Everyone seems to be trading options these days. OK, not everyone. But a lot more people than there used to be. And sure, we know options are valuable tools and it makes sense for a lot of people to trade them. But where did they all come from and why all of the sudden?
Well, there are a few good reasons, and they’re actually kind of interesting. First, a perfect storm happened in 2020. That spring we had the pandemic, of course, and the majority of people spent a lot more time at home. Many were not working but getting inflated unemployment checks. In some industries former employees were making more money staying home than going to work. Oh, and the government also handed out stimulus checks—a little cherry on top.
Incidentally, at the same time online gambling got shut down for a while. These online gamblers (and there were a lot of them) needed action. Enter option trading, stage left.
Those two events led to a huge influx of option traders. Now, I want to be clear: Those reasons—the latter, anyway—are not good reasons, but this is what happened. Sadly, all too many people get into trading and start out making reckless “bets” on stocks using options as an amped-up device of leverage. Of course, some of them figure it out at some point. But before we even get to that part, next came the gasoline on the fire.
Less than a year later, the GameStop / AMC short squeeze with options extravaganza became a huge thing. And trading volumes really popped. See this chart from my friends at the Cboe
And that trend continues. It’s pretty remarkable.
Now, back to the gamblers. I imagine most got “shaken out” and lost and went back to their degenerate ways. But there are some commonalities between gambling and trading, and I imagine likewise that some of these folks figured that out. We got some new traders then and they’re still trading.
Now, you may say (and at this point, rightfully so) that led to option “traders” not “investors.” But the financial markets are a competitive industry, to say the least. You can surely bet (ha, “bet,” get it?!) that the amount of brokerage marketing dollars and education that went into options ramped up as a result.
Once people get educated enough on options, they come to learn about something called “the risk premium.”
The risk premium is this observation that options overall are slightly overvalued, as option theory would say they should be. The reason for this is what one of my students used to call a “sleeping pill”—you’re hedged, so you can sleep better at night. And, of course, you’re willing to pay a little extra for that.
So, yes, options are statistically (but not universally or always!) overvalued. As the saying goes, “The only way to make money in options is by selling them.” (Again, that’s not always the case, but overall, yes.)
So consequently, we’ve seen a massive increase in options-based funds and products, many being option-selling investment vehicles, where the fund manager employs an option-selling strategy. This incidentally puts some downward pressure on that risk premium, making it smaller and squishing out some of the benefit to selling options, and sometimes creating those rare straddle-buying opportunities I’ve talked about in our daily videos recently.
Another more recent phenomenon is what are known as outcome defined ETFs or “buffer ETFs” (just google “options ETFs”). These have become more popular because they are easier to understand for laypeople, and they are a conservative use of options for investing—they limit losses to the downside, though they cap the upside.
There’s been mad innovation using options lately. SPX options trade in extended hours (I never thought I’d see that). And Zero DTEs make up close to half the volume in those major indexes and ETFs.
Bottom line: Options are a massively bigger part of how traders and investors do their thing now, and that trend is growing stronger. You are ahead of the curve. Stay out front, my friends.
Dan Passarelli
Founder and President
Market Taker Mentoring
