An increasing number of retail investors are getting in on the options trading trend with nifty apps that make trading seem easy and fun, while regulators consider enhancing their oversight on risky bets by amateur players.
Options trading gives investors the right or “option” to buy or sell an amount of a specific asset at a predetermined price on a certain date. Most Main Street investors think of trading options as an easy option to turn a quick high-margin profit. With a record of almost 39 million options contracts, on average, traded daily, there has been an increase of 25 percent during 2021 compared to the past year, based on data from Options Clearing Corp.
Twenty-five percent of trades are done by greenhorn investors who make use of gamified apps and beginner-friendly user interfaces to venture into the rather complex world of derivatives trading. A majority of retail investors employ the basic call and put options, which are difficult to generate profits, compared to the more intricate strategies that Wall Street uses.
While “calls” allow the trader to buy a stock at a specified strike price, “puts” gives them the right to sell. Spreads are strategies that consist of a combination of simultaneous buying and selling that allows for hedging risk, and may even be cheaper to execute. However, spreads are mostly made available by brokers to more experienced traders, leaving beginners to learn the money game through losing capital, which many do.
“Everybody in the business knows that if you’re only buying out-the-money calls, then you’re likely going to lose money over time,” John Foley, CEO of Options AI said to CNBC. “The question of democratization shouldn’t be ‘can I trade options?’ but ‘can I have straightforward access to the options strategies that Wall Street uses?’ The playing field is not level right now and no one is really focusing on that.”
Robinhood is one of the apps used by many novice retail investors. According to data from CNBC, less than 1 percent of options trading done on the platform involved strategies or spreads.
The Sway of Reddit
Reddit is a popular meeting point for non-professional traders who often make investing choices on the platform’s message boards. Users have rallied around specific stocks, like that of GameStop and AMC Entertainment, and propelled price movements through unified stock purchases.
Based on a campaign started by retail investors on Reddit, GameStop stock prices jumped 1,000 percent in a period of two weeks, effectively kickstarting the meme-stock trend. Last week, r/WallStreetBets, a message board, was discussing Apple stocks, resulting in a flurry of options trade linked to Apple.
Options are preferred by first-time traders as, unlike other stock trading, it provides the investor with leverage to buy multiple shares of a stock for a fraction of its actual cost, resulting in a dopamine high, especially when urged on by peers. Institutional investors use derivatives trading as a form of hedge for covering losses.
The increasing number of average users turning to options trading has drawn the scrutiny of authorities who are considering putting in effective measures to curtail the “easiness” with which retail investors place big bets.
According to a spokesperson from the Financial Industry Regulatory Authority (FINRA), the regulator will request public opinion on options trading by retail investors in the coming weeks for recommending actions.
“We share the concerns raised by the SEC and others that retail investors may be opening accounts to trade options and other complex leveraged products without fully appreciating the risks involved,” Robert Cook, CEO of FINRA said in a congressional testimony after the GameStop trade.
Following the testimony, FINRA fined Robinhood $70 million for allowing inexperienced traders to deal in options. The regulator has warned other brokerages and encouraged them to issue preliminary requirements before approving customers for options trading.