Top 3 Ways To Incorporate Options Into Your Practice

Options are broadly misunderstood and underutilized as tools in many wealth management practices. Most retail investors and even many advisors have an immediate negative reaction to just hearing the word “Options.”  Many investors simply think of the options market as a personal casino with the potential to win and lose fortunes. We’ve all heard horror stories about a friend or colleague who took a big risk on an option position and lost it all – but it is so much more than that.  What many fail to realize is that options are extremely flexible instruments that can be used to create an income stream, dampen volatility, and even reduce or eliminate capital gains tax liability.  When used properly, options can provide significant benefits to wealth managers and their clients.

Equity markets have struggled for the past year and a half as inflation concerns, geopolitical issues, and recession fears continue to dominate the headlines. This environment has many investors looking for new ways to produce returns. One method to generate diversified yield is to sell covered calls against core stock holdings. Someone who writes (sells) calls against their stock position is limiting their upside over a specified timeframe but receives payment in the form of option premium for doing so.  Practitioners of this strategy will generally sell calls at or above a price level that they deem unlikely to be seen over the life of the option. This allows the stockholder to still participate in share price appreciation, while also generating an income stream and lowering volatility.

Options are widely used by institutional investors for hedging their exposure but are largely overlooked by financial advisors and retail investors for that same purpose. While hedging may be unsuitable for some investors, it can make a lot of sense for those who have reduced risk tolerance. If an advisor has a client concerned about a specific position or the market in general, a simple hedge using options can be used to de-risk the position and help everyone rest easy at night.  Using options offers a great deal of flexibility as to how the hedge can be structured, and oftentimes this can be done at little or no cost with collars. These strategies aren’t for everyone. There are transaction costs involved—which are often higher for options than for other securities. Similarly, hedging trades can erode profits on positions that continue to appreciate, and the option contract itself is a wasting asset.

Arguably the most valuable yet least used application of options is for tax optimization within a portfolio. Many buy-and-hold investors find themselves in the position of being heavily exposed to one or a few companies. Assume a hypothetical investor purchased a sizeable position in a stock like AAPL, NFLX, or MSFT many years ago and has never rebalanced their portfolio to avoid paying capital gains taxes. These holdings are likely now a large percentage of their investable wealth and create the potential for excess volatility and large losses. Option overlays can be used to combat this concentrated stock risk and potentially eliminate capital gains tax liability over time. These strategies can be structured to meet the exact goals of each client without being a drain on liquidity.

Options offer a wide variety of benefits to an advisory practice but are generally overlooked because of their complexity and attention required. In addition to this, there are a very specific set of rules that must be followed to realize their potential tax benefit. The team at Exceed Advisory has over 40 years of professional derivatives experience and can help simplify this process and add value for your clients.

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IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. Hedging does not prevent all losses or guarantee positive returns. Transaction costs and advisory fees apply to all solutions implemented through Exceed.