Options communications

FINRA Rule 2220 was specifically written to govern options communications. The following regulations contained within this rule are covered in this chapter:

• Communications before ODD delivery
• General standards
• Performance projections
• Historical performance
• Options programs

Communications before ODD delivery

As discussed in the previous chapter, options communications to investors that have not received the Options Disclosure Document (ODD) must be filed for approval from FINRA’s Advertising Regulation Department. Additionally, the following protocols must be followed:

• The communication is limited to general descriptions of options
• The communication provides contact information for obtaining the ODD
• The communication may not contain:
  • Recommendations
  • Past performance
  • Projected performance
  • Names of specific securities

The communication may include statements required by state law or administrative authority. Additionally, the communication can be artfully designed, include “attention-getting” headlines, and present graphics (including photographs), as long as these elements do not make the communication misleading.

General standards

FINRA prohibits member firms and registered representatives from distributing options-related communications that:

• Contain false or misleading information
• Omit material facts
• Contain performance guarantees
• Contain exaggerated, unwarranted, or unreasonable claims
• Contain illegible cautionary statements
• Guarantee that a market for an option will exist
• Do not accurately reflect an option’s risks
• Fails to state options are not suitable for all investors (or vice versa)*
• Fails to provide supporting documentation for claims made*

*These requirements do not apply to institutional options communications.

Additionally, FINRA requires all options communications to be fairly balanced. Any “benefit” statement (e.g., you obtain unlimited gain potential with long calls) must appear alongside an appropriate “risk” statement (e.g., you can lose your entire investment - the premium - quickly).

Performance projections

Performance projections (e.g., the expected return is 10%) can be included in options communications if these protocols are followed:

• The recipient(s) previously received the ODD
• No guarantees are made
• Parameters are clearly established
  • E.g., the exercise price, underlying security’s market price, option premium
• All relevant costs (e.g., fees, commissions) are disclosed and included in projections
• Projections are reasonable and are intended as the source of a recommendation
• All material assumptions are identified
  • E.g., “you gain X amount if the option expires”
• The relevant risks are disclosed
• If an annualized return calculation is included:
  • May not be based on any less than a 60-day experience
  • The formula used is clearly displayed
  • It is stated the projection will occur only if the parameters are duplicated (and there is no guarantee this will occur)

Historical performance

Historical performance of previous customer transactions or past recommendations can be included in options communications if these protocols are followed:

• The recipient(s) previously received the ODD
• A balanced portrayal is provided
• All similar recommendations/transactions over at least the most recent 12 months are disclosed (not just the profitable ones)
• All relevant costs (e.g., fees, commissions) are disclosed and included in the performance
• Disclosure of assumptions if past performance is annualized*
• The communication states past performance is not indication of future performance
• The following information is included:
  • The date of the transaction/recommendation
  • The price at the time of the transaction/recommendation
  • The price at the time of liquidation
  • The general market conditions at the time of the transaction/recommendation

*Annualizing the performance of an options transaction can be misleading, as performance is based on market conditions that are never perfectly duplicated. For example, assume an investor makes a 10% return on an options contract in 3 months. Stating this investor made a 40% annualized return is technically correct, but the communication must clearly state the assumptions to achieve this return (e.g., the market conditions would have to repeat three more times, which is very unlikely).

Any records or statistics provided in the communication must be confirmed as factual and initialed (like a signature) by a Registered Options Principal (ROP; Series 4).

Options programs

If a member firm creates a communication about an investment program that includes the systematic use of options, the following must be disclosed:

• The cumulative history, or
• The unproven nature of the program (if there’s not enough history)
• The program’s underlying assumptions