Although options can add flexibility to a client's portfolio, clients are often enticed into unsuitable options trading with high risks, speculative returns, and big losses.
Understanding the Basics of Options Trading
An option is a type of security that constitutes a binding contract with specific terms. Options allow buyers the right to buy or sell underlying assets at a certain price by a specific predetermined date. There are two types of options in options trading, call options and put options. The right to buy is called a call option, and the right to sell is called a put option. One option contract controls 100 shares of stock, but clients can buy or sell as many contracts as they want.
Call options give the owner the right to buy a specific number of shares of an underlying stock at a previously determined price. The client must pay the seller a fee, and the option must be purchased by a certain date or it expires. Call options provide opportunities to profit from price gains in the underlying stock at a fraction of the cost of owning the stock.
Put options give the owner the right to sell a specific number of shares of an underlying stock at a specific price on or before a certain date. Put options act like an insurance policy because they allow the client to profit on stocks that fall in value. Put options will offset the losses on the stock by allowing the owner more time to sell safely.
Options involve risks and are not suitable for every investor. Using the wrong strategy in options trading can lead to disastrous results. Taking unnecessary risks can result in big investment losses. Stockbrokers have a duty to make suitable recommendations for investments based on certain factors:
- The client's age
- The client's financial status
- The client's short-term and long-term objectives
- The client's investment knowledge
- The client's ability to tolerate risks and losses
If a client loses money in unsuitable options trading, the broker and brokerage firm may be held liable for broker misconduct. An appropriate investment for one person can be a very inappropriate investment for another. To protect investors, the broker must carefully consider an investor’s personal circumstances before recommending investments and options trading. If your broker bought unsuitable put or call options on your behalf and you lost money, contact a securities litigation attorney with Meyer Wilson at 888-390-6491.