Why Planners Hate Options

---

A dramatic influx of new retail and institutional customers is continuing to drive the options markets forward. While other market segments remain stagnant, options volume increases at a nearly exponential pace every year. After decades of marketing and educational efforts, it appears everyone is finally catching on to the numerous benefits of using options. Everyone, that is, except one very important segment of the institutional market. This segment represents a vast untapped opportunity in terms of potential assets. It also represents a gateway to the numerous retail customers who rely on it for trading and investment decisions. If the options markets are to continue their impressive 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 be familiar with these instruments. After all, the Series 7, CFA and other professional examinations all contain information about options. Additionally, options are the ideal hedges for equities, an asset class that most brokers and advisors use in their work. Unfortunately, this just isnít the case. The simple fact of the matter is that this group does not use options to any appreciable degree. A 2005 study by Harris Interactive found that only 23% of options investors received their options information from a broker or financial advisor. When it comes to options, the advisory community just isnít interested.

Why canít options penetrate into this lucrative market? The perceived hassle of using options is a prominent hurdle. A busy broker or advisor has a large number of clients to manage. Between meeting with his existing clients, looking for new clients, planning out his investment strategies and keeping abreast of the fluctuations in the marketplace, he simply doesnít have time to add options to his portfolio. The hassle of calculating the optimal covered calls and protective puts for every client, compounded with the frustration of rolling these positions every 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 years by the rising commoditization of the options marketplace. Strategies such as covered call writing, which used to require continued vigilance on the part of the adviser, can now be automated with all-in-one products such as the buy-write index (BXM ñ see earlier issues of The Options Observer for details). Unfortunately, these products remain few and far between in the options world. Until they become more prominent, planners and advisers will still have to do extra work if they want to trade options for their clients.While time is an issue for many planners and advisers, lack of education is a far greater impediment to the options markets. To put it mildly, most financial planners and advisers have little or no understanding of options. As a result, they simply do not feel comfortable incorporating these instruments into their 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 financial services professionals for decades. Unfortunately, these programs are an utter failure when it comes to practical options education. While the series 7, CFA and other programs touch on options to varying degrees, the amount of options content they provide is severely limited. For example, of the ten major topics outlined in the CFA curriculum, 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 programs like the CFA. Even dedicated options examinations like the NASDís Series 4 and Series 42 are relatively useless when it comes to practical options education. Designed primarily for options principals, almost three-quarters of the Series 4 is devoted to rules and statutory provisions rather than options trading, position management and market information. The Series 42 includes sections on basic options definitions, but it devotes most of its time to taxation, marketing and the proper handling of customer accounts. Given these meager educational offerings, it is little wonder that few brokers and financial advisors feel comfortable recommending options investments to their clients.

THEY NEED CERTIFICATION
If the options industry wants to make inroads into the lucrative advisory market, then they need to create a new options certification program that meets the education needs of these individuals. Instead of focusing on sales practices, industry regulations or simple options valuation, this program needs to focus on preparing brokers and advisers to trade and manage options positions. With such a large market at stake, youíd think that the options industry would be eager to create a new certification program. However, that is not the case. Despite its obvious benefits, no one in the options markets is scrambling to usher in a new standard of practical options certification.

EVERYONE IS TERRIFIED OF LIABILITY
The primary source of this reticence is fear of liability. Options exchanges, trading firms and other industry organizations simply donít want to shoulder the burden of certifying planners and advisers. This hesitancy is understandable given the highly leveraged nature of options and the litigious nature of todayís financial market. If a newly certified broker used options to bankrupt his clients, it could leave the certifying firm open to an embarrassing and potentially costly lawsuit. With such dire consequences, itís no wonder that firms and exchanges arenít rushing to create their own options certifications. There are ways around this liability. After all, numerous substandard brokers and advisers have passed the CFA and Series 7 over the years. However, those organizations havenít vanished under a series of lawsuits. The most direct path to avoiding liability is to involve a regulatory agency. If the SEC were to lend its imprimatur to a new options certification program, or if the NASD were to create a new exam that focuses on options competency rather than regulation, it would alleviate many of the problems associated with liability. Unfortunately, given the glacial speed at which the SEC and NASD operate, neither development is likely to happen anytime soon.

Another way around the liability issue is to include some sort of ethical or best-practices component into the certification program. This will allow the certifying firm to spell out exactly what is being certified. It will also clearly state how recipients can implement their knowledge responsibly. The danger of such an approach is that the new exam will be so weighed down by regulatory and ethical information that it loses its focus. Instead of building options competency among brokers, advisers and planners, it will simply become another test about statutes and ethical compliance. In that case, the new certification would be little better than the existing options certifications. Fortunately, there is a light at the end of the tunnel. The Options Industry Council (OIC) recently contacted the CFA, the Global Association of Risk Professionals (GARP), the Charter of Alternative Investment Analysts (CAIA) and other financial certification groups about including more options content in their programs. However, if the options industry is ever going to succeed in this lucrative market, then it is going to have to overcome its paralyzing fear of liability once and for all.   
"

---

View Mark S. Longo's post archive >