HOW FINANCIAL ADVISORS USE AND THINK ABOUT EXCHANGE-LISTED OPTIONS

HOW FINANCIAL ADVISORS USE AND THINK ABOUT EXCHANGE-LISTED OPTIONS

TABLE OF CONTENTS Industry Recommendations...1 Part 1:...2 Who Are They?...2 How Do They Use Them?...2 Motivations and Beliefs...5 Part 2: Non-...6 What Keeps Advisors from Using?...7 What Are They Willing to Consider?...7 What Impact Does the Firm Have?...9 Part 3: Mega Team Advisors...11 What Advisors Can Learn from Mega Team... 11 Conclusions...15 About Cerulli Associates Cerulli Associates is a global research and consulting firm specializing in asset management and distribution trends worldwide. Cerulli produces a suite of annual, quarterly, and monthly publications in addition to an online data platform, and also provides custom research and advisory services. The company has been in existence since 1992, is independently owned, and has fully staffed offices in Boston, London, and Singapore. Cerulli has established a strong global reputation for quality, reliability, and consistency. Questions? Please contact: Emily Sweet, CFA Senior Analyst Cerulli Associates info@cerulli.com INTRODUCTION In this study, Cerulli seeks to understand the behavior of advisors who use exchange-listed options strategies with clients and those who do not. The purpose of this study is to identify target audiences and educational strategies for The Industry Council (OIC) that may lead to increased adoption of exchange-listed options strategies among financial advisors. Important components of this behavioral study are advisors practice characteristics, key influences of their behavior, and perceptions about exchange-listed options. In addition, Cerulli studies the habits of advisors from the largest practices by AUM to provide an aspirational example for all advisors. In sum, Cerulli seeks to identify the types of advisors who are most likely receptive to exchangelisted options and the mechanisms through which to spread messaging most effectively. This study has been sponsored by The Industry Council. About The Industry Council The Industry Council (OIC) is an educational organization funded by OCC, the world s largest equity derivatives clearing organization, and the U.S. options exchanges. The mission of OIC is to increase awareness, understanding and responsible use of exchange-listed options among a global audience of investors, including individuals, financial advisors and institutional managers, by providing independent and unbiased education combined with practical expertise. Learn more about OIC at: www.optionseducation.org

INDUSTRY RECOMMENDATIONS Cerulli recommends that the options industry take the following actions: 1. Target advisors who are most open to using options. The most important advisors are those who are considering using options in the future. These advisors show elevated levels of confidence about options and are willing to incorporate more diverse use by both options strategy and goal. s demonstrate many of these characteristics, and independent s who currently use options implement them more broadly and for a greater percentage of client accounts than advisors in other channels. By narrowing the focus to the most receptive advisors, OIC should have better results increasing adoption of exchange-listed options. 2. Consider building relationships with centers of influence such as custodians, service providers, or consolidators to more effectively distribute the message about exchange-listed options. This will help OIC reach s in a more scalable manner. 3. Develop messaging and educational content that addresses concerns about time management. Promote the risk management capabilities of exchange-listed options and the preexisting preference of them over OTC options. By identifying and responding to advisors biggest hesitations, OIC will likely increase the number of advisors willing to consider using options. Building upon current competitive advantages should help this cause. 4. Do not ignore client impact on advisors options use. It is difficult to quantify the impact clients have on advisors options use, but many advisors acknowledge its presence. This is particularly important given an increase in conversations about the role of a fiduciary and client suitability. Educating advisors and increasing their confidence in talking to clients about options is an important step to managing and understanding clients influence. 5. Consider mega team options users as a center of influence for all advisors. Share best practices regarding how these advisors use and think about options. Advisors from smaller practices often look to the largest and most successful advisors as an aspirational model for building their own practices. By sharing best practices, OIC can help other advisors think and act in a way that may help them create a more successful business. 6. Be intentional and selective with firm-level options promotion. Partner with B/Ds and custodians that have fewer options-related resources to promote the benefits of exchange-listed options to advisors. Extend the reach of this messaging to non-users who are far less aware of existing options messaging than advisors using options. 7. Assess the opportunity to increase marketshare of exchange-listed options with current options users. Half of advisors currently using exchange-listed options also use OTC strategies. Promoting the merits of exchange-listed options to these advisors may increase OIC s penetration of overall exchange-listed options use. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 1

