In response to the low interest rate environment that has prevailed for a decade, many brokerage firms — including well-known wirehouses such as Merrill Lynch, Morgan Stanley, and UBS — have reportedly recommended various options strategies to their customers as supposedly safe and efficient mechanisms to enhance income. However, when stock markets turn volatile, these strategies can quickly spiral into unexpected investment losses for retail investors — as recently occurred during a spike in stock market volatility that peaked on February 5, 2018.
Despite the risks embedded in options, particularly naked options, brokerage firms like Merrill Lynch, Morgan Stanley and UBS have reportedly presented some retail investors with opportunities to engage in sophisticated, highly complex options strategies, often fraught with risk. One such options strategy, marketed in some instances as a yield enhancement strategy (or “YES”), involves writing so-called iron condors through S&P 500 derived options. In some instances, investors are steered into such strategies seeking the option premium income, without actually understanding the risks associated with options trading strategies.
When it comes to yield enhancement options strategies, perhaps the most commonly used financial instrument is the extremely well-known S&P 500 Index (“SPX”), a stock index based on the 500 largest companies whose stock is listed for trading on the NYSE or NASDAQ. The Chicago Board Options Exchange (“CBOE”) is the exclusive provider of SPX options. In this regard, CBOE provides a range of SPX options with varying settlement ranges and dates, including A.M. and P.M. settlement, weekly options and end-of-month options. Significantly, because SPX is a theoretical index, an investor who engages in options trading using SPX will necessarily be engaging in uncovered, or naked, options trading.