Options 101 - Chapter 4

Chapter 4: A Pre-Investment Checklist

• Take the time to check out any firm or indi-vidual that you don’t know through previous experience or reputation. All firms and per-sons offering options on U. S. futures contracts are required by law to be registered with the Commodity Futures Trading Commission (CFTC) and to be Members of National Fu-tures Association (NFA). You can do this quickly, easily and without cost by accessing NFA’s Background Affiliation Status Informa-tion Center (BASIC), located at NFA’s web site (www.nfa.futures.org). BASIC will provide you with the firm and/or individual’s registra-tion status as well as any disciplinary actions taken by NFA, the CFTC or any U.S. exchanges. This same information is also available by call-ing NFA toll-free at 800-621-3570.
• Understand what a firm’s commission charges will be and how they’re calculated. If the charges seem high—either on a dollar basis or as a percentage of the option pre-mium— you might want to seek comparison quotes from one or two other firms. If a firm seeks to justify an unusually high commission charge on the basis of its services or perfor-mance record, you might want to ask for a detailed explanation or documentation in writing.
• Calculate exactly the break-even price for any option you are considering buying or writing. You should know the specific futures price above or below which the option, at expiration, will be profitable.
• Read and fully understand the required Risk Disclosure Statement before making any commitment to purchase or write an option.
• Learn enough about the commodity you would be investing in to have a reasonable ex-pectation that the necessary price change will occur prior to the expiration of the option. Be certain you understand the risks inherent in acquiring a futures position through the exer-cise of an option.
• Don’t purchase an option unless you understand that you could lose your entire investment. Don’t write an option unless you understand that option writing involves poten-tially unlimited losses. And don’t make any investment commitment unless the money you could potentially lose can legitimately be regarded as risk capital.
• Don’t make any investment on the basis of high-pressure sales tactics. Reputable firms don’t operate that way. It’s far better to miss out on an investment opportunity than to be rushed into a decision you may later regret. And don’t make an investment that is pre-sented to you as a sure thing. They don’t exist!
• Always seek the advice of other persons such as a knowledgeable financial advisor, attorney or accountant before making any major investment decision.