A 'safe' put-selling strategy for a conservative retiree
A relationship manager at a full-service broker is paid a higher trail commission on derivative strategies than on fixed deposits. He recommends that a 68-year-old retired teacher, whose only income is a pension and whose risk profile is 'conservative', invest ₹18 lakh of her ₹45 lakh retirement corpus in a 'monthly income' strategy. The strategy sells 300 lots of Nifty 24,000 puts, lot size 25, one month to expiry, for a premium of ₹38 per unit. The margin is ₹9.5 lakh. The RM tells her the strategy is 'safe because Nifty rarely falls 3% in a month' and that she will receive about ₹2.85 lakh in premium. She signs the standard risk disclosure, which she does not read. Two weeks later, Nifty falls 6% on a global shock, the puts are deep in the money, and the client faces a margin call of ₹7 lakh. She calls the branch to complain that she was told the strategy was safe.
1. Assess the suitability of the recommendation and whether the signed risk disclosure cures the problem.
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The recommendation is unsuitable on several grounds:
- The client is a conservative retiree whose income is a pension and whose corpus is meant to fund living expenses. A short put position has unlimited downside in theory and large downside in practice; it is not a fixed-income substitute.
- The position is enormous relative to her resources. 300 lots × 25 = 7,500 units. At a 24,000 strike, the notional is 7,500 × 24,000 = ₹18 crore. The margin of ₹9.5 lakh is only a fraction of the exposure, which is exactly why the strategy looks attractive on premium yield and is dangerous.
- The RM's statement that the strategy is 'safe because Nifty rarely falls 3% in a month' is a material misrepresentation. The premium is compensation for bearing tail risk, not a guarantee. A 6% fall is not a remote hypothetical.
- The compensation structure rewards the RM for recommending derivatives, creating a conflict of interest that must be managed and disclosed.
A signed risk disclosure does not cure mis-selling. Disclosure is meaningful only if the client understands the product, the maximum loss, the margin-call mechanics and the leverage. Here the client did not read it, and the RM gave a verbal assurance that contradicted the risk. The firm's suitability and KYC obligations require the recommendation to match the client's risk profile; a signature cannot convert an unsuitable product into a suitable one.
2. Quantify the risk-return of the strategy and explain what the RM should have done instead.
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The premium is 7,500 × ₹38 = ₹2,85,000. Against ₹18 lakh of capital, that is about 15.8% per month, or against ₹9.5 lakh of margin, about 30% per month. That yield is not income; it is compensation for selling insurance.
The breakeven is 24,000 − 38 = 23,962, about 3.4% below the prevailing market. If Nifty falls 6% to about 22,600, the put intrinsic value is 24,000 − 22,600 = 1,400 per unit, or 7,500 × 1,400 = ₹1.05 crore, before deducting the premium. The loss is roughly ₹1.02 crore, many times the ₹9.5 lakh margin. If Nifty falls to 22,000, the loss is 7,500 × 2,000 = ₹1.5 crore, less the ₹2.85 lakh premium, i.e. about ₹1.47 crore. The client's entire ₹45 lakh corpus could be wiped out, and she could owe money.
The RM should have:
- Treated the conservative risk profile as a limit, not a label.
- Explained maximum loss, margin calls and leverage in writing and verbally.
- Considered a defined-risk alternative, such as a put spread, or a much smaller position sized to a small fraction of the corpus.
- Documented the client's refusal or the reasons for not recommending the product.
- Escalated the suitability question to compliance if the client insisted on a derivative strategy.
A 'safe' label is inconsistent with the actual payoff.
3. How should the firm handle the complaint, and what remediation and supervisory actions are appropriate?
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The firm should treat the complaint as a potential mis-selling case, not as a client misunderstanding. Immediate steps:
- Stop further trading in the account and assess the current position and margin call.
- Preserve the RM's call recordings, messages, account-opening records, risk-profile documentation and commission records.
- Escalate to compliance and the grievance-redressal committee; give the client a written acknowledgement and a clear timeline.
- Assess whether the client understood the product and whether the verbal assurance contradicts the risk disclosure.
Remediation:
- If mis-selling is established, make the client whole for losses caused by the unsuitable recommendation, including costs, and correct the account.
- Review other clients sold the same strategy by the same RM.
- Review the RM's compensation, training and supervisory record; take disciplinary action if warranted.
- Report to the regulator if the conduct meets the firm's reporting threshold.
Supervisory actions:
- Strengthen suitability checks for derivative recommendations, especially for retirees and conservative clients.
- Require a second-level review for high-notional option-selling strategies.
- Monitor commissions and product concentration by RM.
- Train staff that a signed disclosure is not a substitute for suitability.
The firm should also explain to the client, in plain language, how the margin call arose and what options she has. Blaming her for signing the disclosure would not be fair treatment and would weaken the firm's position in any regulatory review.