There is a fairly new type of investment strategy making the rounds among large investment firms that is garnering a lot of negative attention. This strategy involves trading uncovered short options in the attempt to disguise premiums as consistent returns. One specific strategy has been implemented by UBS Financial Services known as the “Yield Enhancement Strategy”—also known as the YES strategy.
The YES strategy is marketed to investors looking to increase returns without exposing their principal to substantial risks. Many securities brokers and brokerage firms pitch the YES strategy as a safe investment designed to pay consistent returns.
Volatile Markets Increase Risks for Unsuspecting Investors
However, there is a very crucial piece of information that many brokers and firms omit when pitching this strategy to potential investors; that the continued success of the YES strategy is directly linked to the stability (or non-volatility) of the equity markets. Memories of the volatility of the market in 2008 have faded, and although brokers know that the market will not remain stable forever, this strategy is pitched as a low risk investment strategy, when, in fact, just the opposite is true.
Although this strategy is explained as a way to enhance the yield on what may be conservative underlying investments, the strategy requires pledging some, or all, of these investments to cover the required margin necessary to write “naked,” or uncovered options. Since the strategy involves writing these naked calls and puts, extreme volatility in the equities markets will result in large losses, and potentially the forced sale of some of the underlying assets to pay for those losses.
Options Trading Investment Strategies May Result in Unexpected Losses
In simpler terms, option trading can be best described as two parties betting against each other regarding the potential future success or failure of a particular security. Significant money is only made or lost in option trading when there are drastic changes in the value of the security. Also, there is a predetermined strike price and expiration date that is set in stone before the option is purchased. Whether or not the buyer or seller makes money by the expiration date is determined by the change in market value.
In a Yield Enhancement Strategy, the broker orchestrates the uncovered sale of various options with differing strike prices. The investor then collects the premiums for “writing” the option. It is these premiums that prove to be the enticing part of the YES strategy. In a flat market, where the YES strategy thrives, there is little, if any change to the market value of the security. Thus, where these investors are seeing returns is through the premiums they receive when the options are written. This idea can appear enticing to investors as it creates an illusion of a low-risk investment with consistent returns. However, while this strategy thrives in a flat market, it can be very dangerous when the market begins to fluctuate.
Imagine an individual has written ten uncovered short call options each for 100 shares valued at $45 with a strike price of $50 a share and premium of $2 a share.
Now imagine that the market shifts drastically before the expiration date and the value of the security increases to $70 a share. Multiply all the shares owned—in this case 1,000—by the new stock price. Then subtract the number of shares owned multiplied by the original strike price, and the investor in the YES strategy is now on the hook for $20,000. All the investor received in this scenario was $2,000 premium when the transaction was executed.
If You had an Account with UBS Financial and Suffered Losses Due to the Use of the Yield Enhancement Strategy – Contact Us
UBS Financial allegedly misrepresented the Yield Enhancement Strategy as safe and low risk. These misrepresentations are a breach of the duty that UBS owed to you as a customer. Many brokers used the complex nature of options trading to their advantage when trying to sell this strategy to unsophisticated investors. Oakes & Fosher dedicates its entire legal practice to helping investors across the nation. If you, or someone you know, have lost money while invested in the Yield Enhancement Strategy, please contact Oakes & Fosher for a free and private consultation.CONTACT US