Financial Planners and Option Strategies

In my continuing problem with how I perceive financial planners servicing their clients. there arises the natural question:  Outside of general guidance, can financial planners really be effective in helping clients create wealth and avoid financial disasters?

From my perspective as an outsider, I see planners helping investors choose mutual funds, ETFs, index funds etc.  That all works very well during bull markets.  What I don't see is any effort to prepare for bear markets.  I'm not suggesting that planners try to time the markets by holding cash for any substantial period of time. That's probably the worst possible strategy because the chances of outperforming the markets by guessing direction as well as timing when to invest, are very small.

Traditionally, the idea of diversification and allocating assets to various investment classes was looked upon as the savior of all portfolios.  Historically, that method has proven to be beneficial, but in 2008, nothing helped.  Investors everywhere were hurt – unless they knew how to hedge their investments.

It's late to be raising this point now, but all through the market debacle I've been worrying about how individual investors were getting crushed – simply because they lacked guidance from competent advisors.  The bottom line question:  Is it feasible for financial planners to adopt risk-reducing option strategies for clients?  Can the planner teach clients how to collar a position?  Or should he/she be expected to make the trades for their clients?  Neither approach seems reasonable in today's world.

To me there are two feasible solutions: 

a) Planners can become experts in hedging techniques.  That allows them to not only guide clients when building a portfolio, but it also allows them to educate those clients about one (maybe two) basic option strategies that can be used to reduce risk.  Those strategies are collars and covered call writing.  More sophisticated clients can eventually learn additional option strategies.

b) Planners can encourage clients to learn option strategies for themselves.  Once the client and planner have chosen an appropriate portfolio of ETFs, individual stocks, or the equivalent of index funds (SPY, QQQQ), clients can learn to write covered calls and buy collars.  This blog and the Rookie's Guide to Options are just what those clients need.

I've been in touch with at least one planner who has used collars.  But the vast majority never learned how options work are are both unqualified and uninterested in placing the needs of their clients first.  I am in favor of a law that makes anyone who gives personal investment advice be required to act as a fiduciary, and place the interests of the client above their own.  The chances of seeing that happen are zero.


7 Responses to Financial Planners and Option Strategies

  1. Income Trader 04/06/2009 at 8:46 AM #

    Hello Mark,
    The issue of acting as a fiduciary is already part of the existing law. I have sat through countless arbitration hearings and I can tell you first hand that most brokers are surprised to learn the extent of the scope of their responsibilities to their clients.
    The blame for that lies with them AND their employing companies. There is always a tug and pull between a firms compliance dept and the sales depts. I can tell you first hand, sales almost always wins…Brokers are ranked and paid in proportion to their commission generating activities and abilities. Firms make the business decision of risking some arbitration losses tomorrow in order to generate revenue today.
    The mold of the retail advisory business is definitely broken and puts clients at tremendous risk. Fee based planners are somewhat better in this regard but they are only a small percentage of the industry today.

  2. Mark Wolfinger 04/06/2009 at 9:19 AM #

    I suppose the uninformed investor has no clue what fiduciary responsibility means and the professional advisors can get away with almost anything.
    What’s lacking today is integrity. But, that’s life in America these days. We see how some irresponsible gamblers took down the whole financial apparatus (not completely their fault), destroying lives for the chance of earning a big score. Thus, it should not be surprising that scams exist and that salespeople sell anything, just to make some money.
    Yes, fee based advice is by far the best. But there’s no proof they know what they are doing.

  3. GMG 04/06/2009 at 10:39 AM #

    This is a problem that bugs me a lot too. I think it comes down to what you and Income Trader both touched on…most advisors are salesmen. Nothing wrong with that necessarily, but you’re both right that many do not have the training to put together an investment strategy more complex than placing clients into box ‘A’ for Aggressive, ‘B’ for Balanced, or ‘C’ for Conservative. The issue there, as you said, is that all three boxes rely on a mix of long equity and bonds exclusively. For the ‘A’ and perhaps a few of the ‘B’ clients, those vehicles may have a risk:reward profile they are comfortable with. Certainly not ‘C’ investors…and I think many more people would retro-actively place themselves in that category after seeing the effects of ’08.
    What about structured products as an alternative? Take the most basic example, where you invest $95K in $0.95 zero coupon bonds and buy index calls with the remaining $5K. At the end of the period, the investor is guaranteed to walk away with their initial investment, plus a chance to capture a portion of any market rally. Obviously those rates don’t exist currently, but there are other possible structures with limited risk. That type of package is something that the average planner should be able to wrap his head around, explain the benefits to his client, and still perform essentially a sales job.
    The point is, I see better possible results by giving sales people a packaged, pre-hedged product they can easily sell, rather than asking them to build those products themselves…something they may not be interested in or very good at. However, I also agree that many individuals would benefit from using basic strategies like collars if they would take the time to learn options basics.

  4. Mark Wolfinger 04/06/2009 at 11:30 AM #

    My problem with ‘structured products’ is that they are structured to provide maximum profit to the person who makes the sale, with no regard for the investor.
    Next, I loathe the idea of buying call options. It’s true they work like gangbusters in a runaway bull market, but that’s the very market in which investors generally require no help.
    I cannot see any product per your example, that would purchase anything other than out of the money call options. In that scenario, you can very easily have a rising market, but the structured product could still provide zero profits.
    That’s not for me, nor would I recommend that idea to any but the most bullish investor.
    The structured product that I want to see is a no-load fund with low management fees that buys specific index shares – and then collars the portfolio. The set up can be slightly conservative (larger possible loss with larger potential gain) to very conservative (very small loss as the worst possible result, with whatever gains are available, depending on the price of the options chosen to build the collar).
    I agree 100% that millions of investors can learn to use options well enough to buy collars – but not all investors and certainly not the elderly – who probably should own very little (if any) stock). And there are some who lack the time to place option trades, some who don’t want to be bothered, and some who simply cannot understand how options work. That’s why I want to see a low-fee fund established to manage a portfolio of collars.
    In reality, I’d expect such a fund to trade equivalent positions, and not ‘real’ collars – but the result is the same.
    Thanks for the discussion.

  5. GMG 04/06/2009 at 12:02 PM #

    I agree, your “product” is a much better idea. Mine was really just the simplest example I could think of, for the benefit of anyone reading this who may not be familiar with structured products.
    Your other points are good too, the elderly are stuck with whatever they have managed to accumulate up until now. Improper asset allocation among middle age and elderly investors seems to be a major reason why so many people are in trouble now, and unfortunately many of those are tempted to once again ignore their age and “get even” now that the bottom seems closer…

  6. Income Trader 04/07/2009 at 8:02 AM #

    The structured products that GMC details have been very popular in the marketplace for some years now. The big issue with them is liquidity. Because these products are issued in very small tranches, there is usually not enough liquidity to effectively get a real bid on these products if you need to sell before maturity. That is when you can get really creamed…
    There are some structures that are a bit better than others at face value but as Mark said usually these products carry such a big sales load that the only one who actually makes money is the salesperson.
    I believe “portfolio insurance” in a very easy to understand monthly premium basis (much like insurance on your car or house) will be something we will see in the very near future. An insurance product that will guarantee a certain percentage of your portfolio for a monthly fee. The truth is that many investors will not understand the complexities of options hedging strategies.

  7. Mark Wolfinger 04/07/2009 at 9:01 AM #

    It’s the sad truth.