$5 billion…
That’s how much retail investors lost from November 2019 to June 2021 by trading options.
That tally is staggering considering that the broader market was up 40% over that time frame… And that includes the 34% COVID-induced decline in the first quarter of 2020.
While the numbers are staggering, they are not surprising… at least to me.
Options get a bad reputation for good reason. I’ve written before about the right way to trade options. But if you don’t know what you’re doing – if you make the critical mistake these traders did – you can lose money fast.
It’s an expensive education…
A new study, “Retail Trading in Options and the Rise of the Big Three Wholesalers,” proves it. From an April Bloomberg article, “Mom and Pop Investors Took a Billion-Dollar Bath Trading Options During the Pandemic”…
Spurred by Reddit posts and urged on by Twitter and TikTok influencers, daily volume in bullish contracts set record after record as stuck-at-home tinkerers flocked to the contracts in an effort to juice up returns.
Researchers Svetlana Bryzgalova, Anna Pavlova and Taisiya Sikorskaya estimated that retail investors lost $1.14 billion trading options from November 2019 to June 2021, assuming a 10-day holding period. Trading costs ate up an additional $4.13 billion. To measure the performance of nonprofessional traders, the authors tracked options orders coded as originating with retail brokerages and sent to high-volume market makers known as wholesalers.
During the pandemic, with everyone bored at home, many investors turned into options traders overnight. They wanted to gamble, and they wanted fast gains. Options can provide that.
The chart below looks at the number of call options (a bullish bet) that were bought for 10 contracts or fewer…
We know these folks were mom-and-pop investors because it’s rare you’ll see a big bank or hedge fund trade in such low amounts. These massive institutions trade hundreds of contracts per trade. When you see 10 or fewer contracts, it’s usually an individual investor hoping to score big.
As you can see, in an era of zero-commission trading, options activity has skyrocketed.
The reason many of these bullish bets didn’t pay off was because they were far too speculative…
If you buy a call option and the underlying stock shoots up in a short period of time, it’s easy to double or triple your money. The more you bet the stock will go up, the more your potential return will be. Essentially, it’s a way to use leverage.
For this reason, greed blinds a lot of new traders. They get sucked into the lure of life-changing gains… all without realizing they’re making ultra-low probability bets.
Here’s more from Bloomberg. It’s an example of how foolish some of these new option traders were…
At the peak of the frenzy in 2021, small-time traders were buying more than 23 million call options a week, according to Options Clearing Council data compiled by Jason Goepfert at Sundial Capital Research. That’s way above any other period going back to 2000…
The derring-do of newcomers was frequently called out by Wall Street. One tactic in particular – buying out-of-the-money calls days or hours before they were likely to expire – was pilloried as a newbie gambler’s mistake. In one celebrated instance, more than 50,000 contracts effectively betting that GameStop would surge sevenfold changed hands on Feb. 25, 2021. The option expired the next day.
Think about that for a second… Folks were betting real money that GameStop (GME) would move up 600% in just one day.
Absolutely absurd.
As I’ve said many times before, options are only dangerous if you want them to be. The way my team and I use options is ultra-safe… In fact, you’ll have less risk than a normal buy-and-hold investor.
We use options for income… or as a form of insurance, to make big returns if markets fall. That’s why my options-selling portfolio has held up much better during this market decline than many all-stock portfolios.
Using options for speculation, however, can be disastrous. Don’t make the same mistake these amateur traders did.
Here’s to our health, wealth, and a great retirement,
— Dr. David Eifrig
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Source: Daily Wealth