Kwamé Adams, a 30-year-old from Georgia, says he started buying stock options on his Robinhood app in August after watching tutorials on YouTube.
were surging, and Adams realized that “you can make much more money from options.” But on Sept. 3, the market reversed direction, and an
call option he bought for $122 that day quickly became worthless.
“It has been a roller coaster,” he says.
has been on this roller coaster, and investors like Adams at times seem to be in the driver’s seat. The heavy buying of call options, which give holders the right to purchase individual stocks or indexes, helped fuel the August surge in stocks like Apple (ticker: AAPL) and
(TSLA), and probably contributed to a recent sharp reversal in tech stocks earlier this month.
Option volume in single-stock equities averaged a record 18.4 million contracts a day in August (each contract gives the holder the right to buy or sell 100 shares of stock), up about 80% from the average monthly volume during 2019, according to
Cboe Global Markets.
So far this month, activity has increased further, with single-stock option volume running at an average of 23.8 million contracts a day through Sept. 8, driven in part by a sharp rise in Apple and Tesla options trading after their Aug. 31 stock splits.
Options are used for many purposes, including the purchase of put options to protect portfolios from market downturns.
But much of the action this summer has involved investor purchases of call options to effectively get leveraged bets on leading stocks.
“There has been a huge ramp-up in speculative trading,” says Jason Goepfert, president of research firm Sundial Capital Research, who has called it a “retail option-trading frenzy.”
Indeed, while there are whales in the market—like Japan’s
(9984.Japan), which reportedly bought call options on $50 billion of technology stocks—it is the minnows who are making the water choppy.
“These small traders have become the biggest part of the options market,” Goepfert says. “Since mid-July, trades for 10 contracts or fewer have consistently accounted for more than 60% of all opening call purchase premiums, massively dwarfing larger trade sizes.”
Anthony Denier, CEO of Webull Financial, a privately held online broker that, like Robinhood, appeals to young traders, says, “These are not calls or puts people are buying and selling for the premium; they’re not doing it to hedge a position. These are naked, purely speculative plays that we’re seeing.”
He is noticing lots of traders buying short-term out-of-the-money calls—all-or-nothing bets that a stock will rise in a short period—a trend that he hasn’t seen previously. “You’re hoping for a huge swing in a very short amount of time,” Denier says.
A bull market in tech stocks, near-zero trading costs, seamless online technology, and perhaps boredom for millions of Americans stuck at home, have all added fuel to the options-trading fire.
“Some of it is the FOMO [fear of missing out],” says Garrett DeSimone, director of quantitative research at OptionMetrics. “People see stocks like Tesla and Apple going through the roof, and they hear about people making money in call options.”
Options trading is part of a trend to democratize investing, giving more power to retail investors. Yet the surge in options trading is also adding volatility to the markets. Even for investors who stick with stocks and funds, knowing the dynamics of—and the risks in—options trading is critical to understanding today’s market.
Retail investors often gravitate to short-dated, lower-priced options that are out of the money, meaning that the stock needs to appreciate quickly for an investor to make money. These options often amount to lottery tickets, DeSimone says.
Highlighting this trend, some 60% of all single-stock options trading recently has been in those with less than two weeks until expiration, compared with 45% at the start of 2020, according to Susquehanna Financial Group.
And reflecting the growth of retail participation, the average option trade is now six contracts, half the level of two years ago, and an increasing number are just a single contract.
Single contracts account for about 12% of all volume in call equity options, up from 6.5% at the start of 2020, according to Susquehanna, and about 11% for put options. Single contracts total about two million a day and can influence the markets, given that they are based on 200 million shares of stock.
This summer, those trades were winners, as Tesla, Apple,
(AMZN), and other tech stocks barreled ahead. Call buyers benefited from both the appreciation in the underlying stocks and the higher implied volatility—a measure of expected change in the stock embedded in the options price.
And even after the recent pullback in tech stocks, investors are still eager to trade Apple and Tesla options. Apple option activity has more than doubled this month, as investors buy more options to get the same Apple exposure following its 4-for-1 stock split. “The surge in options volume is having a big impact on Apple and Tesla,” notes Chris Murphy, co-head of derivatives strategy at Susquehanna.
When investors buy call options, the sellers, who tend to be professionals, hedge their exposure by purchasing the underlying stock. When the underlying stock moves higher, the pros adjust their hedges by buying more stock, which accelerates the upward move. This goes into reverse when the underlying stocks decline, prompting pros to lighten their hedges by selling stock.
A proliferation of short-dated calls with an out-of-the-money strike price and maturities of two weeks or less has accentuated these moves, given the mechanics of options hedging.
With Apple recently at $118, an out-of-the-money call might have a strike price of $125, meaning that the stock needs to rise above $125 for the investor to get any payoff on the option at maturity. A more expensive at-the-money option would have a strike price of $118. An at-the-money call option often has a delta of 0.5. The delta reflects the percentage change in the options price for a given move in the underlying stock. In this instance, that means that a $1 rise in Apple’s share price would result in a 50-cent gain in the option.
With Tesla, there has been a shift since its stock split on Aug. 31 toward a more bearish outlook in the options market. Open interest in puts, which give holders the right to sell stock, is now 30% higher than the calls, according to Rance Masheck, president of iVest Plus, which designs trading platforms. Open interest is the amount of outstanding contracts.
Low costs have helped attract new investors. Charles Schwab and other brokers reduced fees for options trading last year, as they cut stock trading commissions to zero. Schwab once charged $4.95 a trade and a 65-cent fee per contract. When the $4.95 fee was eliminated, options trading rose.
“A lot of investors saw the $4.95 as a barrier to entry,” says Jeff Chiappetta, Schwab’s vice president of trading and education. “If you’re trading one contract, you’re paying essentially $5 plus the 65 cents. So when we removed the $4.95, that really did remove the barrier for a lot of investors.”
The total number of options trades on Schwab is up 116% year to date, but the total number of contracts is up about 80%, Chiappetta notes. That implies that investors are trading fewer contracts per trade.
Robinhood, which pioneered no-commission equity trading, also has no fees for options. It is now adding safeguards, including asking users to review their strategy before exercising options.
Options themselves are relatively cheap. They often cost just $2 or $3, meaning that investors could get exposure to 100 shares of Apple for just a few hundred dollars—less than the cost of a single share before the split.
The risks are rising for call buyers because options on companies like Apple and Tesla are particularly expensive, given their sharp moves, making it even harder to profit on out-of-the-money options.
A key measure of option costs is the implied volatility, or the annualized change in the stock priced into the options. For Apple, implied volatility recently hit 60%, up from 34% at the start of August.
Normally, implied volatility falls in rising markets and increases in falling
In downturns like the March selloff, investors rush to buy puts, lifting option prices and boosting measures like the
Cboe Volatility Index,
or VIX. In rising markets, investors tend to figure that further gains are limited and pay less for options, depressing volatility.
“It’s almost unprecedented to see volatility rise with prices,” says Goepfert of Sundial. “Not only are people buying a lot of Apple calls but also they’re paying more for them. Rarely does that work.”
Despite the risks, options can play a valuable role for retail investors. “Options get painted as a bad tool,” says JJ Kinahan, chief market strategist at TD Ameritrade. But options, he says, can offer ways for investors to limit or define risk as well as offering a substitute to owning stocks.
Still, for some newbies, the recent volatility was a lesson. Adams, the Georgia resident, says he’ll probably tread more carefully. In fact, he has found a new area of investing. “I think in the future I want to start getting into dividends,” he says. “I’d like to have some extra income coming in. Just let it sit there; let it build up over time.”