As of this August, ordinary investors, or what the media refers to as the retail market, have lost everything they came to the market with during the pandemic. The loss comes, amazingly, despite two consecutive years of record-breaking returns, amidst an unprecedented run of stock market euphoria.
As I wrote in Jacobin at the onset of the GameStop saga, the stock market is not a place where the average American can go to earn passive income; it is not a place where we can make up for stagnating wages across the last half-century by way of wise, well-timed moves. Like the workplace itself, for most of us the stock market is simply another arena of capital extraction.
Today’s retail investors are in a position analogous to that of homeowners during the foreclosure crisis period: average people sucked into a market where sustained success was structurally precluded. And if adjustable-rate subprime mortgages were the oppressive product of the Great Recession, options trading might’ve filled their shoes for the current downturn.
From a place of relative obscurity, options trading by retail investors has grown by more than 220 percent in the last two years alone. Take a few steps back and the rise is even more striking: in the year 2000, daily options contract trading rarely rose above one million, whereas last year it frequented above fifty million.
And the rate of losses for the public in options trading is alarming.
Researchers Svetlana Bryzgalova, Anna Pavlova, and Taisiya Sikorskaya found that retail options investors lost over $1 billion during a bull market from November 2019 to June 2021. Their calculations don’t include their estimated $4.13 billion spent on the trading costs, i.e. wide bid-ask spreads that incur immediate losses for options traders. And lastly, we can’t forget the $800 million burned in that time period on commissions.
To be clear: losing in the market is one thing, but managing to be systematically fleeced at a time when all boats were rising should signal another thing, namely, that the stock market is increasingly a machine transferring capital from the masses to the top. Within that machine, encouraging or allowing leveraged options trading on short contracts among retail investors should be considered nothing less than criminal.
Options are a form of derivatives trading. It’s a big word to mean, simply, you don’t own the company’s stock if you buy their option contract — rather, you own a wager on its potential price movement in either direction. If all you own is the option contract on Apple ($AAPL), for instance, you are betting that you can predict its future price — you are not invested in the company itself. Option contracts can be bought with various expiration dates, anywhere from a week away to a number of months; the shorter the riskier, and the data shows incoming retail investors are eating up the shortest one-week contracts.
Retail investors, research shows, are also buying the same options in concert the week before earnings reports. Essentially, they flood the market at the same time, bidding each other up on the same volatile stocks covered by the media — think Tesla and FAANG (Facebook, Apple, Amazon, Netflix, and Google). In doing so, they’ve effectively bought out each other’s earnings, drawing up bid-ask spreads so wide that even the prospect of being correct would leave them in a hole.
Ironically, though, options were introduced to stock exchanges in the 1970s as a way to reduce risk. It allowed hedge funds, hence the name, to take both sides of the company in strategies like “married puts” and “covered calls.” In the former, for instance, at the time of purchasing a stock, in which case one stands to profit from all upside potential, managers would simultaneously purchase an equal number of put options at a strike price that would protect you against a sudden downturn. It’s understood as an imperfect insurance policy, whereby profits can be realized in either direction, curtailing losses.
It wouldn’t be right, either, just to rinse Robinhood and its cavalier approach to opening up options as a means to “democratizing finance” for this phenomenon. The alarm bells on options trading have been sounding for at least the last decade. In the wake of the Great Recession, retail slowdowns incentivized online brokers like E*Trade, TD Ameritrade, and Charles Schwab to attract more activity by promoting options.
Schwab advertised options trading, in the heart of recession, with the tagline, “We’re looking for newcomers who want to get serious.” E*Trade wrote, “Every investor should learn how options trading could benefit them.” What they didn’t say, of course, was that commissions on options trading for these brokers are about double that of traditional stock buys. Though few studies exist on the real outcomes of everyday options traders, there was one longitudinal study of nearly seventy thousand Dutch retail investors. The findings back up the story of the current wasteland of retail traders over the last two years. Over six years, researchers found that retail investors who participated in options trading lost, on average, 4.5 percent monthly, more than halving their accounts within a year.
“Gambling and entertainment appear to be the most important motivations for trading options,” the authors write, with striking applicability to today, “while hedging motives only play a minor role.”
My position, to be clear, is not a patronizing one that posits people can’t do as they please with their money, but rather that a game of Russian roulette wouldn’t be so thrilling if you found out it was a full clip. Options trading, time has borne out, is far more akin to the latter for us than to a coin in midair, equally liable to land heads as tails. And even if options trading is to go on in vogue among the American public, its reality should not be falsely advertised as what “serious” investors do, or as a springboard to future profits; it should come packaged like a European cigarette, with bankruptcy notices and overdraft alerts on the front page much like the pair of black lungs on a pack in Berlin.