What Are Options and How Do They Work? - Transcript

Options are complex financial instruments that offer investors flexibility in that they can be used in many different ways; however, they also come with inherent risks. Essentially, an option is a contract between two parties—a buyer and a seller—that grants the right, but not the obligation, to buy or sell an asset at a predetermined price within a specific timeframe. While options can be powerful tools for managing risk or enhancing returns, they are not without potential pitfalls. At Malecki Law, we have seen how improper use or insufficient understanding of options can lead to significant financial losses for investors.

Options are categorized into two main types:

• Call Options: These give the holder the right to buy the underlying asset at a specified price, known as the strike price, before the option expires.
• Put Options: These give the holder the right to sell the underlying asset at the strike price within the option’s time frame.

Both call and put options can be used for a variety of strategies, from speculative bets on market movements to hedging against potential losses in a portfolio.

Many investors use options as part of broader trading strategies. Some of the most common strategies include:

• Covered Call Writing: This involves selling call options on a stock you already own. While this can generate income through premiums, it also carries the risk of losing the underlying stock if the option is exercised.
• Protective Puts: Investors buy put options to protect against a decline in the value of a stock they own, effectively setting a floor for potential losses.
• Straddles and Strangles: These strategies involve buying both call and put options to profit from significant price movements, regardless of direction.

While these strategies can be effective, they are not inherently safe. Even a seemingly conservative approach, like covered call writing, can lead to unintended consequences, such as tax liabilities or the loss of a long-held position.

Options are often viewed as speculative tools because they involve predicting the future movement of stock prices. This inherent uncertainty introduces several risks, including:

• Loss of Underlying Assets: In covered call strategies, you may be forced to sell a stock you intended to hold long-term, potentially incurring tax consequences.
• Capital Requirements: If you need to repurchase shares due to an exercised option, insufficient capital can exacerbate your losses.
• Unlimited Loss Potential: For certain strategies, such as naked call writing, the potential losses can far exceed the initial investment.
• Market Volatility: Sudden or extreme price movements can render even well-planned options strategies ineffective.

These risks make it critical for investors to fully understand the mechanics of options before incorporating them into their portfolios. Financial professionals should disclose these risks before investing a client’s funds. If you suspect that your financial adviser failed to keep your best interests in mind, contact the experienced securities attorneys at Malecki Law in New York to review your case.

Brokers and financial advisers have a duty to ensure that options strategies align with an investor’s financial goals and risk tolerance. This includes:

• Providing Full Disclosure: Investors should be made aware of the risks and potential consequences of trading options.
• Complying with Regulation Best Interest: Recommendations should take into account the investor’s best interest, including their financial situation, goals, experience, age, and objectives.
• Ongoing Monitoring: Advisers should continuously review options positions and provide updates as market conditions change.

When these responsibilities are neglected, investors may suffer unnecessary losses. At Malecki Law, we work to hold financial professionals accountable when they fail to meet these obligations.

If you’ve experienced losses due to misleading advice or improper handling of your options trading account, Malecki Law can help. Our experienced securities attorneys understand the complexities of options trading and the obligations brokers have to their clients. We work tirelessly to recover losses for our clients and hold financial professionals accountable for their actions. Contact Malecki Law at (212) 943-1233 or reach out online for a consultation.

Transcript:

Options are contracts between two investors they are agreeing to buy or sell a position in a stock based on a price in the future they have a time period they expire at some point um many people believe that covered call writing is a safe investment strategy and they do it to collect premiums some people put puts and calls around the concentrated position to make sure that there’s not a huge movement that they cannot tolerate around that position but they are essentially betting on which direction the stock market is going they are not necessarily stay safe not even covered calls are necessarily safe because you could have a long-standing position that has taxes associated with gains over periods of years and you could lose that position in a covered call strategy you could lose the right to hold it or you have to go back in and buy more and if you don’t have the capital to to buy additional shares you know you’re going to lose your stock so there’s a lot of embedded risk in options transactions.