By Blaine B. Remmick
Options are a form of financial instrument known as a derivative, which Warren Buffet describes as a “financial weapon of mass destruction.” More specifically, options are contracts that allow a person to buy or sell an underlying asset at a specified price as long as the contract is executed by a specified date.
Like all financial products, options also have pros and cons. On the plus side, options allow an investor to utilize small amounts of capital to exert influence over expensive securities positions, offer large returns, offer many investment alternatives to tailor investing strategies, and can limit exposure. On the negative side, options usually pay higher commissions, experience time decay due to an option contract’s limited life span, are very complex, and are taxed at a higher capital gains rate.
So who should invest in options? Generally speaking, options are a young person’s game. This is true for a couple of reasons: (1) options are risky and portfolios investing in options can see wide value swings in either direction, necessitating time to recoup losses; (2) young investors tend to have less money to invest and options allow these investors to leverage their small amounts of capital; and (3) options can offer huge upsides due to the risk involved. Given all of this, the decision to trade options should not be taken lightly and only someone who truly understands the risks and rewards should consider options trading.
Considering the risks and complicated nature of options, why would brokers market options to retired persons? As previously mentioned, the commissions can be considerable. Unfortunately, large commissions can entice some unscrupulous brokers to sell products to consumers who have no need or desire to purchase them. While pressure selling can take many forms, here are a few tactics to watch out for: (1) being pushed to purchase a financial product when no real information is given about the product and/or related company; (2) the broker uses past performance to persuade you to buy a product from them (after all past performance is no indicator of future success); (3) the broker uses manipulative words to convince you that a financial product needs to be purchased immediately; and (4) outrageous promises are made guaranteeing some unrealistic return and/or lack of risk. A good rule of thumb is that if such a sure bet existed, it is likely that financial experts would have already discovered it and wouldn’t take the time to call average retail investors to share their secret.
In summation, options are complicated financial products that can result in serious gains or serious losses. Considering the potential for serious loss, options trading should be left to the experts. Retired persons who need to conserve their nest egg should be wary of brokers who promise huge returns with little risk, especially if the trade concerns options contracts. If a deal sounds too good to be true, it probably is.