If exercised, they’re obligated to deliver the underlying securities at the strike price (in the case of a call option) or purchase the underlying securities at the strike price (in the case of a put).

But because a naked writer doesn’t hold the securities or cash to cover the option they wrote, they need to buy the underlying asset on the open market if the option moves into the money and is assigned, making them naked options. Given the extreme risk of naked options, they should only be used by investors with a very high tolerance for risk.

Key Points

• Naked options involve selling options without owning the underlying asset or reserving cash to cover the trade if the option is exercised.

• Naked options are extremely high risk due to unlimited potential losses if the market moves against the position.

• Naked options sellers must have a margin account and meet specific requirements to trade naked options.

• Naked options strategies include selling calls and puts to try to generate income.

• Using risk management strategies is essential to try to mitigate the significant risk of loss associated with naked options.

What Is a Naked Option?

When an investor buys an option, they’re buying the right (but not the obligation) to buy or sell a security at a specific price either on or before the option contract’s expiration. An option giving a buyer the right to purchase the underlying asset is known as a “call” option, while an option giving a buyer right to sell the underlying asset is known as a “put” option.

Investors pay a premium to purchase options, while those who sell, or write options, collect the premiums. Some writers hold the stock or the cash equivalent needed to fulfill the contract in case the option is exercised before or on the day it expires. The ones who don’t are sometimes called naked writers, because their options have no cover.

Writing naked options is extremely risky since losses can be substantial and even theoretically infinite in the case of writing naked calls. The maximum gain naked option writers may see, meanwhile, is the premium they receive upfront.

Despite the risks, some writers may consider selling naked options to try to collect the premium when the implied volatility of the underlying asset is low and they believe it’s likely to stay out of the money. In these situations, the goal is often to try to take advantage of stable conditions and reduced assignment risk, even if premiums are smaller, though there is still a high risk of seeing losses.

Some naked writers traders may be willing to risk writing naked options when they believe the anticipated volatility for the underlying asset is higher than it should be. Since volatility drives up options’ prices, they’re betting that they may receive a higher premium while the asset’s market price remains stable. This is an incredibly risky maneuver, however, since they stand to see massive losses if the asset sees bigger price swings and moves into the money.

Recommended: A Guide to Options Trading

The Pros and Cons of Naked Options

Naked options offer writers the potential to profit from premiums received, but they come with a high risk of resulting in substantial losses. Here’s what to consider before using this advanced strategy.

Potential benefits of naked options

Premium income: Option writers collect premiums upfront, which can generate income if the contract expires worthless.

No capital tied up in the underlying asset: Because the writer doesn’t hold the underlying asset, their available capital may be invested elsewhere.

May appeal in low-volatility markets: While options writers often seek higher premiums during periods of elevated volatility, naked options may be attractive to some when implied volatility is low and premiums are relatively stable. This is because the price of the underlying asset may be less likely to see bigger price movements and move into the money. There is always the possibility, however, that the asset’s price could move against them.

Significant risks of naked options

Unlimited loss potential: For naked calls, a rising stock price can create uncapped losses if the writer must buy at market value. Naked puts can also lead to significant losses if the stock price falls sharply, obligating the writer to purchase shares at a strike price that is well above market value.

Margin requirements: Brokerages often require high levels of capital and may issue margin calls if the position moves against the writer.

Limited to experienced investors: Most brokerages restrict this strategy to individuals who meet strict approval criteria due to its complexity and risk.

Recommended: 10 Options Strategies You Should Know

How to Use Naked Options

Because naked call writing comes with almost limitless risks, brokerage firms typically require investors to meet strict margin requirements and have enough experience with options trading to do it. Check the brokerage’s options agreement, which typically outlines the requirements for writing options. The high risks of writing naked options are why many brokerages apply higher maintenance margin requirements for option-writing traders.

Generally, to sell a naked call option, for example, an investor would tell their broker to “sell to open” a call position. This means the investor is initiating the short call position. The trade is considered to be “naked” only if they do not own the underlying asset. An investor would do this if they expected the stock to go down, or at least not go any higher than the volatility priced into the option contract price.

