As stock market swings test investor nerves, one line rings true for many wealth managers: options can tame concentrated stock risk, yet many firms still avoid them.
The issue is pressing for clients who hold a large share of their wealth in a single company, often from executive compensation or long-held family stakes. Advisors weigh market risk, costs, and firm policies as they decide whether to use options to protect those holdings.
Background: Concentrated positions meet market volatility
Concentrated positions can expose clients to steep drawdowns. A single earnings miss, legal setback, or sector selloff can erase years of gains in days.
“Options are a prime tool for advisors to hedge a client’s concentrated stock risk, yet they are not always utilized. Here’s why.”
Protective puts, covered calls, and collars are common methods to cap downside or trade some upside for stability. These tools can be paired with staged stock sales, 10b5-1 plans, and tax planning. When used together, they can reduce risk without forcing a client to exit a core holding all at once.
Why some advisors hold back
Even with clear use cases, many firms apply options sparingly. The reasons range from client fit to compliance limits.
- Suitability concerns: Not every client understands option payoff shapes or the trade-offs between cost and protection.
- Cost and complexity: Premiums, spreads, and rolling strategies add expense and upkeep.
- Operational limits: Some platforms restrict options to certain accounts or require extra approvals.
- Behavioral hurdles: Clients often resist paying for “insurance” in calm markets, then want it after losses.
- Tax timing: Hedging can affect holding periods and future sale plans.
The result is a gap between what is possible and what is implemented. Advisors who lack training or tools may default to cash, bonds, or partial sales, even when a hedge could keep a plan on track.
How hedges change client outcomes
Well-designed hedges aim to trade a slice of upside for steadier results. A simple example is a collar: buy a put for downside protection and sell a call to help fund the cost. This can set a floor and a ceiling on a large single-stock exposure for a set period.
Protective puts alone can offer a floor without giving up the upside, but premiums can be high during volatile periods. Covered calls can generate income to cushion dips, though they cap gains if the stock rallies above the strike.
For clients facing blackout windows or insider rules, pre-set plans and longer-dated contracts can keep protection in place without the need for frequent trading.
Compliance, risk, and the duty of care
Firms weigh the risk of misusing options against the risk of leaving a client unprotected. Clear policies, education, and documentation matter. So do tools that show payoffs and “what-if” outcomes in plain terms.
Advisors who use options typically set risk budgets, define time horizons, and schedule reviews. They note trade rationales, costs, and exit plans. This helps align strategies with the client’s goals and constraints.
What could encourage wider use
Several steps could close the gap between theory and practice:
- Plain-language education: Show clients simple payoff charts and scenarios, not jargon.
- Templates and checklists: Standardize collars, puts, and covered calls for common cases.
- Fee transparency: Spell out total costs versus the protection gained.
- Tax-aware design: Coordinate with tax advisors on timing and holding periods.
- Pilot programs: Start with small hedges and scale as clients gain comfort.
Looking ahead
Market shocks will continue to test concentrated holders. Options are not a cure-all, and they carry their own risks and costs. But for clients who cannot or will not sell, they can be a practical line of defense.
The next step for many advisory teams is simple: match education and process with client need. If the goal is to keep long-term plans intact, structured hedging deserves a fair look, especially when the stakes are high.
As one industry refrain puts it, protection bought before the storm is often the cheapest insurance. The watch item for the months ahead is whether more firms equip advisors to make that choice with clarity and care.
