Options Trading: When Your Broker Turns Your Portfolio Into a Casino

Options trading can be a useful tool for experienced investors, but it can also be a fast way to lose money if you don’t understand what you’re doing. Unfortunately, many brokers push options strategies on investors who have no business trading options.

If your broker has suggested options trading, you need to understand exactly what you’re getting into before you risk your money.

What Are Options?

Options are contracts that give you the right (but not the obligation) to buy or sell a stock at a specific price within a certain time period. They’re called “derivatives” because their value is derived from the underlying stock.

There are two basic types:
– Call options – Give you the right to buy a stock
– Put options – Give you the right to sell a stock

Sounds simple, but options strategies can get incredibly complex.

Why Options Are Risky

Time decay – Options lose value as they approach expiration, even if the stock doesn’t move.

Leverage – Options allow you to control large positions with small amounts of money, amplifying both gains and losses.

Complexity – Many options strategies are so complex that even experienced traders don’t fully understand them.

Total loss potential – You can lose 100% of your investment if options expire worthless.

Margin requirements – Some options strategies require margin, adding additional risk.

Common Options Strategies (And Their Risks)

Buying calls or puts – Limited risk (you can only lose what you paid), but high probability of total loss.

Covered calls – Selling calls against stocks you own. Seems conservative but limits your upside potential.

Cash-secured puts – Selling puts with cash to back them up. Can force you to buy stocks at bad times.

Spreads – Complex strategies involving multiple options. Hard to understand and manage.

Straddles and strangles – Betting on volatility. Can lose money even if you’re right about direction.

Who Should Trade Options

Options might be appropriate for:
– Experienced investors who understand the risks
– People with money they can afford to lose completely
– Investors using options for specific hedging purposes
– Professional traders with proven strategies

Options are NOT appropriate for:
– Conservative investors
– People who don’t understand how they work
– Investors who can’t afford significant losses
– Anyone using retirement money

Red Flags in Options Recommendations

Your broker pushes complex strategies you don’t understand.

They emphasize potential profits without explaining risks.

You’re told options are “conservative” or “safe.”

The strategy requires frequent trading (generating more commissions).

You’re using retirement money for speculative options trades.

The Suitability Problem

FINRA requires brokers to determine that options trading is suitable for each client. This means considering:
– Your investment experience and knowledge
– Your financial situation and needs
– Your risk tolerance
– Your investment objectives

Many brokers skip this analysis and approve clients for options trading who have no business doing it.

Real-World Disaster Stories

The Retiree’s Nightmare – A 70-year-old retiree was convinced to sell puts on tech stocks to “generate income.” When the tech crash hit, he was forced to buy stocks at prices far above market value, wiping out most of his retirement savings.

The Complex Strategy Catastrophe – An investor was sold a complex options strategy called an “iron condor” that was supposed to be “low-risk.” When the market moved against the position, he lost $50,000 in a matter of days.

The Covered Call Trap – An investor was told that selling covered calls was a “conservative” way to generate income. When his stocks soared, the calls were exercised and he missed out on huge gains.

Questions to Ask Before Trading Options

• Do I really understand how this strategy works?
• What’s the maximum I can lose?
• What needs to happen for this trade to be profitable?
• How much time do I have for this trade to work?
• What are all the costs and fees?
• Is this appropriate for my risk tolerance and financial situation?

Protecting Yourself

Start small – If you must trade options, start with small positions you can afford to lose.

Stick to simple strategies – Avoid complex multi-leg strategies until you have significant experience.

Set strict limits – Decide in advance how much you’re willing to lose and stick to it.

Understand the Greeks – Learn about delta, gamma, theta, and vega if you’re going to trade options seriously.

Paper trade first – Practice with fake money before risking real money.

What to Do If Options Trading Goes Wrong

If your broker recommended inappropriate options strategies or failed to explain the risks, you might have legal options:
– Suitability violations
– Failure to supervise
– Misrepresentation of risks
– Churning through excessive options trading

Document everything: your conversations with your broker, your stated investment goals, and any losses from inappropriate options trading.

The Bottom Line

Options can be useful tools for experienced investors, but they’re often misused by brokers who are more interested in generating commissions than protecting their clients.

Don’t let brokers convince you that options trading is easy money or a conservative strategy. For most investors, simple buy-and-hold investing is a better approach.

If you’ve been harmed by inappropriate options recommendations, an experienced securities attorney like investment fraud lawyer Robert Pearce can help you understand your options (no pun intended) and potentially recover your losses.

Remember: the options market is a zero-sum game where professionals compete against amateurs. Make sure you know which one you are before you start playing.