PART 1: OPTIONS USERS : Who Are They? In a survey of more than 600 advisors, approximately one-third (32%) currently use options in client portfolios. Use is even higher among the largest practices by AUM, with close to 40% of these advisors currently using options. In addition, almost one-third of advisors in each of the independent registered investment advisor () and national and regional broker/dealer (B/D) channels use options. usage rates are lower among independent broker/dealer (IBD) and hybrid advisors, with 26% and 25% of participants, respectively, currently using options. On average, advisors use options in 21% of their clients accounts, and they expect to increase use by 30% in three years. On average, advisors use options in 21% of their clients accounts, and they expect to increase use by 30% in three years. At present, independent s use options across 28% of client accounts, the broadest use across channels. In addition, independent s and hybrid s expect the greatest increases in options usage rates across client accounts in the next three years, from 28% and 22% to 39% and 33%, respectively. By contrast, wirehouse advisors incorporate options in only 15% of client accounts. While wirehouse advisors report the greatest occurrence of options use (46% currently use options), these advisors incorporate them in only a small percentage of client accounts. Advisors whose practices are primarily fee-based (greater than 90% fee-based revenue) report using options with 29% of clients, the highest usage rate of the four fee categories defined by Cerulli. These advisors also plan to increase use to 37% of client accounts in 2019. By contrast, advisors who produce less than 90% of revenue from fee-based business use options with an average 15% of clients, and they expect to increase use by approximately one-third to 20% of clients in three years. Even so, this usage figure remains much smaller than that reported by primarily fee-based advisors; accordingly, in 2019, primarily fee-based advisors expect to use options with 79% more client accounts than advisors who earn 10%-50% of their revenue from fees. 90% Of advisors from the largest teams in terms of AUM who use options, most (90%) use exchange-listed options. The number of option trades advisors place annually in a typical client account is well distributed across usage buckets, measured by number of trades. Employee channel advisors (wirehouse and national and regional B/Ds) report the highest volume of trades, with 35% of these advisors executing more than 20 trades annually in a typical client account. By contrast, only 21% of independent advisors report doing more than 20 trades annually for clients. Higher frequency of trading is likely supported by greater centralized support services, especially at wirehouse firms, where advisors report a higher overall level of centralized firm resources than other channels. When assessing the opportunity set for increasing adoption of use, it is important to consider not only the frequency of use, but also the depth of use, as these behaviors may not occur simultaneously. : How Do They Use Them? Use of exchange-listed options is more prevalent among advisors than overthe-counter (OTC) options. Most (90%) advisors from the largest teams by AUM (greater than $500 million) who use options use exchange-listed options, while 70% of these advisors also use OTC options. In addition, 86% of all advisors currently using options use exchange-listed ones, while 52% use OTC options. This divergence in use is particularly high among independent s almost 90% of whom use exchange-listed options compared to a 41% usage rate of CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 2

OTC options. Employee channel firms also exhibit high exchange-listed option usage rates of 90%. Advisors preference for exchange-listed options over OTC options is well supported in most cross sections of advisors. Exhibit 1: : Use of Exchange-Listed vs. OTC by Channel, 2017 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 90% 90% 50% Wirehouse 60% Na onal and Regional B/D 80% B/D Though the use of exchange-listed options far exceeds OTC option use today, this trend is less defined among advisors who previously used options (but are no longer using them) and advisors considering using options in the future. Previous users report more balanced use. Close to 30% of previous options users report having used exchange-listed options, while 24% report having used OTC options. No clear tendency exists among advisors who are not currently using options but are considering using them in the future. Overall, 13% of these advisors would consider both exchange-listed and OTC options, but there are differences among channels. Wirehouse and IBD advisors report a slight tendency toward considering OTC options, while independent s and hybrid s show a preference for exchange-listed options. While these figures do not necessarily point to concrete trends, it is reasonable to conclude that the preference among options users for exchange-listed options has grown over time, and advisors considering using options have not formed clear preferences between the two strategies. Advisors concentrate options use heavily in covered calls, long calls, and long puts. Almost all (96%) of advisors currently using options use covered calls, aligning with income generation goals, and 78% use long calls and puts. In addition, two-thirds of advisors use protective puts, which reconciles with capital preservation, a motivation for 80% of options users. Most advisors plan to maintain or increase their use of the above-mentioned options strategies in the future, so it is likely covered calls, long calls, and long puts will maintain their popularity with advisors. Beyond the traditional use of covered calls, long calls, and long puts, advisors appear willing to expand their use of options strategies. Though use is less prevalent than that of the instruments listed above, many advisors also use protective puts, option spreads, short calls and puts, cash-secured puts, and collars. Almost 80% of independent s report using protective puts, the highest usage rate among all channels. Wirehouse advisors use option spreads 89% 43% 41% 81% Hybrid 86% 52% 52% All Advisors Among advisors considering using options, wirehouse and IBD advisors report a slight tendency toward considering OTC options, while independent s and hybrid s show a preference for exchange-listed options. The preference among options users for exchange-listed options has grown over time. Exchange-listed Over the counter Advisors concentrate options use heavily in covered calls, long calls and puts, and protective puts. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 3

