Investors Who Lost Money In The Harvest Volatility Management Strategy Offered Through Merrill Lynch Or Morgan Stanley Have Recovery Options
The Harvest Volatility Management Strategy is an options strategy that was utilized by several brokerage firms, including Merrill Lynch and Morgan Stanley, as a safe method to generate supplemental portfolio income. The Harvest Volatility Management Strategy involves the use of an “Iron Condor” options strategy, which entails selling both near-the money and out-of-the money put and call options against the S&P 500 index, NASDAQ and other primary indices. In a stabilized market environment, some or all of the options will expire and the investor collects the premiums. Conversely, in a volatile market, the premiums associated with the options positions will spike, creating internal margin calls and/or the exercise of the underlying options, or both.
In today’s current interest rate environment, it has been difficult for investors to identify short-term, fixed income investments that generate a stable, predictable income stream. In the absence of such opportunities, many Merrill Lynch and Morgan Stanley Financial Advisors pitched the Harvest Volatility Management Strategy as a safe method to generate portfolio income. Merrill Lynch and Morgan Stanley Financial Advisors represented to customers that the strategy was properly hedged such that even if there were market movements, the investor’s principal was protected. In other words, the Harvest Volatility Management Strategy was represented to be a relatively conservative investment strategy.
The premium value of an option is determined by (1) time (i.e., maturity) and the (2) strike price. If the option has a shorter maturity, there is theoretically less time for an investor to navigate short-term volatility, leading to more pronounced swings in the market value of the option. Conversely, if the option has a longer maturity and the options are further out-of-the-money, short-term volatility may not cause significant changes in the market value of the option.
In 2018, the financial markets experienced extreme volatility. In January 2018, the S&P 500 was at 2,800. Throughout 2018, there were violent fluctuations in the S&P 500, which reached highs of 2,929 and a low of 2,350. The most volatile period was between October and December 2018 during which the market declined 20% followed by a rebound of 12% through January 2019. These violent swings caused the premiums of both the put and call side of the iron condor strategy to spike, leading to losses on both sides of the trade.
The Harvest Volatility Management Strategy involves the use of an “Iron Condor” options strategy, which entails selling both near-the money and out-of-the money put and call options against the S&P 500 index. In a stabilized market environment, some or all of the options will expire and the investor collects the premiums.
Conversely, in a volatile market, the options get exercised. If the options get exercised and the strategy is not properly hedged, investors may experience substantial portfolio losses. In addition, because the iron condor strategy involves leveraged, short option positions, the losses become amplified.
Financial advisors have a legal and regulatory obligation to recommend only suitable investments that are appropriate for their clients’ needs and objectives. Their employing brokerage firm has a legal and regulatory obligation to supervise the Financial Advisors’ sales practices and dealings with clients. To the extent any of these duties are breached, the customer may be entitled to a recovery of his or her investment losses.
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