When I was at Babson, I had a part-time job as a phone rep at Wall Street Games—a stock market contest that used options to boost returns. It was also a training ground for stockbrokers to try out their strategies. My job was to put (pun intended) their strategies in place and let ‘em ride. It was a training ground for me too, giving me a front-row seat in how big money was lost.
Now, as new investors pile into the stock market, whether out of boredom or desperation from losing their jobs to COVID-19 shutdowns, the Wall Street Journal reports they are betting big in the options market. What could possibly go wrong?
Gunjan Banerji and Alexander Osipovich write:
Individuals looking to profit from the stock market’s explosive moves are piling into options, lured by low trading fees and a chance at mammoth payoffs.
Coronavirus-fueled market swings this year have created ample opportunities for these traders, who tend to thrive when markets are more volatile. Big market moves tend to benefit traders because they increase the likelihood that stocks will jump or fall toward levels that can make their options contracts exponentially more valuable.
Meanwhile, individual investors—often stuck at home during the pandemic—are finding it cheaper and easier than ever before to trade options. Popular apps such as the one from Robinhood Markets Inc. offer rock-bottom commissions on options trades.
Options are contracts that give investors the right to buy or sell shares at a specific price, later in time. Traders can tap options to hedge their portfolios from stock declines or make bets that major indexes and individual companies will either go up or down in value.
Such brokerages make more money from options than from stock trades, thanks in part to a system in which high-speed traders pay them to execute small investors’ trades. Such firms find it more consistently profitable to trade against individuals, with their small orders, than against institutional investors, which can push prices up or down with large trades.
Sam Rodela, a Texas-based consultant, started trading options this year after years of trading stocks. He said he recently turned $80 into more than $2,500 through bullish options bets on shares of Walt Disney Co. He bought a few contracts priced at $20 each in May. At one point before they expired May 22, each contract was worth $633, akin to a return of more than 30 times his original investment.
“Other than a casino, there’s nowhere else you can get a return like that,” Mr. Rodela said. “It’s much higher risk and higher reward” than stocks.
Industry veterans say zero-commission trading has made investors quicker to pull the trigger on trades. Robinhood has drawn more than 13 million customer accounts, many of them opened by younger people. Its success helped to spur brokers including Charles Schwab Corp., SCHW +0.71% E*Trade and TD Ameritrade to eliminate commissions for stock trades last year, although they still charge fees for options, often around 65 cents a contract. Until last year, customers often paid $4.95 or more for each options trade, plus a per-contract fee.
Some investor-protection advocates said they are alarmed by the boom and want more guardrails for investors.
“Firms are making it way too easy to trade options, and they’re making it seem very attractive or low-risk,” said Micah Hauptman, financial services counsel at the Consumer Federation of America. “This isn’t a game. People can lose real money and in some cases a lot of money.”
Originally posted on Your Survival Guy.