Stock options trading is up sharply this year, fueled by investor optimism for more gains on Wall Street.
Options are contracts that give investors the right, though not the obligation, to buy or sell a stock at a future date and at a set price. Often, though, investors look to make money trading the contracts, rather than by holding onto them.
Through the first eight months of this year, options trading volume is up nearly 46% from a year ago, according to data from Options Clearing Corp., which tracks options activity across 16 exchanges. Just last month, trades jumped 30.4% to around 611.8 million contracts. That made August the third-highest month on record in terms of options trading volume, OCC said.
Zero-commission trading platforms like Robinhood and E-Trade have helped make the options market more accessible to investors, even those with little or no experience. And increased market volatility, which favours short-term investing, has made options trading potentially more lucrative.
Uncertainty over the economy’s recovery from the pandemic, when a proven vaccine for COVID-19 will be available and how the elections will turn out, could make for more volatility on Wall Street in the months ahead. At the same time, low interest rates and billions in bond-buying by the Federal Reserve have helped prop up the market through the pandemic, and the central bank has signalled it intends to continue doing so. That’s given many investors confidence to double down on a rising market.
“It actually makes sense to engage in that type of investing if you have high volatility,” said Pauline Bell, an analyst with CFRA Research. “That’s what we’ve seen throughout 2020. The strategy isn’t going anywhere any time soon.”
What makes options trading especially attractive is that the investor pays less money to buy an options contract -- to essentially make their bet on whether a stock will go up or down -- than they would buying shares in a company at full price.
In addition, if the market is moving in a direction that favours their bet, an investor can opt to sell their option contract and make money on that, rather than waiting to exercise it. Contracts establishing the right to buy a stock are known as “call” options, while those securing the right to sell it are known as “put” options.
“This is a way for them to play the market on the cheap,” Bell said. “It’s a small entry price to basically gamble on the market.”
Where traders can get into trouble is if their bet goes the wrong way, especially if they borrowed money to purchase their option contracts.
Technology sector stocks have led the market higher this year on expectations they can continue to deliver strong profit growth, regardless of the economy, so it’s no surprise that they have been favourites among option traders. The volume of option contracts to buy or sell Microsoft and Tesla shares is up more than twofold from a year ago, while Apple option contract volume is up more than 86%.
A recent flurry of activity in options contracts on big tech stocks may have fueled more gains for the sector.
For example, published reports last week revealed that Japanese conglomerate SoftBank Group bought options on billions in technology stocks, betting that the share price for these companies would continue to rise.
Large trades by a big investor like SoftBank can have an impact on the market, creating a buying frenzy for a stock. Still, small, individual investors are also playing a big role, analysts say.
Several of the biggest online investment brokerages have seen a record surge this year in accounts opened by individual investors, sometimes referred to as retail investors in the industry, and a record volume of trades.
“These small traders have become the biggest part of the options market,” Jason Goepfert, founder of Sundial Capital Research, wrote in a note published Wednesday.
Data on options trading this year also reveals that investors have been buying up far more call option contracts — bets that stocks will rise — than puts — bets that stocks will fall. Last month, 63% of the options contracts traded were calls, according to OCC data.
“You’re seeing a lot of call options activity and not as much puts,” said Willie Delwiche, investment strategist at Baird. “The put-call ratio has been very, very low and that’s a sign of optimism and complacency.”
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