Investment Standards for Call Buyers

Whether using shorter‐term listed options or LEAPS calls, you need to not only be aware of risk levels, but also to establish a clear investment standard for yourself. This means much more than merely taking the advice of a stockbroker or financial planner; it means considering a range of ideas and choosing standards that fit well for you, individually.

People who work in the stock market—including brokers who help investors to decide what to buy and sell—regularly offer advice on stocks. If a stockbroker, analyst, or financial planner is qualified, he or she may also offer advice on trading in options.
Three important points should be kept in mind when working with a broker, especially where option buying is involved.

Smart Investor Tip

Anyone who wants to be involved with options will eventually realize that a broker's advice is unnecessary and could even get in the way of an efficient trading program.
  1. You need to develop your own expertise. The broker might not know as much about the market as you do. Just because someone has a license does not mean that he or she is an expert on all types of investments. In fact, due to the nature of the options market, you may want to become proficient at making your own options‐related decisions. In this case, you may wish to continue employing outside help for stock‐related decisions, but maintain direct control over options trading.
  2. You cannot expect on‐the‐job training as an options investor. Don't expect a broker to train you. Remember, brokers earn their living on commissions and placement of orders. That means their primary motive is to get clients to buy and to sell. Here again, you may depend on a broker's expertise when it comes to stocks; but you should not assume that the same broker is knowledgeable about options strategies or risks.
  3. There are no guarantees. Risk is found everywhere and in all markets. While it is true that call buying involves specific risk, this does not mean that buying stock is safe in comparison. You need to distinguish between risk levels for stocks and options. For stocks, your broker should be aware of how volatility in stocks matches with your risk levels; but options change the overall picture, and you need to separate stock and options risks, ignoring the tendency to think that there are any risk‐free investments using stocks, options, or the two together. The fact is, once you become comfortable with options trading, you are going to be less likely to depend on a broker for any advice. Options traders tend to think for themselves, and come to realize that they can operate without the services that come with paying full‐price commissions.

Some traders continue using brokers due to personal loyalty or a track record of exceptional advice. Whether you are seeking a broker or using one already, that broker should not give the same recommendations to everyone; advice should be matched to specific risk levels and experience. Brokers are required by law to ensure that you are qualified to invest in options. That means that you should have at least a minimal understanding of market risks, procedures, and terminology, and that you understand the risks associated with options. Brokers are required to apply a rule called know your customer. The brokerage firm has to ask you to complete a form that documents your knowledge or experience with options; firms also give out a prospectus, which is a document explaining all of the risks of option investing.

The investment standard for buying calls includes the requirement that you know how the market works and that you invest only funds that you can afford to have at risk. Beyond that, you have every right to decide for yourself how much risk you want to take. Ultimately, you are responsible for your own profits and losses in the market. The role of the broker is to document the fact that the right questions were asked before your money was taken and placed into the option. One of the most common mistakes made, especially by inexperienced investors, is to believe that brokers are responsible for providing guidance. They are not. However, they are required to make sure you know what you're doing before you proceed.
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2016. Content published with author's permission.

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