If the investor who writes a naked call is right, and the option stays “out of the money” (meaning the security’s price is below a call option’s strike price), then the investor will pocket a premium. But if they’re wrong, the losses can be theoretically unlimited.

This is why some investors, when they expect a stock to decline, may instead choose to purchase a put option and pay the premium. In that case, the worst-case scenario is that they lose the amount of the premium and no more.

How to Manage Naked Option Risk

Most investors who employ the naked options strategy will also use risk-control strategies given the high risk associated with naked options.

Perhaps the simplest way to hedge the risk of writing the option is to either buy the underlying security, or to buy an offsetting option that would create an option spread, which may help limit potential losses if the trade moves against the writer. This would change the position from being a naked option to a covered option.

Some investors may also use stop-loss orders or set price-based exit points to try to close out a position before assignment, though this requires monitoring and quick execution. These strategies aim to exit the option before it becomes in-the-money and is assigned. Other risk-mitigation strategies can involve derivative instruments and computer models, and may be too time-consuming for most investors.

Another important way that options writers try to manage their risk is by being conservative in setting the strike prices of the options. Consider an investor selling a put option with a $90 strike price when the stock is trading at $100 (for a premium of say $0.50). Setting the strike price further from where the current market is trading may help reduce their risk. That’s because the market would have to move dramatically for those options to be in the money at expiration.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

The Takeaway

With naked options, the investor does not hold a position in the underlying asset. Because this is a risky move, brokerage firms typically restrict it to high-net-worth investors or experienced investors, and they also require a margin account. It’s crucial that investors fully understand the very high risk of seeing substantial losses prior to considering naked options strategies.

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

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

Explore SoFi’s user-friendly options trading platform.

🛈 SoFi does not offer naked options trading at this time.

FAQ

What is a naked option?

A naked option is a type of options contract where the seller does not hold the underlying asset, nor has sufficient cash reserved to fulfill the contract if exercised. This exposes the seller to potentially unlimited losses. Naked calls and puts are typically permitted only for experienced investors with high risk tolerance and margin approval.

What is an example of an uncovered option?

A common example of an uncovered, or naked, option is a call option sold by an investor who doesn’t own the underlying stock. If the stock price rises significantly and the option is exercised, the seller must buy shares at market price to deliver them, which can result in substantial losses.

Why are naked options risky?

Naked options are risky because the seller has no protection if the market moves against them. Without owning the underlying asset or an offsetting position, losses can be substantial or even technically unlimited in the case of naked call options if the stock price rises sharply.

Can anyone trade naked options?

No, not all investors can trade naked options. Many brokerages restrict this strategy to high-net-worth individuals or experienced traders who meet strict margin and approval requirements, due to the significant risk involved.

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

SOIN-Q225-066

Jul

2025

The Effects of Deadweight Loss

By Matthew Zeitlin | invest, Investing, Terminology | Comments Off

Table of Contents

What Is Deadweight Loss?
Common Causes of Deadweight Loss
How to Calculate Deadweight Loss
Why Investors Should Care About Deadweight Loss
FAQ

Deadweight loss is a macroeconomic term that refers to the total value of lost trades, caused by a mismatch between supply and demand. Deadweight loss can be the result of taxation, price restrictions, the impact of monopolies, and other factors.

Deadweight loss isn’t limited to a single company, but rather describes the impacts on the overall economy of certain policies, which can trickle down and have an effect on the markets.

Key Points

• Deadweight loss refers to the value of all the trades or transactions that did not occur owing to a market inefficiency.

• These inefficiencies are the result of a market distortion, or mismatch, such as what occurs when a tax or minimum wage is imposed.

• These factors can impact production costs and pricing, which can cause a disequilibrium in both supply and demand, leading to deadweight loss.

• Deadweight loss generally plays out in terms of larger societal and/or economic trends, and as such can impact markets as well.

What Is Deadweight Loss?

Deadweight loss refers to inefficiencies created by a misallocation or inefficient allocation of resources, and is an important economic concept. Deadweight loss is often due to government interventions such as price floors or ceilings, or inefficiencies within a tax system that effectively reduce trades or transactions by interfering with supply and demand equilibrium.

To understand more fully, it can be helpful to think about how government interventions can impact the equilibrium between supply and demand.

