US options trading heats up even as speculative stock rally cools
Industry participants see ‘no sign’ US equities wobble has caused exodus from derivatives bets
Investors are turning to derivatives to make supercharged bets on the US equities market, highlighting how the pandemic has left a lasting mark on Wall Street even as the rally in speculative shares fizzles.
Trading volumes in options, tools that let investors bet on price movements of shares without holding them, have jumped this year, in an acceleration of a trend that began in the early days of the pandemic.
Turnover at the main US equity derivatives clearing house, OCC, hit records on two consecutive days last month, exceeding 63mn contracts on both occasions. The average daily volume in January was 44.9mn contracts, compared with 39.4mn last year.
The sharp rise underscores how the US options market has boomed over the past two years, following a surge in interest from smaller traders who deal in more diminutive lot sizes. OCC last year handled 9.9bn options, up almost a third on the previous year and double 2019’s total, which was also a record.
“The options market has meaningfully changed in the past two years,” said Thomas Peterffy, founder and chair of Interactive Brokers, a retail brokerage that handles a tenth of the US options market volume.
Options volumes have doubled on the brokerage since the start of 2020. Easy-to-use platforms with no-fee investments have helped fuel the rise in options trading, Peterffy said.
High stock prices, which soared to record peaks during the pandemic in a rally spurred in part by a historic barrage of central bank stimulus, have also made options more attractive for investors looking to make amped up trades with less cash.
Options give traders the right to buy or sell shares at a fixed price by a pre-determined expiration date. The derivatives are often considered higher risk because they allow traders to make potential big bets with a small outlay. If an option expires before the shares either rise or fall beyond the “strike” price, the trader loses out on the premium they paid to buy the options contracts.
Investors have sought out options on individual tech stocks such as Tesla, Apple, Facebook and Nvidia, as well as tech-related indices such as CME’s Micro E-mini Nasdaq-100 index futures, which caters to retail customers.
Trading in “meme stocks” — favoured by investors who strategise on Reddit message boards — has slowed sharply, and many speculative shares that benefited from pandemic lockdowns have tumbled in recent weeks. The declines mark a sharp reversal from a year ago, when companies such as GameStop, and vehicles such as Cathie Wood’s Ark innovation fund, were in vogue.
But when it comes to options trading, “[w]e have seen no sign of things slowing down”, said Henry Schwartz, head of product intelligence at Cboe Global Markets, one of the US’s largest derivatives exchanges.
“The concept of viewing a call option particularly as [a] lotto ticket with possible infinite payout has become very attractive, and when you get a lot of activity . . . it just snowballs,” he said, referring to a type of option that allows traders to bet on share price rises.
Demand for options among retail investors, especially in the expectation that underlying prices would rise, has encouraged more professional traders to sell the contracts at a mark-up.
“This used to happen in a few dozen stocks a day, there were little pockets of speculation in the market,” Schwartz said. “Now this repricing of the upside risk is happening for hundreds of stocks every day.”
The duration of options contracts has also fundamentally shifted as more volatile “yolo” (“you only live once”) trades have come to define much of the market.
The majority of options trades historically had expirations between 15 and 30 days. But this has now flipped, and flows into short-dated options are the dominant force in the market, with contracts expiring in just two to three days, according to Cboe.
In a sign of how options trading is rippling across markets, Bank of America last month warned clients to “ignore the options market at their own risk”. The Wall Street bank noted stocks with high participation from retail traders, and which are the subject of significant options activity, are geared towards big surges — something that can inflict pain on those betting against them.
“The interaction of retail flows and options activity remains a force to be reckoned with,” BofA said.