Having That Little Talk With Your Clients - Continued
Options are contracts in which the buyer relies on a seller’s promise to perform under adverse circumstances. It is such circumstances which have contributed to the negative connotation surrounding options – think Orange County, California. However, this notion can actually be used to assuage, rather than stoke fears. The use of exchange listed option contracts, guaranteed by the Option Clearing Corporation (OCC), effectively spreads performance risk across the entire industry, rather than any one institution as is the case with many over-the-counter options and structured products containing embedded options.
So why might having this little chat be so difficult? Options are instruments of risk transference. The notorious blow-ups which involved derivatives reported in the media occurred because the blown up parties accepted payment to bear risk. The risk transpired, leverage accentuated the pain, and the bearers were on the hook. This is a gross simplification, but in essence, success with options is all about how they’re used.
While it is no doubt possible to structure a portfolio of options that uses leverage in a way that can bring your clients to financial ruin more quickly and more efficiently than with stock holdings, doing so is easily avoidable. Using options allows you to, in fact, more acutely manage your client’s exposure to risk than is possible though outright purchase of the assets themselves. This can reduce the volatility of returns and make outcomes more predictable. That alone should grease the skids when it’s time to get your clients to sign an option trading agreement.
There are thousands of options that can be used to cost efficiently create exposure to individual stocks, sectors, industries, countries, or broad market indices. This is in addition to well developed option markets in currencies, commodities, resources, and interest rates, and because of the leverage of options, you can keep the lions’ share of your client’s assets in highly safe, interest bearing instruments.
By explaining that options can function as a core component of an effective risk management strategy that you are using to keep their investment plan as free of surprises as possible, you are both solidifying their trust in you, and accentuating your added value as an Advisor.
Jon Gold is a principal with Helios, an independent fee-only Registered Investment Advisor that offers objective investment counsel free from industry and product affiliations. Helios works closely with advisory firms so that they may expand their suite of services to include low-cost, diversified, tax-efficient portfolios that exhibit less volatility than traditional equity investments. You can reach Mr. Gold at email@example.com.