First: Calculate Surplus

In order to know how to calculate deadweight loss, we must first be able to calculate surplus.

Typically, a business will only sell something if they can do so at a price that’s greater than what they paid for it themselves, and a consumer will only buy something if it’s at or less than the price they want to pay for it — the same principle as generating a stock profit.

Scenario A — The Equilibrium: Let’s imagine Store X sells comic books for $10 each. The store buys the comic books from the wholesaler for $5 and sells them for $10, pocketing $5 of “producer surplus.”

Before the Store X opened, consumers traveled to another store to buy comic books for $15. This $5 difference between the price they were willing to pay and the newly available price is the “consumer surplus”.

In this case, let’s say Store X is able to sell 1,000 comic books, that means the combined producer and consumer surplus is $10,000.

Breakdown:

• P₁ = Producer’s Cost of a Comic Book = $5

• P₂ = Producer’s Price to Sell a Comic Book = $10

• P₃ = Price the Consumer Pays = $10

• P₄ = Price the Consumer Is Willing to Pay = $15

• Units Sold = 1,000

• Producer Surplus = (P₂ – P₁) * Units Sold = ($10 – $5) * 1,000 = $5,000

• Consumer Surplus = (P₄ – P₃) * Units Sold = ($15 – $10) * 1,000 = $5,000

• Total Surplus 1 = Producer Surplus + Consumer Surplus = $5,000 + $5,000 = $10,000

In this theoretical example, there is no deadweight loss because supply and demand are in balance. That would change if another factor entered the picture that caused a market distortion that caused a loss in the number of purchases. Deadweight loss being the value of the trades or transactions that did not occur, owing to a market inefficiency.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

Common Causes of Deadweight Loss

There can be several causes of deadweight loss, but some of the most common are government-mandated changes to markets. Examples include price floors, such as a minimum wage, which can create some inefficiencies in the labor market (there may be workers who would be willing to work for less than minimum wage).

Price ceilings, also can create deadweight loss — an example could be rent control. Finally, taxes can create deadweight loss, too.

How to Calculate Deadweight Loss

To properly calculate deadweight loss, you need to be able to represent the supply and demand of the goods being sold graphically in order to determine prices. According to the laws of supply and demand, the higher a price goes, the fewer of that item will get sold; and vice versa.

Example of Deadweight Loss

Let’s go back to our comic book example and imagine that the town’s government imposes a $2 tax on comic books.

Scenario B — The Impact of Taxes

What happens to the price of comic books and the surplus generated by the sales of comic books? Theoretically, Store X could simply bump up prices $2 and sell 1,000 comic books for $12 each, maintaining a $5 producer surplus on each comic book sold, with $2 going to the government, and consumer surplus of $3.

In this case the combined consumer and producer surplus is lower — $5 × 1,000 + $3 × 1,000 = $8,000. So there’s a missing $2,000 of what economics call “gains from trade.” But, the government is collecting $2,000, so the money does not disappear from the economy.

In other words, the government is collecting $2,000, with which it can buy things, hire people, and literally send money to people via economic stimulus measures. Thus, the tax revenue does not disappear from the economy.

But in reality, if Store X were to increase the price to $12, thus passing on the tax to customers, they may not be able to sell enough comic books to maintain the revenue needed to keep the store open.

If they lower the price to $11, splitting the cost of the tax between the store and consumers, it’s likely fewer consumers would buy comic books: let’s say Store X would now sell 600 comic books instead of 1,000.

The combined consumer and producer surplus is $4,800 ($4 × 600 + 600 × $4) with $1,200 of tax collected (600 × $2) meaning there’s a total of $6,000 of consumer surplus, producer surplus, and government revenue. In this case the deadweight loss is $4,000.