most frequently. Cash-secured puts and collars are used by fewer than half of advisors, but with 43% and 40% usage rates, respectively, adoption is still significant. Though covered calls top current and future usage rate trends, advisors exhibit an openness to more specialized strategies, a solid indication for interest in adopting new strategies. Exhibit 2: : Use of Option Strategies by Channel, 2017 Strategy Wirehouse National and Regional B/D Channel B/D Hybrid All Advisors Covered calls 95% 100% 96% 96% 100% 96% Long calls and puts 77% 80% 82% 75% 79% 78% Protective puts 67% 63% 64% 79% 53% 66% Option spreads 60% 45% 46% 55% 37% 49% Short calls and puts Cash-secured puts 49% 50% 39% 60% 47% 49% 41% 37% 41% 57% 28% 43% Collars 44% 45% 29% 51% 32% 40% Employee advisors goals may indicate a more open-minded approach to incorporating options into their practice, but it may also indicate less focused use of these instruments. Income generation is a universally popular goal of using options, but employee channel advisors exhibit a more diverse set of goals than their peers at independent channel firms. Employee channel advisors emphasize short-term speculation and alpha generation as goals more frequently than independent channel advisors. Almost 30% of employee advisors frequently use options for short-term speculation, while only 10% of independent advisors do the same. In addition, close to 40% of employee advisors frequently cite alpha generation as a goal, while only 15% of independent advisors do. Using options to satisfy a diverse set of goals might indicate a greater willingness and capacity for use, but less focused use may also increase the challenge of engaging employee advisors to increase adoption of options use. Though covered calls top current and future usage rate trends, advisors exhibit an openness to more specialized strategies. Employee advisors goals may indicate a more open-minded approach to incorporating options into their practice, but it may also indicate less focused use of these instruments. Stock indices and ETFs are a distant second and third to stocks as a choice for the underlying instrument, but a significant percentage of advisors at least sometimes use these two instruments. Individual equity securities are the most frequently used underlying instrument in option contracts, but advisors also exhibit willingness to trade options on other instruments. More than 60% of advisors frequently use stocks as the underlying security for options contracts. Stock indices and ETFs are a distant second and third to stocks, but a significant percentage of advisors report at least sometimes using these two instruments. Though only 19% of advisors frequently use ETFs as the underlying instrument, an additional 40% sometimes use them. Approximately one-quarter each of independent s and national and regional B/D advisors frequently use options on ETFs. More than 30% of independent s, hybrid s, and wirehouse advisors frequently trade options on stock indices. In addition, the instruments advisors are most considering for future use volatility indices, currencies, fixed income, and commodities are today s most unused instruments. The percentage of advisors considering using these instruments is small, but coupled with the CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 4

adoption of other instruments and the growth in popularity of underlying instruments such as ETFs, it indicates a willingness of advisors to branch out beyond individual equities. : Motivations and Beliefs The types of clients for which advisors use options may indicate their perception of options inherent risk. One-third of advisors report never using options with conservative clients, and one-third report always using options for highly aggressive clients. This behavior may indicate preconceived ideas about the riskiness of adding options to client portfolios. Whether these ideas are driven by the client or the advisor, OIC may have success increasing adoption of exchange-listed options by encouraging advisors to evaluate how incorporating options impacts the risk characteristics of the entire portfolio, rather than focusing on the isolated or perceived riskiness of options as an investment vehicle. One-third of advisors report never using options with conservative clients, and one-third report always using options for highly aggressive clients. The impact of client demand on advisors use of options is difficult to quantify. Advisors most often report that using options was their own idea, while client demand is the second-most significant influence. Though clients seem to have a sizeable influence on advisors use of options, advisors report that clients are not extensively familiar with options. For example, almost one-quarter (24%) of advisors report that clients have a significant influence on their use of options in client accounts, yet only 33% of advisors agree that clients are highly familiar with options. Client influence is less pronounced among independent s and hybrid s compared to B/D channels. In addition, only 33% of advisors who currently use options report that they would increase options use given demand for them by clients, and almost 60% would maintain the same use. The influence of clients is unclear. Exhibit 3: : Agreement with Statements about by Channel, 2017 Analyst Note: Data represents options users who agree or strongly agree with each statement. Channel Benefits of Use Wirehouse National and Regional B/D B/D Hybrid All Advisors Enhance yield and income 80% 85% 83% 84% 95% 85% Solve a specific client need 85% 75% 70% 90% 90% 80% Create a better investment outcome 70% 75% 73% 84% 81% 76% Cost-effective expression of short-term views 65% 70% 73% 71% 80% 71% Differentiate my practice 67% 75% 53% 66% 57% 61% Incorporate volatility as asset class 53% 60% 47% 52% 62% 52% Clients are highly familiar with options 23% 50% 27% 29% 14% 33% Few advisors consider either centralized resources or a center of influence at their firm significant drivers of their use of options in client accounts. Only 10% of advisors report that either their firm s capital markets desk or home-office strategies are significant influences. Another 10% cite a center of influence at the firm, such as another advisor or manager, as a significant influence. This may indicate a roadblock in reaching advisors in scalable, centralized messaging about exchange-listed options and could necessitate appealing to advisors individually. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 5

