Trading on Customer Ignorance

In my 20 years as a broker and 13 as a fund manager I never traded on client ignorance. Its off limits in my view. As a matter of fact, I see a broker's role as one who educates clients, especially with an unfamiliar or complex strategy, and THEN THEY can trade it. Either way we don't take advantage of their lack of knowledge.

Last Friday's Wall Street Journal had a misleading story on a major broker with client losses over a "low risk" "income" strategy. These clients traded iron condors. Iron condors, in my view, are not extremely bad or extremely good. When markets are flat, you can sell and keep options premiums-an income strategy when markets don't move much. IC's are sometimes called (like all option selling strategies) "picking up pennies in front of a steam roller". Yes, when markets MOVE, option sellers get rolled over. 

Source: The Tickertape, 3/25/19

But these clients didn't trade options at all. They actually invested in a fund created by the broker. This fund traded iron condors and was advertised as low risk income and took in billions of assets. Yep, interest rates are low and people want income. This fund charged huge 1.75% fees. Whatever else it did, it separated clients from their money.  

To put on an iron condor, you don't need a fund. You don't need to pay management fees. You need an options trading account AND you need to KNOW how to do it. It isn't hard but yes, you do need some education. Which takes us back to trading on ignorance. The best brokers focus on education, other brokers, not so much.

Because these people had no idea what the broker was doing and listened only to the sales pitch (income, low risk, neutral strategy, etc.) they trusted billions NEEDLESSLY to this fund. Needless for everyone except the broker. 

Its hard for a major pub like the WSJ to write a critical story about a major advertiser like a major broker so the focus of the story is the "complex investment strategy" and not the actions of the broker. In my view, the options markets are NOT to blame for these client losses.

Feel free to post comments.

Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.