Running With the Pack - Part 1
THE BIG BAD WOLF
Options have always been portrayed as the big bad wolves of the financial world. They are said to lurk in the ìshadow marketsî of Chicago, waiting to gobble up any unsuspecting trader or portfolio manager who crosses their path. Although most of the stories about the destructive power of options are fanciful, there is a kernel of truth hidden inside these tall tales. Like any leveraged instrument, options can be dangerous in the wrong hands. High profile financial disasters like Long Term Capital, Barings and Enron are bleak testaments to that fact. Given the colorful history of options, itís no wonder that so many financial planners break out in a cold sweat at the mere mention of them. After all, financial planners are the shepherds of their clientís portfolios. They spend years tending to each individual investment, diversifying and managing risk in order to keep the predators at bay. With so many vulnerable investments to safeguard, only a lunatic would open the door and let the wolves in among the sheep. However, thatís exactly what a few intrepid financial planners are doing, and the world of portfolio management may never be the same.
A BOOMING MARKET
It may shock you to learn that, while you have been avoiding the world of options, many of your clients have embraced it wholeheartedly. Although options were once considered the exclusive domain of high net-worth individuals and shadowy hedge funds, they have recently exploded into the mainstream. While overall equity volume has remained stagnant over the past five years, option volume over the same period has exploded. Not too long ago, the industry was struggling to clear a few hundred million contracts a year. Last year, the industry cleared a record 1.2 billion contracts. That exponential growth rate is showing no signs of slowing anytime soon. ìThe options markets continue to defy expectations year after year,î says Matt Andresen, President of Citadel Execution Services. ìIf you look at the industryís growth rate from 1999 to today, you can see a clear trend. Even though the growth of the equity markets has been sluggish during the same period, options volume has continued to increase at an impressive rate. Five years from now, itís likely that the market for options products will be significantly larger than it is today.î
Although options have become common sights in many portfolios, most financial advisers have completely missed this booming market. While overall option volume has increased dramatically during the past five years, the number of options accounts handled by large trust companies like FISERV has actually decreased. This decline suggests that, while investors are turning to options in ever-larger numbers, they arenít relying on financial advisers for guidance. A recent study by the Options Industry Council supports this assessment. The study found that 72% of options investors donít rely on financial advisors for investment advice. Even more shocking, only 2% of respondents listed financial advisors as an important source for information about their options investments. These startling statistics highlight two key problems facing the financial advisory community:
1. Options investors have a severe lack of confidence in financial advisers, particularly when it comes to options.
2. The advisory community has displayed a stunning lack of interest in this segment of the market, allowing options business to flow to brokerage firms and specialty options firms instead.
The indifference of financial advisers to the options market is even more surprising when you consider the demographics of the typical options investor. The OIC study found that options investors have higher incomes, a higher level of education, more financial experience and more liquid assets than non-options investors. In short, they are the ideal clients, but the financial advisory community is ignoring them.
Continued in Part Two...
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