Over the last several years, financial advisors have aggressively marketed covered call strategies to their high-net-worth clients. Advisors often market these programs to investors who have concentrated positions in stocks. The programs allow firms to earn significant commissions and fees from accounts that may otherwise have little to no trading activity.
Options contracts are agreements between investors to sell stock at a specific price on or before a certain date. Calls are a type of options contract that gives the buyer the right to buy a stock. A covered call strategy involves writing (selling) options on stock you own while receiving a premium (income) from another investor. The investors basically sell the right to benefit from the future appreciation of their stock – creating a stream of income.
Sales pitches for covered call programs are delivered in unusual and often misleading ways explains investor attorney Marc Fitapelli. These pitches don’t come from salespeople or even the client’s financial advisor. Instead, they usually begin with a call from your advisor’s risk department. The calls are usually directed to high-net-worth clients who have concentrated positions in one or a handful of stocks. Sometimes clients accumulate these single multi-million-dollar stock positions by hitting it big at startup. Regardless of how the positions were acquired, investors almost always face an enormous tax bill if they sell out.
When clients with concentrated stock positions are contacted by their advisor’s risk management department, they are advised that options can be utilized as a type of insurance to hedge against the risk of having all their eggs in one basket. Investors are led to believe that options are a conservative solution to a problem they never had in the first place, argues investor attorney Marc Fitapelli. Covered calls and other complex options strategies are often presented to these clients as a conservative win-win – risk is mitigated and extra income is generated. Sounds too good to be true – right? Many investors, and even their financial advisors, don’t realize the complex and unique risks associated with options trading.
One of the main misunderstood risks of covered calls is lost opportunity costs. If the concentrated position continues to increase in value, the investor forgoes the opportunity to benefit. In some cases, the investor may even end up losing if the value of their stock rises too quickly in value. If the prospect of losing money when your stock goes up sounds confusing to you, you are not alone. Marc Fitapelli believes that financial advisors are misleading many of their high net worth clients into enrolling in covered calls and other complex options programs. Fitapelli’s law firm, MDF Law, represents high-net-worth individuals who lost money through these programs through FINRA arbitrations.
Disputes against brokerage firms and financial advisors are handled confidentially through arbitration that is administered by the Financial Industry Regulatory Authority, or FINRA. Marc Fitapelli, the owner and founder of MDF Law, believes that volatility in the stock market has resulted in massive losses for retail investors in options programs. This, in turn, has resulted in an increased filing of confidential FINRA arbitrations. Investors in these cases often seek lost opportunity costs, interest and attorney’s fees.