PART 2: OPTIONS NON-USERS Non-: What Keeps Advisors from Using? The biggest factors preventing advisors from using options are a preference for other risk management tools and a lack of time. With respect to risk management tools, advisors most often monitor investment manager risk and overall portfolio risk. But these preferences do not necessarily preclude using options as a risk management tool. That this group of advisors is already inclined to monitor overall portfolio risk may indicate a willingness to consider tools, such as exchange-listed options, to manage risks. Most (81%) of these advisors do not use other derivatives such as futures or swaps. This may further support the argument for using options because they are not currently tied to use of certain derivative instruments. In addition, less than one-quarter (24%) of these advisors believe that options are too risky to use in client accounts and in the current regulatory environment. Particularly given that options inherent risk and the regulatory environment do not appear to be major hurdles, OIC may find success in building a case for exchange-listed options and scalable technology solutions as a way for advisors to enhance their current methods for monitoring portfolio risk factors. Time consumption is another reason that deters some advisors from using options in client portfolios. This dynamic is strongest among the group of advisors who have used options in the past but are not currently using them. Three-quarters (75%) of previous users subscribe to the idea that options are too time-consuming. This coincides with their top reason for no longer using them. But the aversion to options based on time commitment is lower among advisors considering options use; less than half (48%) of these advisors agree that time commitment is a factor preventing them from using options, and 41% are neutral on the issue. This group may present fewer objections than previous users and, therefore, a better opportunity for increasing adoption of options use. The biggest factors preventing advisors from using options are a preference for other risk management tools and a lack of time. The two largest business factors preventing options use are compliance and client suitability. Approximately 40% of advisors report these as major factors preventing them from using options. Advisors not currently using options show relatively low confidence levels about using them. Confidence levels are greater among advisors who are considering using options in the future. The two largest business factors preventing options use are compliance and client suitability, with approximately 40% of advisors reporting these as major factors preventing them from using options. Notably, advisors do not consider technology and cost as major factors preventing them from using options. Only 16% and 14% of advisors consider these, respectively, as major factors preventing their use, and approximately half report that these are not a factor. Eliminating technology and cost as major limiting factors may help OIC effectively target messaging to address advisors primary concerns, compliance and suitability, through education. Advisors not currently using options show relatively low confidence levels about using them. Only 19% of advisors would feel very comfortable using exchange-listed equity options, and this is the greatest level of confidence advisors report. The remaining 80% of advisors are split between feeling somewhat confident and not confident at all using exchange-listed equity options. In addition, 49% of advisors would not feel confident using ETF options, and another 60% would not feel comfortable using long-term equity anticipation securities (LEAPS). All other strategies, futures, commodity, currency, and bond options, elicit even lower levels of confidence. But confidence levels are greater among advisors who are considering using options in the future, a positive indication of an audience willing to increase adoption of options use. Almost one-third of these advisors would feel very confident using exchange-listed equity options, compared to 4% of non-users who give no indication of plans to use options in the future. A similar trend CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 6

exists for LEAPS, ETF options, and index options. For all option strategies indicated, confidence is higher among advisors considering using options than it is among previous options users. In addition, those considering using options demonstrate relatively low levels of not confident responses for exchangelisted equity options, index options, and ETF options. This is a positive sign for reaching advisors who show both an interest in using options and more confidence than other advisors not currently using options. Wirehouse advisors may represent another opportunity to increase adoption of exchange-listed options. These advisors report higher overall levels of confidence in options than advisors in other channels. For example, 28% of wirehouse advisors would feel very confident using exchange-listed equity options, compared to 19% across all channels. Similarly, 37% fewer wirehouse advisors would not feel confident using exchange-listed equity options than all advisors. Overcoming confidence hurdles through advisor education may be most feasible among the subset of advisors who are considering, but not currently using, options. This group appears much more receptive to education than previous options users and other non-users. Almost 50% of advisors considering using options would find education related both to implementing options and to training on position management very useful compared to 38% and 21% of previous users, respectively. In addition, far fewer advisors in the considering using group would consider any of the training types measured (implementation, position management, baseline education, and trading) definitively not useful. Educational opportunities are likely to be most effective among advisors who indicate a preexisting willingness to consider using options in the future. Non-: What Are They Willing to Consider? Advisors are most willing to consider using the same options strategies commonly used by other advisors: covered calls, protective puts, long calls, and long puts. More than half (54%) of advisors considering using options would be willing to use both protective puts and long calls and puts, and 70% would consider using covered calls. Those advisors who are currently considering using options would be most interested in using them to incorporate risk measures and generate income in client portfolios. More than 70% of these advisors would be interested in the former reason and 60% in the latter, indicating a keen focus on risk management. These points of emphasis are consistent with current advisor options use and demonstrate a focus on generating income and managing risk. Overcoming confidence hurdles through advisor education may be most feasible among the subset of advisors who are considering, but not currently using, options. Availability of off-the-shelf products incorporating options would be the most-effective method of encouraging advisors to use options in the future. Other factors that would encourage advisors to use options include client demand, a better understanding of how to manage option positions, and technology. Availability of off-the-shelf products incorporating options would be the mosteffective method of encouraging advisors to use options in the future. Overall, 36% of advisors would be encouraged by the availability of packaged products or firm discretionary models using options. Combined with the common assumption that options are time-consuming to manage, this indicates a willingness of advisors to use options if they were offered in a more efficient format. This is particularly the case among wirehouse and IBD advisors, 50% and 46% respectively of whom cite this as a factor that would encourage their use of options. This is also emphasized with larger (but not the largest) practice advisors. This makes intuitive sense, as advisors from the largest teams by AUM may already have resources to handle the time requirements of implementing options, while an advisor or team managing between $100 million and $500 million in AUM may have not yet reached that scale. Other factors that would encourage advisors to use options include client demand, a better understanding of how to manage option positions, and CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 7

