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Why Options Investing?

By William H. Mears; CPA, JD

Although options can be used to raise cash from a long stock position that is not salable, individual physician-investors should use options primarily as a hedging mechanism. Individuals and doctors may want to hedge their portfolios to gain peace of mind by purchasing portfolio insurance to guard against major market declines or unpredictable events.

Many Different Uses

Options can also be used by physician-investors or other individuals to lock in profits where a stock has performed well and the investor would like to capture current market value in a stock (without triggering a sale). If an individual investor has a negative outlook on a stock, because of either a short-term economic view or a sentiment about a long-term bear market cycle, the investor can protect his or her portfolio against market movements, both short-term and long-term.

Options can be useful to manage risk in a single stock portfolio. The price for the use of an options strategy can be significant or relatively minor, so it is important to understand the risks, limitations and benefits of options strategies; and to understand this information when these instruments are used.

Traditional Personality of Discomfort

Individual physicians and investors have traditionally been uncomfortable with investments in options. The risk in these instruments is a function in part of the short duration for which they are generally purchased (e.g., three months, nine months). It is difficult to determine the direction of a market for a short time period.

Time-Risk Management

However, one of many ways to hedge the time risk is to increase the duration of an instrument. As the duration of an instrument is extended (to two years, for example), it is possible to determine with greater confidence that the market is likely to move through various cycles.

Long-term Equity Appreciation Options provide the investor with an opportunity to invest in options for up to two and one-half years. During the period of the option, the investor can liquidate the option position at any time, through either an exercise or a sale of the option itself. If the option is not exercised or sold prior to the expiration at the end of the duration, it will expire worthless.

Assessment

The physician investor who understands the vagaries of the markets—and can afford to take the losses if they occur—is the right client for a sophisticated investment strategy involving options. While there are no specific rules that define the characteristics of an option investor, a broker transacting in options for a physician-client is required to make sure that the client is appropriately aware of the risks.

Conclusion

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Filed under: Investing, Op-Editorials, Portfolio Management |