Memorial Day Encore: Why Planners Hate Options
A dramatic influx of new retail and institutional customers iscontinuing to drive the options markets forward. While other marketsegments remain stagnant, options volume increases at a nearlyexponential pace every year. After decades of marketing and educationalefforts, it appears everyone is finally catching on to the numerousbenefits of using options. Everyone, that is, except one very importantsegment of the institutional market. This segment represents a vastuntapped opportunity in terms of potential assets. It also represents agateway to the numerous retail customers who rely on it for trading andinvestment decisions. If the options markets are to continue theirimpressive growth rate, then they must learn how to reach stockbrokers,financial planners and financial advisors.
THEY JUST AREN'T INTERESTED
It stands to reason that the advisory community would at least befamiliar with these instruments. After all, the Series 7, CFA and otherprofessional examinations all contain information about options.Additionally, options are the ideal hedges for equities, an asset classthat most brokers and advisors use in their work. Unfortunately, thisjust isnít the case. The simple fact of the matter is that this groupdoes not use options to any appreciable degree. A 2005 study by HarrisInteractive found that only 23% of options investors received theiroptions information from a broker or financial advisor. When it comesto options, the advisory community just isnít interested.
Why canít options penetrate into this lucrative market? The perceivedhassle of using options is a prominent hurdle. A busy broker or advisorhas a large number of clients to manage. Between meeting with hisexisting clients, looking for new clients, planning out his investmentstrategies and keeping abreast of the fluctuations in the marketplace,he simply doesnít have time to add options to his portfolio. The hassleof calculating the optimal covered calls and protective puts for everyclient, compounded with the frustration of rolling these positionsevery few months, outweighs the protection and income that they offer.
THEY JUST DON'T UNDERSTAND THEM
Fortunately, this problem has been somewhat alleviated in recent yearsby the rising commoditization of the options marketplace. Strategiessuch as covered call writing, which used to require continued vigilanceon the part of the adviser, can now be automated with all-in-oneproducts such as the buy-write index (BXM ñ see earlier issues of TheOptions Observer for details). Unfortunately, these products remain fewand far between in the options world. Until they become more prominent,planners and advisers will still have to do extra work if they want totrade options for their clients.While time is an issue for manyplanners and advisers, lack of education is a far greater impediment tothe options markets. To put it mildly, most financial planners andadvisers have little or no understanding of options. As a result, theysimply do not feel comfortable incorporating these instruments intotheir clientsí portfolios. How can this lack of education be overcome?The answer is quite simple ñ certification.
The financial industry has been testing and certifying financialservices professionals for decades. Unfortunately, these programs arean utter failure when it comes to practical options education. Whilethe series 7, CFA and other programs touch on options to varyingdegrees, the amount of options content they provide is severelylimited. For example, of the ten major topics outlined in the CFAcurriculum, only one of them covers derivatives. To make matters worse,only one-fifth of the information in that topic is related to options.This problem is not limited to broad financial certification programslike the CFA. Even dedicated options examinations like the NASDísSeries 4 and Series 42 are relatively useless when it comes topractical options education. Designed primarily for options principals,almost three-quarters of the Series 4 is devoted to rules and statutoryprovisions rather than options trading, position management and marketinformation. The Series 42 includes sections on basic optionsdefinitions, but it devotes most of its time to taxation, marketing andthe proper handling of customer accounts. Given these meagereducational offerings, it is little wonder that few brokers andfinancial advisors feel comfortable recommending options investments totheir clients.
THEY NEED CERTIFICATION
If the options industry wants to make inroads into the lucrativeadvisory market, then they need to create a new options certificationprogram that meets the education needs of these individuals. Instead offocusing on sales practices, industry regulations or simple optionsvaluation, this program needs to focus on preparing brokers andadvisers to trade and manage options positions. With such a largemarket at stake, youíd think that the options industry would be eagerto create a new certification program. However, that is not the case.Despite its obvious benefits, no one in the options markets isscrambling to usher in a new standard of practical optionscertification.
EVERYONE IS TERRIFIED OF LIABILITY
The primary source of this reticence is fear of liability. Optionsexchanges, trading firms and other industry organizations simply donítwant to shoulder the burden of certifying planners and advisers. Thishesitancy is understandable given the highly leveraged nature ofoptions and the litigious nature of todayís financial market. If anewly certified broker used options to bankrupt his clients, it couldleave the certifying firm open to an embarrassing and potentiallycostly lawsuit. With such dire consequences, itís no wonder that firmsand exchanges arenít rushing to create their own optionscertifications. There are ways around this liability. After all,numerous substandard brokers and advisers have passed the CFA andSeries 7 over the years. However, those organizations havenít vanishedunder a series of lawsuits. The most direct path to avoiding liabilityis to involve a regulatory agency. If the SEC were to lend itsimprimatur to a new options certification program, or if the NASD wereto create a new exam that focuses on options competency rather thanregulation, it would alleviate many of the problems associated withliability. Unfortunately, given the glacial speed at which the SEC andNASD operate, neither development is likely to happen anytime soon.
Another way around the liability issue is to include some sort ofethical or best-practices component into the certification program.This will allow the certifying firm to spell out exactly what is beingcertified. It will also clearly state how recipients can implementtheir knowledge responsibly. The danger of such an approach is that thenew exam will be so weighed down by regulatory and ethical informationthat it loses its focus. Instead of building options competency amongbrokers, advisers and planners, it will simply become another testabout statutes and ethical compliance. In that case, the newcertification would be little better than the existing optionscertifications. Fortunately, there is a light at the end of the tunnel.The Options Industry Council (OIC) recently contacted the CFA, theGlobal Association of Risk Professionals (GARP), the Charter ofAlternative Investment Analysts (CAIA) and other financialcertification groups about including more options content in theirprograms. However, if the options industry is ever going to succeed inthis lucrative market, then it is going to have to overcome itsparalyzing fear of liability once and for all.
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