technology. While it is difficult to quantify the impact that clients have on advisors options use, a significant number of advisors consider clients an important influence. More than one-third (35%) of advisors report that, should a client allow or request them to use options, it would encourage them to do so. This influence is elevated among wirehouse and IBD advisors at 48% and 42%, respectively. A better understanding of options position management would also encourage almost one-third (30%) of advisors to implement options, particularly in the IBD and hybrid channels. Technology is mainly a factor for wirehouse advisors, 43% of whom report that acquiring the technology to manage options would encourage them to use them. By contrast, fewer than 30% of advisors in most other channels cite technology as a factor. OIC may find that emphasizing ease of use to all non-users and selectively emphasizing key issues to targeted advisor segments an effective way to increase options use. Advisors who previously used options appear reticent to consider using them again. Increasing adoption will be challenging with this group. Exhibit 4: Non-: Factors That Would Encourage Future Use by Channel, 2017 Channel Factor Encouraging Use Wirehouse National and Regional B/D B/D Hybrid Insurance B/D All Advisors Availability of packaged products 50% 29% 46% 30% 38% 33% 36% Clients allow or request use 48% 27% 42% 36% 32% 24% 35% Better personal understanding 24% 24% 39% 28% 41% 21% 30% Acquiring technology to manage options 43% 22% 28% 19% 32% 19% 26% Third party ideas 30% 20% 27% 20% 30% 10% 23% strategies suggested by my firm 22% 17% 35% 17% 22% 24% 23% Firm allows use of options 13% 51% 14% 9% 21% 48% 20% Advisors who previously used options appear reticent to consider using them again. Close to 40% of these advisors cite time consumption and 35% cite lack of a current need as their primary reasons for discontinuing options use. Onethird of these advisors ceased using options in favor of packaged products. These advisors primarily used the options strategies most popular with today s options users: covered calls, long calls and puts, and protective puts, but few would be willing to consider using these instruments again. Only 44% would be willing to use covered calls again, and fewer than 30% would be willing to use either long calls and puts or protective puts. It is worth noting that fewer than 20% of these advisors report complication and expense as reasons for discontinuing options use, but without convincing these advisors that there is a more efficient way to implement options, increasing adoption will be challenging in this group. Advisors wanting to learn more about options would turn to a variety of sources, including financial websites, their firm s research department, and third-party resources. They also indicate a bias away from gathering information from people in their professional network such as their firm s trading desk, colleagues, and other industry acquaintances. Almost 50% of these advisors would turn to a financial services website to gather information, CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 8

while only 25% would approach a colleague for the same information. Likewise, 47% would contact industry resources such as OIC for information, and 36% would contact their firm s trading desk. When it comes to gathering information about options, advisors are more likely to gravitate toward third-party resources than personal contacts. Wirehouse advisors are most likely to consult in-house resources such as their research department or trading desk. This may be due to scale, which affords wirehouses with the ability to provide more well-established resources to their advisors. For example, wirehouse advisors are 55% less likely than independent s to gather information on options from financial services websites and 31% less likely than independent s to turn to industry resources such as OIC, likely due to the availability of centralized resources. When designing outreach and educational opportunities for advisors, it may be most effective to consider which centralized resources are currently available to them. Many advisors are approved by their firms to use options. Approval does not appear to be a major roadblock to increasing adoption of options use. Exhibit 5: Non-: Sources Most Likely Used to Gather Information about by Advisory Channel, 2017 Channel Information Source Wirehouse National and Regional B/D B/D Hybrid Insurance B/D All Advisors Financial services websites 23% 39% 46% 52% 43% 56% 44% Firm's research department 64% 51% 45% 19% 49% 47% 40% Third-party providers 43% 34% 41% 44% 41% 26% 40% Industry resources 30% 29% 34% 43% 41% 30% 36% Firm's trading desk 68% 44% 28% 13% 33% 33% 31% Colleagues or team members 36% 44% 35% 28% 25% 23% 31% Industry acquaintances 11% 20% 7% 17% 14% 26% 15% Non-: What Impact Does the Firm Have? Many advisors are approved by their firms to use options, and approval does not appear to be a major roadblock to increasing adoption of options use. Two-thirds of advisors who do not currently use options are already approved to use them by their firm. Most (91%) of wirehouse advisors are approved, while more than 60% each of IBD advisors, hybrid s, and independent s have options approval. By contrast, this figure is lower for national and regional B/D advisors at 44%, implying that more initial effort would be necessary to increase adoption in this channel. More than half of advisors (51%) at national and regional B/Ds indicate firm approval as a factor that would encourage them to use options. In addition, firm-level approval appears to be positively correlated with practice AUM; the larger the practice, the greater the chance an advisor not currently using options is approved to do so. More than 70% of advisors with practices exceeding $100 million in AUM have firm-level approval to use options, but this number falls to less than 60% for advisors with practices having less than $50 million in AUM. The same trend is apparent with advisors from the largest CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 9

