Options trading is a gamble. It’s also a contract to buy or sell a stock at a pre-determined price by a certain date. These types of trades place a bet that the market will change directions according to an investor’s hunch.

Options trading allows investors to buy time and observe the market before committing to a final strategy, and if managed carefully, this strategy could amplify a portfolio’s returns. That said, options trading is quite complex and only suitable for experienced investors. (And even they can get it very, very wrong.)

Complex securities should always make investors wary, no matter how wealthy they might be. With so much lingo surrounding this type of trading, it can be tempting to just nod along with a broker. But as many investors have learned the hard way, even if your broker seems confident, it’s always possible for options strategies to lose a significant amount of money.

What Investors Need to Know About Options

It’s essential to grasp basic options trading vocabulary before talking shop with your investment advisor or broker.

Strike Price

The agreed-upon price for an option is called the “strike price.” Brokers can buy or sell at the strike price for a limited amount of time. Hopefully, the broker’s intuition about how the market will move is correct, and they’ll be able to buy or sell at a time when the difference between the market price and the strike price results in a healthy return.

Call Options and Put Options

Call options and put options are the two basic types of options trading.

  • Call options give investors the right to buy a security at a certain price, within a specified timeframe.
  • Put options give investors the right to sell a security at a certain price, also by a specific date. Puts are less common than calls.

Staddles are neutral positions, taken when an investor buys a put and a call for the same security. In a straddle, the put and the call both have the same expiration date. This strategy can make an investor a good return when the market moves sharply up or down.

Note: It’s also possible that the broker won’t use their call or put options by the pre-determined date, and will simply let the option expire.

How Options Can Go Wrong: UBS and the Yield Enhancement Strategy

Options strategies don’t always live up to their marketing materials. For example, a number of brokers from financial firm UBS are facing an avalanche of customer complaints in connection with their options strategy.  The complaints alleged that the strategy proved riskier than their clients had believed. Complaints like these often refer to suitability — one of FINRA’s most basic rules for investors, and one of the most frequently broken. Investment advisors have a fiduciary duty to ensure that they recommend investment strategies that support their clients’ financial goals, instead of simply following their gut feeling about how the market will behave.

According to complaints filed with FINRA, the Yield Enhancement Strategy (YES) is an options strategy that UBS offered to wealthy investors. According to its strategy description, it sought “to provide an additional source of income when markets are flat.” Investors might rely on marketing material to explain the strategy, and for YES, they would have read that it was “market neutral,” and that the market could fluctuate without affecting investor’s income. But this was simply not the case.

Holdings for YES reached their height at $6 billion in 2018. When the COVID-19 pandemic hit, investors suffered losses that amounted to 33%. BrokerCheck reveals complaints from investors who allege they did not understand the downsides of the options strategy. Many of these investors were seeking six figures in damages.

What Went Wrong?

The Wall Street Journal reports that YES relied on an “iron condor” strategy, which generates positive results only if the market doesn’t have sharp spikes. The YES strategy also made use of borrowed money, which made the already risky strategy even riskier. YES tells a story anyone familiar with the securities industry has heard before: Financial advisers claim they have an investment strategy that comes with spectacular yields, but when the market suffers a downturn, many investors are left wondering how to recoup their spectacular losses.

If you believe your broker may have taken a gamble on a speculative options strategy, contact an attorney at Fitapelli Kurta to get a free case evaluation. Call (877) 238-4175 or email info@fkesq.com.

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