In our recent Part II post from the OIC Advisor White Paper, “Tales From the Front,” we looked at the sections, WHAT CAUSED THEM TO ADD OPTIONS?(THE AHA! MOMENT) and?HOW DID THEY GET STARTED.
For this third part, we’ll review an advisor’s TYPICAL OPTIONS CLIENT and HOW THEY TALK TO CLIENTS ABOUT OPTIONS.?
THEIR TYPICAL OPTIONS CLIENT
The majority of the advisors interviewed saw certain commonalities among the clients with which they use options. Many advisors said their clients that used options tended to be among their more knowledgeable or sophisticated clients, who presumably could better understand the complexities of options. These clients could better tolerate volatility, and a loss.
- ?We first started using them in our client?s portfolios that were more market-savvy.?
- ?They?re high net worth clients or they?re very aggressive clients who do not mind having a loss. That would be my client base for which options have been offered, they have to really understand the markets. I have not offered them to a single client who I felt was a novice investor.?
- “My top clients, my high net worth clients, the ones that I perceived would want some sort of differentiation and could also handle any extra volatility within their portfolios. Those are the ones I used it with.?
Also, some said that professionals ?who are accustomed to turning ?to other professionals for advice– were good candidates, as were entrepreneurs or small business owners, who are more comfortable with risk. Often these clients also have a desire to preserve the wealth they have accumulated.
- ??successful professionals or executives of large companies, doctors, dentists, pilots, engineers. Also small business owners– a landscaper, construction company owner, truck driving company owner– you know, guys that own successful businesses that are saying ?Hey, I want to enhance my stock portfolio. ??
- ?There?s a do-it-yourself, entrepreneur flavor to options. It attracts those people who have that small business outlook.?
- ?Well, if you look at our clients overall, they have typically assets with us in the $20-50 million range, so they?re all successful business owners, corporate executives, family officers, whatever it may be. They are, for the most part, not looking to find a stock that goes from $10 to $150 but they?re looking to preserve their wealth and generate income.?
In addition to characteristics that would be somewhat easy to identify like a client?s financial sophistication or career history, advisors noted some intangibles, like being open minded, or having a high level of trust in the advisor. And it was pointed out by more than one advisor that the most important factor in the profile was that the client could benefit from the options strategy.
- ?I think it just comes down to finding people who are open-minded.?
- ?I think it comes down to their trust in us and our ability to tell them that this product is a cheaper, easier way to protect your assets on the downside. I don?t think our clients are all that sophisticated, I guess they?re as sophisticated as any, but I think they trust us to do the right thing, and I think in many cases options were the right thing for these people.
- ?We use options with any client where we feel it is an appropriate strategy for their situation.?
HOW THEY TALK TO CLIENTS ABOUT OPTIONS
Almost every advisor OIC spoke with started out by saying that every client is different, and so they speak with each client based on his or her perspective.
- ?One of the things that makes our team successful is that we are able to explain complex financial concepts to people in terms they understand based on things we know about them in their lives.?
- ?I try to relate to the client?s personal life as much as possible, and explain to them an option in terms of what they do.?
That said, there are themes that came out. For example some of the advisors avoid the word ?options? at least initially, so that the client listens to the concept and doesn?t just react to the word.
- ?I feel that the words ?options? and ?derivatives? are very scary to a lot of?people. If we as advisors allow the discussion to stop there then we?re missing opportunities. I think advisors need to understand, and in turn explain to their clients, that sometimes options strategies are less risky than outright owning the stock, the mutual fund or the ETF. And they need to understand that there are strategies where you can literally sit down with your client and say, ?OK, this is what you could lose, and this is what you could gain. They?re bookends. In this strategy there is limited loss and limited gain. Are you comfortable with that???
Advisor often use analogies when explaining options to clients. Buying puts is similar to buying insurance, selling covered calls is compared with owning and then renting that property, and the concept of an option losing value over time can be similar to any asset that depreciates over its lifetime.
- ?There are some people for whom options seems to be a dirty word. And for some of those people we are able to overcome that stigma, and for others we aren?t. We talk to them in terms of buying insurance. We say, ?we hope you don?t have a car accident, we hope a hurricane doesn?t come and knock down your house, but you need to have insurance and you?re gonna pay that premium every year whether you use it or not. Now, to deal with options in our strategy is to buy the insurance when it?s cheap. When it?s expensive, we don?t see much of an advantage to buying that insurance.?
- ?The insurance analogy is the best. The only thing I?d add is that since this is my specialty, I?ll get you that insurance for as little money as possible.?
- ?I compare covered calls to rental property. ?You own a property then, rent it out for income and give the renter the option to buy that property from you for a certain price in the future. ?
- ?Most people can sell most products pretty easily but it takes a pretty smart guy to sell what we do. I use analogies a lot. Here?s an example?when you buy a new car and you drive it off the lot, it immediately begins to depreciate and eventually it?s worthless and it ends up in a junkyard. That?s the same thing when you buy an option, it?s constantly depreciating until it expires.”
While the initial client conversation may be the most difficult, a few advisors pointed out that the conversation is likely to be on-going. Clients come back with questions about the strategy and the advisor has to be prepared to deal with them.
- ?One of the challenges with clients owning options is that a lot of our performance-reporting software will not show the history of owning an option on a specific position over time. So we may meet with a client who says, ?my Deere position is down in value,? and we may say ?yes, that?s absolutely true. But let?s look at the history of the options written on this position?. And then we actually show them that even though they?re down in value in that position, this is their overall return on that position. That?s a challenge, but it?s something important to do, to remind our clients and help them to understand why we?re using these strategies, and how the strategy has worked over time.
- ?Just the other day, I had a client who said, ?I want to talk to you because I know you say what we?re doing is less risky, but all of my friends say that options are too risky. My CPA tells me options are too risky.? I looked at her and I said I have to ask you just one question, ?When they say that, do you ask them why? Because options can be risky but they can also massively lower risk so if people say that to you, you need to ask them why??? They all get it at that point.?
- “Sometimes it?s better not to use the word options. We have a game on my team that we play called ?take the labels off? where we?ll be routinely introducing product without the name, or asset class or what category it belongs to. We?ll say, ?Here are the characteristics of this investment?here?s the return profile, here?s the risk profile,? without naming it. Because no matter how intelligent a person is, we all have preconceived notions about things. So I?ll describe the concept and the client goes ?Wow, that?s really interesting, that sounds like a neat idea, why don?t we try that.? And I?ll say ?Great, here?s the options paperwork.? And the client says,? What?!!? So, if you call it options right away, people might think speculation which is ironic since the concept behind listed options was to mitigate risk.”