What if you have held a stock position for a really long time in a great company, and the stock has done spectacularly well? Do you want to sell it, and diversify your investments? Some people will want to do that, but many will want to stick with what has been working and keep their concentrated positions in wildly successful companies like Apple, Amazon, Microsoft and others. Your financial advisor has of course recommended that you sell quite a bit of your concentrated position over the years, but you have refused. Then one day, your financial advisor presents a “no lose” proposition to you, recommending what he describes as a “covered call strategy.” The broker explains that there are expert managers who can implement a strategy where calls are sold against your concentrated position of stock, creating additional income for you. Knowing that you do not wish to sell the stock, the financial advisor explains that not only will you not lose the stock, or any appreciation in the stock, but you will receive a couple of extra percentage points a year in income on the stock without any risk. The broker will likely explain that there are fees involved, but as long as you are making money, you should not really care about the fees in this “no lose” proposition.

Why has the financial advisor recommended this to you? It is not so you can make 1 or 2 percent more a year on your concentrated position in returns. It is so the financial advisor can start making money on that concentrated position that they otherwise would earn zero commissions or fees from. And is it true that there is no risk of your losing appreciation in the stock or the stock itself? It is a misrepresentation, as there is a very real risk of losing appreciation in the stock or even the stock itself.

We have seen many cases over the last few years where stock brokers have recommended this type of covered call strategy to people with concentrated positions in volatile stocks like Apple, Amazon and Microsoft, where the investors who listened to their financial advisors ended up losing most or all of the stock that they never wanted to sell. And for what? One or two percent? It doesn’t make sense, and it never did. When the investor complains, the broker might point to documents that the investor signed explaining that there is a risk of losing the stock, even though the broker or investment advisor had explained previously that this was more of a theoretical risk than an actual one.

The fact of the matter is that if you sell covered calls on your stock, there is a very real risk that you will lose the stock, especially if it appreciates dramatically after you have sold the calls, making it difficult, if not impossible, to re-purchase the calls after they have appreciated dramatically after you shorted them.

For a mere 1 or 2 percent that is promised to you, the results can be tragic, not only losing significant appreciation in your prized stock, or the stock itself, but also having to pay substantial capital gains taxes when the stock is called or otherwise sold.

If a financial advisor recommends a covered call strategy to someone who does not want to sell their stock, that investment advisor is recommending an unsuitable investment strategy and the investor may be able to recover damages from the investment advisor for that recommendation. Again, we believe there have been many cases of this over the last few years involving stocks like Apple and Microsoft.