UBS’s Yield Enhancement Strategy (“YES”) reportedly has over $5 billion under management and over 1,200 investors. Investors in YES must agree to commit capital to the program, a so-called “mandate,” which may take the form of securities or cash. The committed capital provides collateral for options spread trading in each investor’s account. Although marketed to bond investors, the bonds held by each investor have nothing to do with the YES strategy other than serving as collateral for the options trades. Some investors pledge other securities or cash as collateral for the YES program.

The YES strategy entails generating option premium income through the strategic sale and purchase of SPX (S&P 500) index option spreads. This strategy, which is also sometimes referred to as an “Iron Condor” spread, involves writing two vertical options spreads – a bear call spread and a bull put spread. Thus, this strategy entails four different options contracts, each with the same expiration date and differing exercise prices. The “Iron Condor” strategy involves writing both a short put and a short call against the SPX, with these naked, or uncovered, options are designed to generate income for the investor via the receipt of premium. Further, the “Iron Condor” strategy involves writing both a long put and long call against the SPX, with these trades, or options legs, designed to mitigate the risk associated with the uncovered options positions.

While the YES strategy may deliver solid returns in a market that neither rises nor falls substantially over relatively short time frames, the strategy’s inherent substantial risks become apparent in times of heightened stock market volatility. For example, earlier this year in February 2018, when markets turned volatile, a volatility index known as VIX spiked to extreme levels in excess of 20. During that same time frame, YES incurred its first substantial losses of 2018. Unfortunately, the February 2018 losses appear to represent only the beginning. YES investors have reportedly suffered losses in excess of 20% of their committed capital during November and December 2018 as markets once again turned volatile. Many investors found to their chagrin that their options positions incurred steep losses- far beyond what they had thought was possible- over very short periods of time.

Ultimately, options strategies like the iron condor amount to bets in favor of the time decay embedded in options (which have fixed expiration dates) versus volatility. On the one hand, an investor can pocket options premium income in those instances where the option — which has a finite lifespan and fixed expiration and is therefore properly viewed as a decaying asset — goes to zero and expires worthless. However, on the other hand, periods of pronounced market volatility can quickly lead to scenarios where the option premium is dwarfed by losses due to market volatility.

UBS reportedly marketed the “Yield Enhancement” strategy to high net worth investors as presenting limited risk while providing single-digit annual enhancement of returns on bond portfolios. This marketing angle may have appealed to risk-averse investors due to the lower bond yields available during the recent multi-year period of low interest rates.

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience representing investors who have sustained losses due to the negligence or misconduct of their broker and/or brokerage firm. In particular, the firm has substantial experience in cases involving non-conventional investments and structured products, including commodity futures, options, and leveraged ETFs and ETNs. Investors may contact us via the contact form on this website, by telephone at (866) 966-9598, or by e-mail at newcases@investorlawyers.net for a no-cost, confidential consultation. Attorneys at the firm are admitted in New York and Wisconsin and various federal courts around the country, and handle cases nationwide (in cooperation with attorneys located in those states if required by applicable rules).

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.

An iron condor is an options strategy that entails writing a series of options, typically all at once or around the same time. The iron condor structure entails writing two near money options that are short, in addition to purchasing two deeper out-of-the money options that are long. The first component of an iron condor involves selling an out-of-the money put (short put), while simultaneously selling an out-of-the money call (short call). When implementing this first component of an iron condor — the options trader is essentially hoping that between now and expiration, SPX’s trading will remain range-bound between the two strike prices — thereby ensuring that the naked options will expire worthless and the investor will profit from the option premium earned.

In recognition of the extreme risk associated with short naked options, the iron condor has a second component for purposes of risk mitigation. Specifically, the second part of an iron condor involves buying a further out-of-the money put, as well as buying a further out-of-the money call. Thus, while the first two legs of the iron condor involve two extremely risky short naked options, the third and fourth legs of the iron condor seek to mitigate that risk with less risky long SPX options. Collectively, these four options trades, or legs, make up an iron condor.

Ultimately, options strategies like the iron condor amount to bets in favor of time decay versus volatility. On the one hand, an investor can pocket options premium income in those instances where the option — which has a finite lifespan and fixed expiration and, therefore, is properly viewed as a decaying asset — goes to zero and expires worthless. However, on the other hand, periods of pronounced market volatility can quickly lead to scenarios where the option premium is dwarfed by losses due to market volatility. Recently, a volatility spike in the stock markets in early February 2018 reportedly caused substantial losses to some investors placed in so-called “yield enhancement” and other strategies premised on low market volatility.

Unfortunately, some investors have been steered into unsuitable and risky options strategies without receiving full disclosure from their financial advisor concerning the significant risks embedded in options investing and/or hedging. Investors who have sustained losses in connection with options investing may be able to recover their losses in FINRA arbitration, if the recommendation by a broker lacked a reasonable basis in the first instance, or if the nature of the investment — including its risk components — was misrepresented.

The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors who have sustained losses due to the negligence or misconduct of their broker and/or brokerage firm, including cases involving managed futures, options, and leveraged and/or inverse ETFs. Investors may contact Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or newcases@investorlawyers.net for a no-cost, confidential consultation.