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One of the biggest changes in investing in recent decades has been the rise in popularity of passive funds, as more and more people follow Warren Buffett’s advice to log out of their accounts and simply invest in the S&P 500.
And while this has happened, something else is going on at the other end of the spectrum. In what appears to be a classic dumbbell-shaped pattern, risk tolerance becomes more sensible and riskier at the same time.
Options trading is reaching new heights of popularity – and playing a bigger financial role at brokers like Robinhood. The company, which just published its quarterly results this week, saw trading volume rise and with it, options revenue.
As you can see in our Chart of the Week, the share price for the third quarter has risen to $202 million – and this is decoupled from share trading income.
Robinhood’s innovative free trading has transformed the brokerage industry, making fee-free trades ubiquitous. And with the main barrier to action gone, price-sensitive retail investors flocked in, likely helped by stimulus measures. As trading grew significantly, investors also explored derivatives and margins.
“Retail participation in options trading has risen sharply during the pandemic, peaking at 48% in July 2022. While participation has increased since then, it reached 45% in July 2023,” wrote Steven W. Poser , NYSE research director. last year. “This data suggests that there will be significant retail options trading in the near future.”
At the same time, Robinhood was constantly beating the drum about being a place for set-and-forget index fund investors, which was true. There is evidence that retail investors also helped stabilize the market during the 2020 pandemic crash by buying the S&P 500’s dip.
However, these two things are very different. While the S&P 500 is composed of volatile stocks that are subject to wide swings that require risk tolerance, there’s no arguing that it’s an investment worth throwing your lot into. If there are wounds, time will almost certainly heal them.
But options trading, while traditionally used to hedge risk, is an easy way to speculate and place high-risk, high-payoff bets. And as is the case with certain forms of leveraged investing, the downsides can be endless. As the Merrill Lynch website notes, “If you write an uncovered call, you face unlimited potential loss because there is no limit to how high a stock price can rise.”
