FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
September 15, 2020

IN THIS ISSUE:

1. Small Investors Flock to Options Markets, Often Unprepared

2. Surge in Options Volume Led by Small Investors This Year

3. Conclusions: Most Investors Lose Money Trading Options

4. Consider ZEGA Financial’s Successful Options Trading Strategy

Overview – Options Trading Soaring

The US stock markets have seen some powerful moves, both up and down, so far in 2020. We had the 30+% plunge in late February to early April, followed by the powerful run to new record highs from mid-April through August and early September. That was followed by another sharp pullback earlier this month, and it remains to be seen where we go from here.

The wide-swinging volatility we’ve seen this year is an ideal environment for seasoned options traders. Options trading has skyrocketed in 2020 and as such, it has been drawing in record numbers of smaller, often first-time, options investors into this market.

Options trading has long been viewed as a less expensive way of investing in stocks or commodities, in terms of the initial investment to get started, which is typically considerably less than owning stocks outright. So, small investors are piling in, as I will discuss below.The problem is, however, options trading is quite complicated and success is difficult for even experienced options traders, much less the droves of newcomers who have come in this year. How difficult? All options have a pre-set expiration date and must be liquidated prior to expiration or they expire worthless – in which in the latter case the purchaser loses 100% of their investment. This happens all too often.

Despite the low odds for success, investors are drawn to options whenever markets turn very volatile. So today, I want to talk about the pros and cons of options and how they work. If you are a sophisticated options trader, this discussion may be old news for you, but you might want to share it with your adult children, relatives, business associates or friends who are considering trading options for the first time.

At the end of today’s letter, I will also tell you about the only options strategy I do recommend to my clients. Let’s get started.

Small Investors Flocking to Options Markets, Often Unprepared

Individuals looking to profit from the stock market’s explosive moves are piling into options, lured by low trading fees and a chance at potentially huge payoffs if their market hunches are correct. Unfortunately, most investors new to options are not aware that the odds of them losing all the money they invest in options are very, very high.

The coronavirus-fueled market swings up and down this year have created an impression among small investors that even they should be able to cash in on the markets’ swings by using options. It’s true that big market moves tend to benefit experienced traders because they increase the likelihood stocks will jump or fall toward levels that can make their options contracts exponentially more valuable.

Meanwhile, many individual investors – often stuck at home during the pandemic – are finding it cheaper and easier than ever before to trade options. Popular apps such as the one from Robinhood Markets offer rock-bottom commissions on options trades.

Options are contracts that give investors the right to buy or sell shares at a specific price, later in time. If they guess right about the market’s direction and the timing, they can potentially make a lot of money. Traders can also tap options to hedge their portfolios from stock declines or make bets that major indexes and individual companies will either go up or down in value.

With the wild market swings this year, individual investors are piling into options at an unprecedented rate. Options contract trading volume has exploded, as you can see below, and this chart only goes through June. Volume has continued to increase since then.

Adding to the appeal, option contracts allow an investor to put down a relatively small amount of cash – called the “option premium” – for a potentially outsized return if the investor’s hunch about the market proves to be correct. The downside, as noted above, is that an investor can lose 100% of the premium paid should the stock or index move unfavorably.

A record 28 million options contracts have changed hands on an average day this year, a jump of 45% from last year, according to Options Clearing Corp data. That’s huge!

Surge in Options Volume Led by Small Investors This Year

Individual investors are driving the surge in options trading this year. The percentage of options volume stemming from small trades of just one contract on the most frequently traded stocks has risen to 14% this year, up from 10% at the end of 2019, according to a recent analysis by Goldman Sachs.

Online brokerages have seen big jumps in customer options activity. E*Trade Financial Corp. reported record levels of derivatives trades, which mostly involve options, for the first quarter of 2020. Data from TD Ameritrade show daily options trades surged about 60% in the quarter ended March 31 from the previous quarter. This dizzying increase in options trading volume continued to accelerate in the 2Q.

You might ask how we know this huge spike in volume is being led by small investors. We know because we can track the number of option trades that only involve one contract. Or five contracts or less. Both segments have jumped substantially this year.

Robinhood Markets has drawn more than 13 million new customer accounts, many of them opened by younger, inexperienced people. Its success helped to spur discount brokers including Charles Schwab,  E*Trade and TD Ameritrade to eliminate commissions for stock trades last year, although they still charge fees for options, but often only around 65 cents a contract.

Robinhood requires fewer account opening and suitability hurdles on new options customers than some other brokers. New clients assess their own suitability through a questionnaire. Those who say they don’t have much investing background can’t open an options account initially. But wannabe users can simply revise their answers on the questionnaire to get their accounts opened and begin trading.

As you can see in the chart below, the opening of new options trading accounts is far outstripping the opening of traditional stock investing accounts this year. I predict this may not turn out well for these younger new investors who, for the most part, have no idea how poor their chances are to succeed in options trading.

Conclusions: Most Investors Lose Money Trading Options

While some discount brokers make it sound like options trading is easy, the truth is most individual options investors lose money, period. And oftentimes, a LOT of money! This has been true as long as I have been in the investment business.

As noted above, all options have a pre-set expiration date, and unless they are exercised by that date, they expire worthless and the buyer loses 100% of his/her money. Plus, as the options approach their expiration date, they tend to lose value unless the underlying market is moving strongly in the right direction. All too often, it is not and time runs out.

Here’s another caveat which happens all too often: Sometimes the market does move in the direction investors predicted, but oftentimes they get greedy and assume the trend will continue. So, they hold on hoping for even more profit, but many times the trend reverses suddenly, the profit evaporates and their options end up worthless – total loss.

For all these reasons, and more, I do NOT recommend options for most investors – EXCEPT…

Consider ZEGA Financial’s Successful Options Trading Strategy

ZEGA Financial is one of the professional money managers we recommend at Halbert Wealth Management. ZEGA specializes in options trading and has a very impressive track record. But they do it in a way that just might surprise you.

As emphasized above, the vast majority of options contracts expire worthless. That’s why I don’t recommend you buy them. But what if you could SELL them? That’s one of the things ZEGA Financial does. Yes, ZEGA is a SELLER of options contracts through trading option spreads (buying one month and selling another).

As the seller of options, ZEGA collects the premiums paid by the buyers. If the market doesn’t move as the buyer expected, the options expire worthless, and ZEGA pockets the premium paid. Or if the market does move as expected, but the buyer gets greedy and doesn’t exercise the option in time, then ZEGA also banks the premium paid.

If you are interested in diversifying your portfolio into successful strategies which do not depend on a bull market in stocks or bonds – and who isn’t these days – I highly recommend you seriously consider ZEGA Financial and its successful options trading system.

Call us at 800-348-3601 to get more information. I think you’ll be glad you did. As always, past performance is not necessarily indicative of future results.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES

Is It Risky to Invest in Options? Yes

Options Trading Volume Higher Than Underlying Stock Volume

Gary's Between the Lines Blog: Many Americans Are Shoring Up Their Finances

 

Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.