‘Going to Vegas:’ Newbie options traders face a reckoning as the tech stock rally fades

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Ben Eifert is an expert in options trading, a complicated field that involves calculating delta, gamma and other exotic variables that help predict price movements. In 2020, he’s watched a flood of amateurs rush into his niche of finance—a phenomenon he last saw more than two decades ago.

“The ’90s were the last time retail investors were active and aggressive like this. Lots of older folks in Silicon Valley recall that time. Talk to your patent lawyer, and he was probably trading options in the ’90s,” says Eifert.

Like the current wave, the 1990s spike in amateurs trading options was spurred by a huge run-up in the price of tech stocks. And like that last wave, this one will end in tears, according to Eifert and other veteran options traders, who say most newbies don’t understand how derivates markets really work.

New players, ancient market

To understand the current mania among retail investors—and why they’re poised to take a bath—it’s helpful to look at the options market through a broader lens. Options are not a recent invention, of course. They’ve been around since biblical times, and their purpose is easy to grasp: They are a contract that locks in the right to buy or sell a given asset at a fixed price in the future, which is very useful if your business relies on a volatile commodity like grain or fuel.

That’s why the airline industry has long used options contracts, in the form of puts and calls (the right to sell and buy at a given price), to hedge against swings in commodity prices. Likewise, gold producers use such contracts to create a predictable revenue stream even as the price of the yellow metal bounces up and down.

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Since options contracts can be valuable in their own right—think of a call option that gives you the right to buy a share of Apple at $100 when the market price is $115—they’ve given rise to an industry of speculators as well.

The trader Eifert, who founded a firm called QVR that specializes in derivatives, says speculative options trading took off in the 1970s after two academics created the Black-Scholes model, which offers a formula to help price them.

Despite their complexity, amateur investors have been quick to glom onto options during bull markets, viewing them as a way to bet that a given stock will go higher. That’s what happened prior to the dot.com bust of the late 1990s, when investors rushed to snap up shares of new tech companies—and also rushed to acquire options to buy and sell those shares.

The Robinhood effect

A similar rush has taken place this year as trading in calls of firms like Tesla and Apple has surged. The recent wave has seen individual investors account for as much of 75% of options trades on a given day, while sales of call contracts exceeded puts …read more

Source:: Fortune

      

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