The Dangers of Options Trading

THE BRIEF

If it looks like a stock, is bought like a stock, and is sold like a stock, then it’s probably a stock, right? No. Options are very different, highly complex, and could be extremely risky… so be warned.

• Options, the lottery-like investment, have become increasingly popular with retail investors (i.e the Average Joe) gambling for big returns.
• Alexander Kearns, a 20-year old Robinhood customer, committed suicide on June 12 after seeing his account turn from a $16,000 balance to a negative balance of $730,000 overnight in his options trading account.

THE EXPLANATION

Similar to stocks, options can be bought and sold on the stock market with a value that goes up and down. But aside from that, they are vastly different from stocks. Options are essentially digital contracts that give the investor the “option” to buy a set number of stocks on a predetermined date at a particular price. Confusing? This is only the surface.

Robinhood disrupted the brokerage business by introducing zero-commission trading fees. Alongside its seamless onboarding experience, Robinhood made it much easier and cheaper for the regular investor to access options trading. Prior to Robinhood, trading options require a screening process where a financial advisor assesses your personal financial information, trading knowledge, and investment objective.

• Since 2000, the stock market trading volume only doubled while options trading volume grew more than six times.

After news broke of Kearn’s death, it was discovered that the negative balance shown on his account was temporary and would have likely corrected the next day. Options traders on Robinhood would often see negative cash balances as a result of an interface issue. This raises the question, why is the average investor able to access such a complex investment so easily?

Ultimately, buying options are no different from gambling in a casino. Why don’t casinos go bankrupt? The odds are stacked against the gambler and the casino will always make money in the long run. Buying options is no different and the house (option sellers) will win in the long run.

THE ACTION

Those who do not have a solid understanding of the financial markets should not be trading options. Professional traders buy and sell options as a full-time job and fully understanding options can take years. Before you buy options as a get rich quick scheme, ask yourself, would you go to a casino to get rich? If the answer is no, then you probably shouldn’t be trading options.

For those that want to look further into options trading, tastytrade offers free educational resources.