Sunday, October 10, 2010

Don't Be Afraid of Options - Part 7: Ethical Investing in Options

This post is the last of the "Don't Be Afraid of Options" series.  I will close with a treatment of the ethical issues around investing in options.  In my last post on ethical investing, I talked about the ethics involved in owning shares of a company, that as a shareholder, one bears the social responsibility for the actions of the company.  Today, let's talk about owning options.  How does that fit in?

Ethical Risks in Owning Options
What should you be concerned about when buying or selling options?  Below are a few points to consider.

  1. Buying and selling options, in and of itself, is ethically neutral.  An option, as we have discussed in my past posts on options, simply gives the right to the buyer to either buy or sell a stock at a given price before a given time.  Its ethical implications are similar to that of gambling.  The Catechism of the Catholic Church (paragraph 2413) tells us that "games of chance or wagers are not in themselves contrary to justice."  However, gambling often leads to sin.  I would say under certain circumstances, using options recklessly can lead to sin.

    For example, if you put 100% of your portfolio in one out-of-money call option, in hopes that the stock would rise significantly, you risk losing the value of your entire portfolio.  Losing that much money often leads to anger and could also deprive one's ability to provide for one's family.  If you are going to get into options, make sure you know exactly what you're getting into and know what risks you are exposed to.
  2. Owning options is entirely different than owning shares of a company.  Companies never obtain money from options that are traded on the market.  Companies do offer a similar instrument for their shares, but these are called warrants.  The options that are traded on an options exchange are created by investors.  It's almost like sports gambling.  In places where sports gambling is not prohibited, one can bet on the outcome of a certain sports game, but these wagers do not affect or are affected by the teams playing the games (unless illegal activities are taking place).  They are linked only because the wagers are based on the outcome of that particular game.  The same goes for options.  They are linked with the underlying stock only because their value is dependent on the stock price of that company.
  3. If a company participates in unethical activities, is it morally acceptable to own a call option for that company's stock?  Let's examine that a little bit.  Who is selling the call option to you?  An investor who owns the company's stock may be selling you the call option, because he wants to have an income while he holds onto the shares, because he has a somewhat bearish outlook of the company in the short term.  If he didn't have the ability to sell the option, he may have sold the company's stock instead.  So, your buying of the call option gave an indirect boost to the shares of the company.

    However, you do not actually know why the other investor wanted to sell that call option.  The above was purely hypothetical.  In my opinion, the buying of the call option falls into a somewhat grey area in investing ethics.  You could be helping out the immoral company, but maybe not.
  4. How far would you need to be removed from the company before you are no longer ethically liable for its actions?  I don't think I can give you a good answer.  Say there is a company called Nuclear Warheads Inc. making nuclear warheads, and as we know, nuclear warheads are weapons of mass destruction.  They are, without a doubt, an immoral thing.  I have not heard of any other uses for nuclear warheads that are beneficial to human life.

    So, the company that supplies the machinery to Nuclear Warheads Inc., called Warhead Machinery Inc., is likely to be somewhat morally liable.  Although they are not making the warheads themselves, they are knowingly selling a product to a company that makes unethical products.  Then, there's the company, Machinery Tables Corp., that sells tables on which various types of machinery sit.  They are somewhat less morally responsible than Warhead Machinery Inc.  Moving on, a steel company called Steel Co. supplies Machinery Tables Corp. the steel that they need to manufacture the machinery tables.  I would say Steel Co. is pretty far removed that they are not ethically responsible.  But the point is, where does one draw the line?  It is a difficult, if not impossible, task.

    Since there are thousands of companies available for anyone in which to invest, why would one risk one's personal values by choosing to buy/sell options of a company that one knows is immoral?  I believe the risk is too great.  I would rather be safe than sorry.
The Key is Knowledge
The key to investing ethically and responsibly in options is knowledge, the knowledge of i) the moral principles of the underlying company, and ii) the risks involved in your trade.  If you have both, and both are not contrary to your values and principles, I would definitely encourage you to invest in options.  I believe options are a very good complement to purely investing in company stock.  When used properly, they can reduce risk and increase returns.

Now that you have finished reading my series on options, go out there and try them out.  I've had success with them and I believe you will too!