Breakdown:

• P₁ = Producer’s Cost of a Comic Book = $5

• P₂ = Producer’s Price to Sell a Comic Book = $9

• P₃ = Price the Consumer Pays = $11

• P₄ = Price the Consumer Is Willing to Pay = $15

• Units Sold = 600

• Tax = $2/Comic Book

• Producer Surplus = (P₂ – P₁) * Units Sold = ($9 – $5) * 600 = $2,400

• Consumer Surplus = (P₄ – P₃) * Units Sold = ($15 – $11) * 600 = $2,400

• Gains From Trade (Tax) = $2 * 600 = $1,200

• Total Surplus 2 = Producer Surplus + Consumer Surplus + Gains From Trade = $6,000

• Deadweight Loss = Total Surplus₁ – Total Surplus₂ = $10,000 – $6,000 = $4,000

The higher price, created through taxation, has impacted the equilibrium between supply and demand and created a deadweight loss — the number of sales that evaporated due to fewer transactions happening between the comic book seller and the readers.

While this is a rather extreme example of what happens when taxes force up prices, it’s a good way of thinking about how deadweight losses are more than just items getting more expensive. Rather, the deadweight loss formula can illustrate the evaporation of mutually beneficial economic transactions due to different types of taxes and other policies.

A similar impact can occur when a government imposes price floors or ceilings on items.

💡 Quick Tip: Are self-directed brokerage accounts cost efficient? They can be, because they offer the convenience of being able to buy stocks online without using a traditional full-service broker (and the typical broker fees).

Why Investors Should Care About Deadweight Loss

Deadweight loss can affect investors in a number of ways, and it’s important to consider it when looking at different types of investments. One of the most debated issues in economics is the effects that the tax system has on income, investment, and economic growth in the short and long run.

Some argue that income taxes, payroll taxes (the flat taxes on wages that fund Social Security and Medicare) and capital gains taxes work like the comic book tax described above, preventing otherwise beneficial transactions from happening and reducing the economic gains available to all sides. There’s evidence on all sides of this debate, and the effects of tax rates on overall economic growth are, at best, unclear.

As an investor, deadweight loss might matter when it comes to companies or sectors impacted by specific taxes, such as sales taxes or excise taxes on alcohol or cigarettes.

Deadweight loss shows how taxes on specific items can not only reduce profitability by increasing a company’s tax bill, but also affect revenue by reducing overall sales or driving down prices that businesses can charge or receive from buyers. As an investor, this knowledge and insight can be useful when allocating capital between companies, sectors, or types of assets.

The Takeaway

Deadweight loss is the result of economic inefficiencies, and it can affect an investor’s portfolio if it results in slower sales and revenues for businesses. It’s a large economic concept, and may not have a day-to-day direct impact on the stock market. But it’s still good for investors to know the basics of deadweight loss and how it applies to them.

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

FAQ

Why does a monopoly cause a deadweight loss?

A monopoly can cause deadweight loss because competitive markets create competition and fairer prices. A monopoly distorts prices, leading to inefficiencies.

Can deadweight loss be a negative value?

No, deadweight loss cannot be a negative value, but it can be zero. Zero deadweight loss would mean that demand is perfectly elastic or supply is perfectly inelastic.

Is deadweight loss market failure?

Deadweight loss is not a market failure, but rather, the societal costs of inefficiencies within a market. Market failures can, however, create deadweight loss.

Photo credit: iStock/akinbostanci

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

SOIN-Q325-025

Jul

2025

Comparing SPAC Units With Different Warrant Compositions

SPAC Warrants and Warrant Compositions

By Inyoung Hwang | Growing Wealth, invest, Investing | Comments Off

Table of Contents

How to Evaluate SPACs
SPAC Warrants 101
Can You Trade SPAC Warrants?
Converting SPAC Units Into Shares
SPAC Warrants: Merger vs No Merger
Examples of SPAC Investments With Different Warrant Compositions
Finding SPAC Warrants
Using SPAC Warrants
FAQ

An investor in a SPAC, or special purpose acquisition company, typically buys something called units, which are like packages that include shares of common stock as well as warrants (or fractions of warrants).

SPAC warrants are similar to options in that these contracts give investors the right to purchase shares of common stock, for a certain price (the strike price), by a certain date in the future, when the warrant expires and can no longer be redeemed. Fractions of warrants must be combined in order to purchase the appropriate number of shares.

The terms of different SPAC warrants can vary widely, though, and have a direct bearing on how many shares of stock the investor can purchase, during what period, and the circumstances whereby a SPAC can redeem the warrants. Investors interested in investing in SPACs after the IPO need to verify whether they are buying common stock shares, warrants, or units.