teams compared to smaller teams. More than 80% of mega team advisors (greater than $500 million in AUM) not currently using options are approved to use them, while only 65% of advisors from practices smaller than $500 million in AUM are approved. More than 60% of advisors not currently using options report that their firm does not promote their use. Firm-level promotion of options is much less likely to reach advisors who are not currently using them, and many options nonusers may not be aware such communications exist. By contrast, only 27% of current options users report that their firm does not promote options. Onethird of options users report that their firm has an options strategy desk, while only 11% of non-users report the same characteristic. This pattern repeats for all forms of communications about which Cerulli and OIC inquired. Within channels, wirehouse firms seem most effective in raising awareness of options resources with advisors. Almost as many wirehouse advisors not using options (52%) report that their firm has an options strategy desk as current options users (58%). The difference in awareness between options users and non-users diverges more significantly in the IBD and national and regional B/D channels. For OIC to effectively spread messaging at a firm level, it will be important to understand to what extent advisors in each channel currently receive messaging or are aware of options-related resources at their firm. 60% More than 60% of advisors not currently using options report that their firm does not promote their use. Exhibit 6: Firm-Level Promotion of by Advisory Channel, 2017 Channel Wirehouse National and Regional B/D B/D Hybrid All Advisors Promotion Type Non- Non- Non- Non- Non- Non- Firm does not promote the use of options 20% 30% 20% 66% 40% 61% 31% 67% 29% 64% 27% 62% Provides an options strategy desk 58% 52% 40% 15% 17% 8% 24% 4% 19% 8% 32% 12% Provides education on incorporating options 28% 33% 40% 5% 27% 8% 32% 9% 33% 6% 32% 10% Provides compliance support 40% 35% 20% 7% 27% 11% 19% 1% 19% 11% 27% 9% Provides technology 43% 24% 35% 12% 13% 4% 22% 2% 29% 11% 27% 7% Distributes option trade ideas 40% 24% 50% 7% 20% 1% 19% 1% 38% 3% 30% 5% Communicates written content 38% 26% 25% 5% 3% 1% 8% 2% 10% 3% 17% 6% CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 10

PART 3: MEGA TEAM ADVISORS What Advisors Can Learn from Mega Team This section examines the ways in which advisors from the largest teams use options and their beliefs about the value of implementing options in client portfolios. Cerulli identifies the largest practices (mega teams) as those exceeding $500 million in assets under management (AUM). These teams often specialize and divide responsibilities, allowing them to offer a larger range of services to their clients. Mega teams may include a CIO or investment analyst as well as multiple senior advisors and junior staff members. Advisors often look to the largest, most successful teams as an example from which to model behavior, so it is instructive to examine the different ways the largest teams incorporate options to learn how to increase the adoption of exchange-listed options use. Mega team advisors use options for more diverse purposes than smaller teams. Like most advisors, income generation is a primary objective for these advisors; however, they place a greater emphasis on downside risk and portfolio diversification than advisors from smaller teams. Almost 60% of advisors from the largest practices frequently cite downside risk protection as a goal of using options, while only 37% of advisors from smaller teams do. In addition, almost 40% of mega team advisors report portfolio diversification as a frequent motivation compared to the 25% of smaller practice advisors. Exhibit 7: : Mega Team Advisors Frequency of Use by Objective, 2017 Analyst Note: Represents advisors who frequently use options to achieve each objective. Mega team advisors use options for more diverse purposes than smaller teams. Mega team advisors employ specialized strategies, particularly collars and cash-secured puts, more frequently than other advisors. Teams with investment personnel use collars and cash-secured puts almost twice as frequently as teams without investment personnel. Objective Practices with $500m AUM Practices with <$500m AUM All Advisors Income generation 51% 57% 55% Downside risk protection/hedging 57% 37% 38% Portfolio diversification 39% 25% 26% Create an entry or exit point 14% 29% 26% Alpha generation 21% 26% 25% Preserve capital 18% 24% 22% Stock alternative/substitute 13% 23% 21% Short-term speculation 21% 20% 19% Replacement of a limit order 8% 15% 14% In addition to diversity in objectives, advisors from the largest practices use more diverse types of options strategies than advisors from smaller practices. Income generation through covered calls is common for advisors of all practice sizes, but mega team advisors employ specialized strategies, particularly collars and cash-secured puts, more frequently than other advisors. Mega team advisors use these options strategies greater than 50% more frequently than CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 11

