Coffee With Cott

Overcoming the Misconceptions About Options

Coffee With CottCoffee With Cott is a blog from The Options Industry Council's Financial Advisor Division. Written by Eric Cott, a former advisor who has been the Director of Financial Advisor Education at the OIC since he developed the organization's outreach program in 2009, Coffee With Cott offers percolating insight on options strategies, as well as practice management ideas.

The data tells us that a large percentage of advisors are using options for their clients. That's great to hear. At the same time, a whole lot more are not using options. Not so great, in my opinion.

So, what's going on here? Options can be a tremendous tool for managing risk or generating income, so why is it that many advisors avoid them? There are plenty of reasons cited, some of which are detailed in a 2017 Cerulli Associates paper that OIC commissioned. But I believe that options are simply misunderstood - and that advisors are doing a disservice to their clients by not educating themselves on the benefits of incorporating these products in to investor portfolios.

That's what I'm hoping to change. While it's true that your clients need to know about all the risks before they invest in options, it's also true that, for many portfolios, options may present opportunities to enhance risk-weighted returns. So, in this edition of Coffee With Cott, I'm going to cover five of the big misconceptions about options to see if I can get a few new ideas brewing.

Misconception 1: Options are high risk. If you're selling naked calls, obligating you to cover something you don't own and that could theoretically rise forever, sure, that would be a risky move - and you could get burned. But if you're selling covered calls, meaning you might have to sell something you do already own, that has a defined risk. And that risk is less than the risk of uncovered securities. The main risk with covered calls is you would miss the upside beyond the strike price. But when you think about it, that's similar to a limit order. To conclude, certain option strategies may carry significant risk. Others have a lot less or can remove risk almost entirely.

Misconception 2: They're too hard for investors to understand. Personal financial decisions can be difficult. But if you are already having conversations with clients about managing interest rates, different investing time frames, volatility and multiple asset classes, there's a decent chance they can handle a talk about options, too. In fact, you can get a sense of the modern options investor from an in-depth Harris Poll study on the topic. There's no doubt that some option strategies are best left for more sophisticated investors, but there are also strategies for investors who are new to options. The Options Industry Council's website is a great place to start learning the basics. We've also got a section dedicated to detailing almost 50 unique strategies. Options aren't going to be right for everyone, but they absolutely can be effective means for managing risk or producing income in the right scenarios.

Misconception 3: If you want to underperform, trade options. Your client is long a stock, and he buys puts to protect against the downside. But the stock just keeps going up, and the money for the long put is gone forever. If he had just held the stock, he would have been better off. Now, he's bitter. Well, what if that stock fell instead? That put could have been a nice offset that may have produced stability for the client. While there are times you may trail another investment with options, that's not always so. Think about insurance for your home. The premiums do have a cost, but in the event of a disaster, you'll be glad you have a policy.

Misconception 4: Options are all about timing, and you can't time the market. As with a lot of things, there's some truth to this. There's also the other side, or the "cup-is-half-full" scenario. Although you can buy and sell options that are only days away from expiration, and timing is obviously crucial there, you can also find options that won't expire for months. With LEAPS®, or Long-Term Equity AnticiPation Securities®, you can invest in options that may not expire for a few years. But whatever your time frame, the U.S. listed equity options market is efficient and liquid, as illustrated by the fact that OCC, the world's largest equity derivatives clearing firm and proud sponsor of OIC, cleared a record 5.14 billion option contracts last year.

Misconception 5: Almost all options expire worthless. There's a widely held belief that up to 90% of options "expire worthless." However, the data from OCC paints a very different story. OCC indicates that in 2017 about 23% of options expired.  Another 7% of options were exercised, while the majority, just under 70%, were sold by investors to close the transaction. Also, it's important to remember that in some strategies, such as call writing, the investor may want the option to expire worthless.

These are only five of the misconceptions I hear when I'm at conferences or meeting with advisors. There are other notions about options that I'm trying to dispel. All I'm asking for now is this: Take another look at the information available on OIC. Then decide if options could have a place for your clients.

You can also send me an email (ecott@theocc.com) so we can start talking about it. Or, let's grab a cup of coffee one of these days. I travel all over this great land talking to advisors about options, and there's a good chance I'll be in your area before too long. Here's something else: You can contact my Investor Services colleagues at options@theocc.com or chat with them during market hours. These market professionals have a wealth of knowledge, and they're ready to help you with all your great questions, entirely for free.

So why not contact OIC today? Once you understand all sides of the options equation, you can have a real conversation with your clients about whether they might make sense.

Be sure to watch for our next Coffee With Cott blog: Options Terms You Need to Know. Do you have a topic you want to see covered in the Coffee With Cott blog? Let us know by writing to options@theocc.com.

 

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