Options

The Chicago Board Options Exchange defines an option as follows: “An option is a contract giving the buyer the right, but not the obligation, to buy or sell an underlying asset (a stock or index) at a specific price on or before a certain date (listed options are all for 100 shares of the particular underlying asset). An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties.”

There are only two kinds of options: call options and put options.

A call option is an option to buy shares from the option seller at a specified price (called the “strike price”) by a certain expiration date. You must pay the seller of the option a premium for the call. If you decide not to exercise the option, your loss is limited to the cost of the premium. When you hold call options, you hope the price of the stock goes up. When the stock exceeds the strike price, you can exercise the calls and buy the stock at a price below market value. Then you can either keep the shares or sell them for a profit.

A put option is an option to sell shares, or more accurately, to force the option seller to buy shares from you at the strike price. When you hold put options, you exercise them only if the price of the stock goes down. Because you can force the seller of the option to buy your shares at a price above market value, the put option is like an insurance policy against your shares losing too much value. If the market price goes up and there is no damage to your shares, you can let the option expire and your cost will be limited to the premium you paid for the put.

Purchasing options can give you a hedge against losses, and in that sense, they can be used conservatively. But there are many options strategies that amount to little more than gambling and can increase your risk to a frightening degree. One simple example is the sale of uncovered calls requiring physical delivery of stock upon exercise. When a call you sell is “covered,” it means you already own the underlying stock and your cost for those shares has already been incurred. If the option is exercised, you’ll simply deliver those shares to the option holder. But if you sell an uncovered call, your potential for loss is unlimited. If the option is exercised, you’ll have to obtain shares to cover your obligation by purchasing them at the market price, regardless of how high that price may be at the time. If a strong market advance or a major announcement by the issuer has driven the share price up sharply, your losses could be enormous.

As indicated, many option strategies involve great complexity and risk. For this reason, not all options strategies will be suitable for all investors. In fact, with the exception of sophisticated, high net worth individuals who can afford and are willing to incur substantial losses, the writing of puts or uncovered calls would be unsuitable for just about everyone. Nevertheless, brokers sometimes engage in inappropriate options trading on behalf of customers who do not understand the risks.

If you have lost a significant amount of your assets because your stockbroker was engaging in options trading, please contact a financial misconduct attorney at Hermann, Cahn & Schneider in Cleveland, Ohio, today.

Brokers who lose their client's money buying options may be liable for recommending unsuitable investments.

At Hermann, Cahn & Schneider, our broker misconduct attorneys represent all types of clients whose brokerage accounts have been mishandled by their stockbrokers. Many of them are successful in their own fields, but not skilled in the ways of Wall Street.

We are dedicated to helping victims of stockbroker misconduct get their money back through the securities arbitration process. To learn if we can be of assistance to you, please contact a lawyer at Hermann, Cahn & Schneider today.