Key Points

• A SPAC is a shell company that raises capital in order to go public, and then seeks a private company to acquire or merge with, thereby taking that company public as well.

• Investors in a SPAC purchase “units,” which include common stock shares as well as warrants.

• SPAC warrants are contracts that allow investors to buy more common stock shares as long as certain terms are met in terms of price, timing, and so on.

• The terms of one SPAC warrant can differ from another, so investors have to understand the conditions so they make the best choices.

• A SPAC can decide to redeem outstanding warrants, particularly if the stock is trading above a certain price. If investors miss the redemption period, their warrants can expire worthless.

How to Evaluate SPACs

When evaluating whether or not to invest in a SPAC IPO, potential investors often consider:

• Who is the sponsor?

• Have they launched other SPACs before?

• Have those SPACs found targets and completed a successful company merger?

• Do the board members have the experience and track records that you would expect to evaluate investment opportunities?

However, it’s just as important for investors to understand the quantitative aspect of a SPAC deal. All SPACs are typically priced at $10 per unit, but the makeup of the units can vary.

Warrants and their inclusion, or absence, in a SPAC unit can affect investor profits. A SPAC unit can have the following compositions:

• One share + one full warrant

• One share + no warrant

• One share + partial warrant (e.g., ⅓ or ½ )

SPAC Warrants 101

SPAC warrants are similar to contracts known as stock warrants.

These contracts give stock warrant holders the right, but not the obligation, to buy stocks online or through a brokerage, at a later date. But unlike traditional options, stock warrants are offered by the company itself as a way to raise capital.

Similar to stock warrants (and options), SPAC warrants also have an expiration date, so investors must pay attention if they want to exercise them. Another nuance worth noting is that when warrants get exercised, the action can be dilutive to shareholders, since a flood of new shares can enter the market, impacting the price when investors buy shares.

SPAC Warrant Details

But warrants have the potential to be lucrative for these early SPAC investors. This is because, as explained, essentially they’re paying $10 for one share, plus the right to buy additional shares at a set price — what’s known as the strike or exercise price.

Also, even if an early investor decides to redeem their shares in the SPAC before a merger is completed, they get to keep the warrants that were a part of the SPAC units.

If the company doesn’t want to issue additional shares, they may not include warrants in their SPAC units. Market conditions may also dictate whether warrants are unnecessary.

Remember: Warrants are meant to entice investors to put in their money early. If demand for the SPAC is strong enough, the company may not feel the need to issue units with warrants.

Can You Trade SPAC Warrants?

Generally, an investor can only trade stock warrants if there is a whole number of warrants. If partial warrants are issued, that fraction may not be sold. In order to sell, the investor would need to purchase additional units in order to make up a whole warrant.

Here’s an example: Let’s say a SPAC unit consists of one share and a partial warrant that’s one-third of a warrant. This means that to own a whole warrant and purchase a share of stock, the investor would need to purchase two more units.

If they were to do this, then they could trade the whole warrant, either on a stock exchange or in the over-the-counter market.

Converting SPAC Units Into Shares

Another thing likely on investors’ minds: How do SPAC units actually get converted into shares? Depending on the specifics of the SPAC, the process happens more or less automatically, and there’s no action needed on the part of the investor. That’s assuming that the SPAC does end up merging and going public.

Converting SPAC warrants into shares is a bit more involved, however. In the case an investor wants to convert SPAC warrants to shares, investors should get in touch with their broker to discuss their options.

SPAC Warrants: Merger vs No Merger

SPAC warrants can be traded after a merger — for years, in some cases. That’s somewhat theoretical, though, as there may be redemption clauses in contracts that require investors to redeem their warrants under certain conditions. It really all depends on the specific SPAC, and the guidelines outlined within the contracts governing them.

If there is no merger, however, SPACs typically liquidate the funds they raised. Investors get their money back, and warrants are more or less worthless.

Examples of SPAC Investments With Different Warrant Compositions

It’s important for investors to examine the deal structure of each SPAC closely, and investors can do this by reading the initial public offering (IPO) prospectus.

The information around the composition of the shares or units being offered is usually on one of the first few pages, but reading the entire prospectus is essential for investors to make the right investment decision for them.