smaller practices. This trend is echoed by teams with at least one research analyst or CIO, a trait that is characteristic of mega teams. These teams use short calls and puts 90% more frequently than other advisors, and they use collars and cash-secured puts almost twice as frequently. This trend also holds true for multi-advisor teams compared to solo and partnership structures, supporting the idea that teams with more specialized capabilities can help advisors expand their practices. Exhibit 8: Mega Team : Strategies Used by Practice AUM, 2017 Analyst Note: Mega Team advisors are defined as practices with $500 million in AUM. Strategy Practices with $500m AUM Practices with <$500m AUM All Advisors Covered calls 90% 97% 96% Long calls and puts 80% 77% 78% Protective puts 77% 65% 66% Option spreads 58% 49% 49% Short calls and puts 60% 48% 49% Cash-secured puts 62% 41% 43% Collars 59% 37% 40% Exhibit 9: Mega Team : Strategies Used by Practices with Investment Staff, 2017 Analyst Note: Practices with investment staff are defined as those with a least one research analyst or CIO. Strategy Practices with CIO or Research Analyst Practices without CIO or Research Analyst All Advisors Covered calls 84% 97% 96% Long calls and puts 84% 79% 78% Protective puts 85% 64% 66% Option spreads 67% 45% 49% Short calls and puts 82% 43% 49% Cash-secured puts 74% 37% 43% Collars 70% 36% 40% Short-term speculation 21% 20% 19% Replacement of a limit order 8% 15% 14% CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 12

Advisors most commonly implement options directly in client accounts, but mega team advisors use other methods more frequently than advisors from smaller practices. Mega team advisors use alternative strategies such as hedge funds 40% more frequently than advisors from smaller practices to indirectly implement options in client accounts. By contrast, smaller practice advisors use mutual funds more frequently than mega team advisors; however, almost onethird of mega team advisors are considering using this strategy in the future. Mega team advisors also use ETFs as an indirect method of implementing options more frequently than smaller practice advisors, though 20% of smaller practice advisors are considering using ETFs in this manner in the future. Direct option implementation is currently the most popular method, but advisors of all practice sizes are considering other formats, signaling a willingness to adapt to new strategies. The ways in which mega team advisors think about options is distinct from smaller teams, providing insight into options use beyond covered calls. The importance of income generated through covered calls is a popular and important goal of using options, but options can also serve other purposes. Almost 80% of options users agree that they are useful in managing specific client needs, and this view is positively correlated with the size of an advisor s core client market. Almost 40% of advisors who focus on clients with greater than $5 million in assets strongly agree that options are useful in addressing specific client needs, while less than 25% of advisors with smaller core client market do. This makes intuitive sense because higher-net-worth clients are more likely than less wealthy clients to have specific needs that require customized solutions. In addition, advisors from the largest teams more broadly agree that options are useful to incorporate volatility as an asset in client portfolios. More than 80% of the mega team advisors agree with this, while only 49% of smaller team advisors agree. The ways in which mega team advisors think about options is distinct from smaller teams, providing insight into options use beyond covered calls. Advisors who use options in client accounts also frequently use them in personal accounts, signifying a deeper understanding and conviction level in options. In addition, teams with at least one research analyst or CIO more strongly agree that options can lead to better investment outcomes for clients than teams that do not have these resources. More than 40% of these teams strongly agree that using options can enhance investment returns while only 28% of advisors without these resources respond this way. This makes sense because the presence of more specialized investment resources implies more time and expertise to focus on the investment potential of vehicles such as options. Advisors who use options in client accounts frequently use them in personal accounts, but this occurs more commonly among advisors from the largest teams than it does with advisors from smaller teams. Almost 90% of mega team advisors use options in personal accounts, while 75% of smaller practice advisors do. In addition, only 8% of advisors currently using options for personal accounts are not using options in client accounts. And just 18% of advisors using options in client accounts do not use them in personal accounts. This may signify a deeper understanding and conviction level in options as an investment vehicle among mega team advisors. The significance of the positive correlation between options use in personal accounts and client accounts is also supported by advisors who do not use options in client accounts. Only 25% of these advisors, including those who have previously used options with clients, use options in personal accounts. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 13

Exhibit 10: Mega Team : Advisors Use of in Personal Accounts by Practice AUM, 2017 Analyst Note: Mega Team advisors are defined as practices with $500 million in AUM. No, But Considering in the Future, 5% Practices with $500m AUM No, 7% No, 18% No, But Considering in the Future, 7% Yes, 88% Practices with <$500m AUM Yes, 75% The diversification of goals for which mega team advisors use options aligns with a more holistic approach to wealth management to which many smaller practices aspire. Because mega team advisors use options for purposes beyond income generation, namely risk management and portfolio diversification, they emphasize important components of comprehensive wealth management. The ability to think about client portfolios in a more holistic fashion may be a key reason for the success of these mega team advisors. Thinking in a broad portfolio context is particularly important for larger clients, and it may encourage them to entrust a larger percentage of their net wealth to one advisor. Advisors from smaller practices might consider broadening their objectives for options use to focus on goals consistent with serving larger clients and larger proportions of clients net assets. OIC can help them accomplish this while simultaneously increasing use of options by sharing ideas used by mega team advisors. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 14

