An influx of institutions and do-it-yourself retail investors is continuing to drive up volume in the options markets. That's a deserved payoff for the industry, given the years of hard work it has undertaken in both its marketing and educational efforts. It appears more investors finally understand the numerous benefits of using options.
But one notable exception represents a vast untapped opportunity in new business. If the options industry is to continue its impressive growth, then it must find a new customer base in stockbrokers, financial planners and financial advisers. These are the investment pros whose retail customers rely on them for trading and investment decisions. (Retail order flow, by the way, is also the most cherished type of flow for market makers.)
Unfamiliar
It stands to reason that the advisory community would at least be familiar with options. The NASD's Series 7, chartered financial analyst (CFA) and other professional examinations all contain information about them, and options are the ideal hedge for equities. It's an asset class that most brokers and advisers should use. Unfortunately, that just isn't the case. This group does not use options to any appreciable degree. A 2005 study by Harris Interactive found that only 23 percent of options investors received their options information from a broker or financial adviser. The advisory community just isn't interested.
Why can't options penetrate this lucrative market? The perceived added workload to using options is a prominent hurdle. A busy broker or adviser has a lot of clients to manage. Between meeting with existing clients, looking for new clients, planning investment strategies and keeping abreast of market fluctuations, an adviser simply doesn't have time to add options to clients' portfolios. 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 they offer.
Fortunately, this problem has been 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). Unfortunately, these products remain scarce. Until they become more prominent, planners and advisers will still have to do extra work if they want to trade options for their clients.
No Education
While time is an issue for many planners and advisers, lack of education is a far greater impediment to them using options. To put it mildly, most financial planners and advisers don't understand options. As a result, they do not feel comfortable putting them into clients' portfolios.
How can this lack of education be overcome? The answer is simple: certification. The financial industry has been testing and certifying financial services professionals for decades. However, these programs haven't shed the necessary light on options. While the Series 7, CFA and other programs touch on options to varying degrees, the amount of options content is small. For example, of the 10 major topics outlined in the CFA curriculum, only one covers derivatives. To make matters worse, only one-fifth of the information on 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 NASD's Series 4 and Series 42 provide almost no practical options education. The Series 4 was designed primarily for options principals, and almost three-quarters of the exam 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 still focuses on taxation, marketing and handling customer accounts. Given these meager educational offerings, it's understandable that few brokers and advisers are comfortable recommending options investments.
Inroads
If the options industry wants to make inroads into the lucrative advisory market, then it needs to create a new options certification program that meets the needs of brokers and advisers. Instead of focusing on sales practices, industry regulations or simple options valuation, this program needs to look at preparing brokers and advisers to trade and manage options positions.
With such a large market at stake, you'd think 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. The primary reason is fear of liability. Options exchanges, trading firms and other industry organizations don't 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 today's markets.
If a newly certified broker used an options strategy that wiped out a client, it could leave the certifying firm open to a potentially costly lawsuit. With such dire consequences, it's no wonder firms and exchanges aren't 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, and those organizations haven't vanished under a series of lawsuits. The most direct path to avoiding liability is to involve a regulatory agency. If the Securities and Exchange Commission 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 liability problems. But given the glacial speed at which the SEC and NASD operate, neither is likely to do so soon.
Best Practices
Another way around the liability issue would be to include some sort of ethical or best-practices component into the certification program. This would allow the certifying firm to spell out exactly what is being certified. It would also clearly state how recipients can implement their knowledge responsibly. The danger of such an approach is that the new exam would 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 would simply become another test about statutes and ethical compliance. In that case, the new certification would be little better than the existing options certifications.
There is a light at the end of the tunnel. The Options Industry Council recently contacted the CFA Institute, the Global Association of Risk Professionals, the Charter of Alternative Investment Analysts 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, it's going to have to overcome its paralyzing fear of liability once and for all.
The views of this column are those of the author. They do not necessarily reflect the opinions of Traders Magazine. The author welcomes comments and questions. He can be reached at Mark.Longo@SourceMedia.com