In general, here are some other pertinent pieces of information relating to warrants that potential investors should be looking for when reading through the prospectus:

• The strike price

• Exercise window

• Expiration date

• Whether there are any specific conditions that can trigger an early redemption

Investors should also inspect the exact composition of a SPAC unit. Does it offer one whole warrant, no warrant, one-quarter, one-third, or one-half?

The strike price, or exercise price, of SPAC warrants is often $11.50 a share. Investors sometimes have until five years after the merger before the warrant expires. However, the terms of different SPAC deals can vary. It’s possible that the deal terms call for an early redemption period, and if investors miss exercising their contracts in that period, the warrants could expire worthless.

SPAC Unit With Whole Warrant

Let’s say an investor buys 1,000 units of a SPAC. In this case, each SPAC unit is composed of one whole share, plus one whole warrant. That means the investor now owns 1,000 shares of the merged company stock, plus 1,000 warrants to buy shares of stock at $11.50 each.

If the SPAC completes its merger or acquisition and the shares jump to $20, the investor can buy additional shares for just $11.50 each. This would be a significant discount compared to where the existing shares are trading.

Here’s a hypothetical step-by-step example of how an investor could potentially profit from exercising their whole warrants:

1. Investor buys 1,000 units at $10 each, spending a total of $10,000.

2. SPAC shares jump to $20 each.

3. Investor exercises warrants, purchasing 1,000 shares for $11.50 each and spending an additional total of $11,500.

4. Investor sells all 2,000 shares immediately for the market price of $20 each, for $40,000 total.

5. Our investor pockets the difference (so $40,000 – $21,500 = $18,500).

SPAC Unit With No Warrant

Now, imagine that same investor bought into a SPAC where the units had no warrants. That means, while the investor’s 1,000 shares doubled in value, they didn’t have the right to buy an additional 1,000 shares. Here’s an example of this scenario:

1. Investor buys 1,000 units at $10 each, spending a total of $10,000.

2. SPAC shares jump to $20 each.

3. Investor sells the 1,000 shares immediately for $20 each, for $20,000 total.

4. Our investor pockets the difference (so $20,000 – $10,000 = $10,000).

SPAC Unit With Partial Warrant

Let’s say our hypothetical SPAC has units with partial warrants. So in each unit, there’s one share attached to a ½ warrant. Here’s how this would look:

1. Investor buys 1,000 units at $10 each, spending a total of $10,000.

2. SPAC shares jump to $20 each.

3. Investor exercises warrants. Every two warrants converts to one share of stock, so the investor buys 500 shares for $11.50 each, spending $5,750.

4. Investor sells all 1,500 shares immediately for $20 each, for $30,000 total.

5. Our investor pockets the difference (so $30,000 – $15,750 = $14,250).

Here’s a hypothetical table that lays out different profit scenarios depending on the warrant composition, assuming that an investor has bought 1,000 units, that the exercise price of the warrants is $11.50, and the underlying shares hit $20 each.

Warrants Attached to Each SPAC Unit	1 Whole Warrant	½ Warrant	⅓ Warrant	¼ Warrant	No Warrant
Units Purchased	1,000	1,000	1,000	1,000	1,000
Number of Shares That Can Be Bought With Warrants in SPAC Unit	1,000	500	333	250	0
Cost of Exercising Warrants at $11.50 Strike Price	$11,500	$5,750	$3,829.50	$2,875	$0
Proceeds From Selling Shares Acquired Through Warrant Exercise	$20,000	$10,000	$6,660	$5,000	$0
Net Proceeds from Selling Shares Exercised From Warrants	$8,500	$4,250	$2,830.50	$2,125	$0
Net Proceeds From Selling All Shares	$18,500	$14,250	$12,830.50	$12,125	$10,000

Finding SPAC Warrants

Since SPAC warrants trade like shares of stocks, and are listed by many brokerages, investors can often look them up and execute a trade like they would many other securities.

One tricky thing to watch out for, though, is that SPAC warrants may trade under different ticker symbols on different brokerages or exchanges. So, you’ll want to make sure you’re looking for the SPAC warrant you want before executing a trade.

