Fueled by a cocktail of slick trading apps and social-media hype, retail trading has soared since competition between brokerages squashed commissions in 2019. Stocks were the focus initially. But these days much of the excitement appears to be in options, which offer a cheap way for traders to bet on a stock going up or down in price without having to actually purchase the shares.
By one measure, options activity in the US is on track to exceed that of the stock market for the first time: The average daily notional value of traded single-stock options has risen to more than $450 billion this year, compared with about $405 billion for stocks, according to Cboe Global Markets data. The notional value is the trading volume multiplied by the spot price.
Make no mistake—institutional investors are still heavy hitters in options contracts, which give traders the right, but not the obligation, to buy or sell an asset at a certain price.
Sometimes investors use these derivatives to hedge: An options contract can be used as an insurance policy in case an asset falls in value, for example. Options also are a cheap way to speculate. A contract betting on a stock to rise to a certain price within a week (a weekly call option) can cost a few dollars or less. But while these options don’t cost very much, they’re also not very likely to pay out.
Why is options trading so popular?
Options contain leverage that can magnify investment gains (and losses). A typical contract gives the trader the option to buy or sell 100 shares of a stock, for a fraction of the money it would take to actually buy 100 shares of that stock.
Buying and selling of options has roughly quadrupled during the past five years, the Wall Street Journal reports, citing Cboe data. Legions of armchair investors, fanned by posts on Reddit and TikTok, are probably chasing a dopamine high as much as they are chasing dollar signs.
The boom in options could be making financial markets more volatile, but it’s possible to overstate their influence. These derivatives were thought to have exacerbated the wild swings in GameStop shares, which in early 2021 became a battleground between retail traders and hedge funds. While trading in options linked to the video-game retailer did indeed skyrocket, a report by the US Securities and Exchange Commission found no evidence (pdf) of a popular theory that the options trading had unintended consequences on the share price from market makers racing to hedge the options activity (known as a gamma squeeze). Quartz reporting on Robinhood shares and options came to a similar conclusion.
But even if it doesn’t destabilize financial markets, the options boom risks burning armies of new traders when equity markets eventually change direction and US stocks finally cease setting new record highs. That could leave a new generation of investors sour on an important wealth generator.