Options Losses | Key Causes and How To Avoid Them

• December 12, 2024
• Options Trading

Options trading is a complex and high-risk investment strategy that, without proper knowledge and risk management, can lead to significant financial losses. When options losses are the result of fraud, unsuitable recommendations, breach of fiduciary duty, or other kinds of broker misconduct, you may have options for recovery available through FINRA arbitration or an options trading risk lawsuit. Contact Wolper Law Firm for a confidential consultation about the facts of your loss and possible claim.

What Is Options Trading?

Options trading involves derivatives contracts wherein investors have the right, but not the obligation, to either buy or sell an underlying asset at a specified time. When options trading is done in American-style, the investor can call any time before the contract expires. European-style options can only be called or put on the expiration date. Regardless, options, unlike other standard stock market investments, come with a pre-set expiration date. This means that holders have a specified period of time in which to exercise their option, and are less able to sit on the investment and see how it performs over the years. Because of this, options are best suited to informed and proactive investors.

Call and Put Options

Options trading is divided into call options and put options. Calls give the investor or holder the “option” to buy an asset at the strike price specified in the contract after entering into the contract by paying an “option premium”. This insulates them against a certain amount of potential future market loss, while hypothetically securing substantial profit potential. Puts, on the other hand, create an obligation to the writer (or seller) of the underlying option. The investor is not obligated to sell the asset, but they have the right to. Should the holder choose to exercise their put option, then the writer is obligated to buy the asset involved.

Investors buy puts when they have reason to believe that the price of the underlying asset will decrease in the future. They might sell if they believe the asset’s value will increase. The writer of the put loses money if the spot price of the underlying asset drops below the strike price that they received from the investor for the contract. However, if the spot price does not rise above the strike price, then the option typically expires unused, and the seller keeps the investor’s initial buy-in. Similarly, a holder of a call option makes money if the underlying asset’s value increases, but can stand to lose their premium if the value drops or does not move, causing them to let their option expire.

Why Is Options Trading Dangerous?

Options trading is designed to insulate investors against market volatility by allowing them to hedge their bets against price changes, and even capitalize on a downturn. However, despite these benefits, options trading comes with several risks. For instance, if an investor is sold a call option expecting the market to rise, but does not act on it in time or the asset never increases in value, then the option may expire worthless. This built-in expiration date is one reason why options trading may be considered higher stakes than other kinds of investments.

Another risk is the time decay element (or theta curve) of options contracts. The closer that an option approaches its expiration date, the more its value changes. For instance, a short-term option, such as a one-month call option, loses its value every day that the underlying asset does not increase its price. This can result in options trading being considered more of an illiquid investment than say, general stocks.

Options trading also carries some counterparty risk. This means that there is always an element of concern about whether or not the other party will fulfill their obligations to buy in a put contract. However, many options come with the additional concern that the counterparty will call while the stock price is rising prior to the expiration date of the contract, meaning that you as the seller or writer of the option will have to fulfill the obligation and take a loss.

Some financial advisors may genuinely recommend options trading as a way to insulate yourself against a potential drop in the market. For instance, a protective put might be advisable when an investor is pessimistic about the performance of an asset that they hold. In this case, an options contract can provide some downside protection for an investor who still wishes to maintain the investment in question in their portfolio. But bear in mind that your financial advisor generally knows more than their average client does about market trends, derivatives, and risk management strategies. If your advisor is recommending something that you do not understand, or if they are not doing their homework, then you stand at risk of losing your money with a badly advised options contract.

Common Causes of Options Trading Losses

Options trading can be very beneficial when done properly. However, financial advisors who handle options trading must be well-informed in leveraging, options chains, Greeks, and other highly specialized areas of derivatives contracts. They should never be undertaken by someone without specialized knowledge, and should never be sold to novice or less-informed investors because of the heightened risk involved. Many options trading risks are caused by:

• Insufficient understanding of market dynamics or inaccurate predictions
• Inadequate research and due diligence
• Poor risk management strategies
• Inability to cut losses or make wrong decisions

Options Losses | Do I Have a Case?

Financial advisors are supposed to have your best interests in mind when they make recommendations. Unfortunately, some brokers may take advantage of their clients by cloaking their recommendations behind the innate complexity of options trading. No option is entirely risk-free, even as a safety net for a larger investment. Any financial advisor who tells you otherwise may be taking advantage of you.

If your financial advisor fails to perform their due diligence on an options contract, recommends an unsuitable investment for your portfolio, or breaches their fiduciary duty to you as a client, you may be able to make a legal claim for recovery. Suitability, as outlined by FINRA Rule 2111, provides that factors like age, income, investment experience, and risk appetite should be considered when brokers make investment recommendations to clients. Options contracts may be considered unsuitable for a vast number of clients, especially when they lead to significant losses.

How Can an Options Loss Attorney Help Me?

An options loss attorney can represent you in the event that you suffer an investment loss due to broker misconduct. You may be able to recover a percentage of your loss as well as additional compensation through a FINRA arbitration claim. Your options loss attorney can build your case, review any contracts or other paperwork that you have signed with your investment firm, situate your claim within the larger landscape of investment loss regulation, and review your options risk management strategy.

Options Losses FAQs

Are Options Losses Tax Deductible?

Tax treatment of options losses depends on specific circumstances. For instance, in some situations, an investor may have the possibility to take an options loss tax write off but the tax benefits may be deferred to prevent investors from writing off a loss before the offsetting gain is realized. Investors should consult a tax professional for specific guidance regarding options losses.

How Much Money Can You Lose Trading Options?

Options trading losses can quickly pile up. There is no limit to how high a stock price can rise, and a writer of an uncovered call may be forced to buy assets at a hugely inflated price.

How Can I Protect Myself From Options Losses In the Future?

There is no surefire way to stop losses on options, but there are some ways to protect yourself as an investor. Do your due diligence on the derivatives contract, as well as your advisor who recommends it. Taking steps to understand market volatility can help you avoid risky investments before you sign another contract.

Don’t Let Your Investment Losses Go Unchallenged | Contact Wolper Law Firm For Help

Options trading carries inherent risks that can lead to substantial financial losses. At times, investors fall victim to broker misconduct or receive unsuitable investment advice. However, options recovery is possible with the help of a skilled investment loss attorney.

Wolper Law Firm has a 99% success rate of recovering investor losses for our clients. Our proven track record comes from our diligence, attention to detail, and years of experience in investment regulation law. We offer confidential consultations to discuss our clients’ road to potential recovery. Contact us today to learn more.