Using SPAC Warrants

SPAC warrants’ main utility is that they can be traded or executed — meaning they can be converted into shares and, under the right conditions, sold at a profit.

So, for investors, using a SPAC warrant typically comes down to one of the two in an attempt to generate a return. There may be times when a SPAC doesn’t merge and investors get their money back, but the true utility of warrants is that they can be executed or traded.

The Takeaway

With SPAC investments, whether units come with full warrants, no warrants, or partial warrants is a quantitative consideration. All else being equal, SPACs that provide full or partial warrants offer more potential profit than SPACs that offer no warrants.

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

FAQ

How do you evaluate SPACs?

Investors can evaluate SPACs by looking at qualitative aspects, including who the sponsors are, their backgrounds, whether the SPAC has found a target, and what types of experiences the board members have.

What is an example of a SPAC unit with a whole warrant?

An example of a SPAC with a whole warrant means that the investor would have one share per unit, plus a warrant to buy an additional share per unit. So if they owned 500 units, they would have 500 shares and warrants for 500 more shares.

What is a partial warrant?

When an investor buys a SPAC unit, it typically includes a share of stock and a warrant or partial warrant to be applied to additional shares, at some point in the future, per the terms of the warrant contract. Partial warrants might include a ½ warrant or a ⅓ warrant. In order to redeem the warrants for a full share of stock, the investor would need to buy more units, in order to combine the partial warrants into a whole warrant that’s worth a full share.

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Navigating the IPO Lock-up Period

What Is an IPO Lock-up Period?

How the IPO Lock-Up Period Works

What Does “Going Public” Mean?

What Is IPO Underwriting?

How IPO Lock-ups Get Used

What Is the Purpose of a Lock-up Period?

Ensuring Share-Price Stability

Avoiding Insider Trading

Public Image

What’s an Example of a Lock-up Period?

What Does the Lock-up Period Mean for Employees with Stock Options?

How Does the IPO Lock-Up Period Affect Investors?

Reading the IPO Prospectus

Waiting to Buy Until After Lock-ups End

The Takeaway

FAQ

What is the purpose of a lock-up period?

How do I know if an IPO has a lock-up period?

What is the lock-up period for IPO employees?

Dividend Reinvestment Plans: How DRIP Investing Works

What Is Dividend Reinvestment?

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What Is a Dividend Reinvestment Plan?

How DRIPs Help Build Wealth Over Time

Types of Dividend Reinvestment Plans

Company DRIPs

DRIPs through a brokerage

Partial DRIPs

DRIP Example

Long-Term Compounding With DRIPs

Pros and Cons of DRIPs

Pros of Dividend Reinvestment Plans

Cons of Dividend Reinvestment Plans

Cash vs Reinvested Dividends

Tax Consequences of Dividends

How DRIPs Affect Cost Basis

Should You Reinvest Dividends?

Factors to Consider Before Reinvesting

The Takeaway

FAQ

How do you set up a dividend reinvestment plan?

Can you calculate dividend reinvestment rates?

What’s the difference between a stock dividend and a dividend reinvestment plan?

Are dividend reinvestments taxed?

What are the benefits of using DRIPs for long-term investing?

The Risks and Rewards of Naked Options

What Is a Naked Option?

The Pros and Cons of Naked Options

Potential benefits of naked options

Significant risks of naked options

How to Use Naked Options

How to Manage Naked Option Risk

The Takeaway

FAQ

What is a naked option?

What is an example of an uncovered option?

Why are naked options risky?

Can anyone trade naked options?

The Effects of Deadweight Loss

What Is Deadweight Loss?

First: Calculate Surplus

Common Causes of Deadweight Loss

How to Calculate Deadweight Loss

Example of Deadweight Loss

Scenario B — The Impact of Taxes

Why Investors Should Care About Deadweight Loss

The Takeaway

FAQ

Why does a monopoly cause a deadweight loss?

Can deadweight loss be a negative value?

Is deadweight loss market failure?

SPAC Warrants and Warrant Compositions

How to Evaluate SPACs

SPAC Warrants 101

SPAC Warrant Details

Can You Trade SPAC Warrants?

Converting SPAC Units Into Shares

SPAC Warrants: Merger vs No Merger

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