CONCLUSIONS There is a demonstrated preference for exchange-listed options over OTC options by current options users. More than 80% of current options users implement exchange-listed options, and about 50% use OTC options. Advisors from the largest teams, s, and employee channel advisors also demonstrate this preference. Previous options users report having used a more balanced selection between the two strategies, suggesting that exchange-listed options have increased in popularity over time. By contrast, those advisors considering using options in the future do not demonstrate a clear bias toward either type of option. A broad preference for exchange-listed options over OTC options may be a strong advantage in increasing their use by advisors. Advisors exhibit an openness to considering other options strategies, methods of using options, and underlying instruments beyond the plainvanilla variety. Advisors heavily favor covered calls, long calls, and long puts to generate income and preserve capital. But many advisors, particularly s, wirehouse advisors, and mega team advisors, also use protective puts, cashsecured puts, and collars for a more diverse set of goals such as downside protection, portfolio diversification, and alpha generation. Though advisors most frequently use individual equity securities as the underlying, a significant percentage of advisors occasionally use stock indices and ETFs. The most popular instruments and goals may remain in favor, but advisors are willing to expand their options use beyond them. The top reasons preventing advisors from using options are time consumption, preference for other risk management tools, compliance concerns, and client suitability. Previous users also cite time consumption as the top reason for which they stopped using options. Though advisors place an emphasis on compliance and suitability concerns, far fewer cite that the inherent riskiness of options and the regulatory environment are preventing their use of options. In addition, neither technology nor cost appear as major factors preventing use. Advisors not currently using options do not feel very confident about using them. Exchange-listed options are the type about which they feel most confident, albeit at low levels. Advisors who are considering using options exhibit elevated confidence levels compared to other non-user types, including previous users. But advisors do not necessarily want education on the basics; they would prefer educational content related to implementation and position management. And they are most likely to seek information from third-party resources rather than people in their firm or professional network. Building confidence among those most willing to increase adoption is an important step to increasing overall use of exchange-listed options. Advisors not currently using options who indicate that they are considering doing so in the future are an attractive audience for increasing adoption of exchange-listed options. Almost 90% of these advisors are already approved to use options. These advisors report higher confidence levels with respect to options use, and many of them know which options strategies they would consider using and for which goals. Advisors considering using options cite time consumption as a barrier far less often than other non-users. Advisors who indicate a willingness to use options represent an attractive market segment for promotion of use. CERULLI ASSOCIATES How Financial Advisors Use and Think About Exchange-Listed 15

Recommendations Cerulli recommends that OIC take the following actions: 1. Target advisors who are most open to using options. The most important advisors are those who are considering using options in the future. These advisors show elevated levels of confidence about options and are willing to incorporate more diverse use by both options strategy and goal. s demonstrate many of these characteristics, and independent s who currently use options implement them more broadly and for a greater percentage of client accounts than advisors in other channels. By narrowing the focus to the most receptive advisors, OIC should have better results of increasing adoption of exchange-listed options. 2. Consider building relationships with centers of influence such as custodians, service providers, or consolidators to more effectively distribute the message about exchange-listed options. This will help OIC reach s in a more scalable manner. 3. Develop messaging and educational content that addresses concerns about time management. Promote the risk management capabilities of exchange-listed options and the preexisting preference of them over OTC options. By identifying and responding to advisors biggest hesitations, OIC will likely increase the number of advisors willing to consider using options. Building upon current competitive advantages should help this cause. 4. Do not ignore client impact on advisors options use. It is difficult to quantify the impact clients have on advisors options use, but many advisors acknowledge its presence. This is particularly important given an increase in conversations about the role of a fiduciary and client suitability. Educating advisors and increasing their confidence in talking to clients about options is an important step to managing and understanding clients influence. 5. Consider mega team options users as a center of influence for all advisors. Share best practices regarding how these advisors use and think about options. Advisors from smaller practices often look to the largest and most successful advisors as an aspirational model for building their own practices. By sharing best practices, OIC can help other advisors think and act in a way that may help them create a more successful business. 6. Be intentional and selective with firm-level options promotion. Partner with B/Ds and custodians that have fewer options-related resources to promote the benefits of exchange-listed options to advisors. Extend the reach of this messaging to non-users who are far less aware of existing options messaging than advisors using options. 7. Assess the opportunity to increase marketshare of exchange-listed options with current options users. Half of advisors currently using exchange-listed options also use OTC strategies. Promoting the merits of exchange-listed options to these advisors may increase OIC s penetration of overall exchange-listed options use. Cerulli Associates 699 Boylston Street, Boston, MA 02116 +1 617-437-0084 info@cerulli.com www.cerulli.com CERULLI ASSOCIATES OIC White Paper 16