Options trading has found its place in the do-it-yourself world of young investors, opening possibilities of cashing in on high returns in short order. But it can be a risky game, experts say.
Wider access to options trading on DIY platforms has democratized an area of the market once cornered by finance professionals. Combined with more stock market chatter on social media and market volatility, options trading has gained steam with mom and pop investors.
The trend truly picked up during the pandemic when many were stuck at home and has since continued, with options trading surging 89.4 per cent in 2023 compared with the year before, a World Federation of Exchanges report shows.
Social media and online commentary have pushed demand for options trading, said Josh Sheluk, portfolio manager at Verecan Capital Management.
"People hear about how great somebody on Reddit has done with a specific options trade and they want to try to do the same thing and get very, very rich, very, very quickly," Sheluk said.
"It's become very appealing," he added.
Options — a derivative whose value is directly linked to an underlying asset or stock — allows investors to bet on which way a stock will move in a specific time period. It's a contract between two investors.
There are two types of options: calls and puts. A call option gives investors the right to buy a stock at a certain price and a put option is the right to sell a stock at a certain price.
For example, if an individual stock is trading at $50 per share, an investor can buy a call option for $55 — predicting the stock will go up five dollars within a period of time, Sheluk said.
"As the holder of that 'call' option, if the stock price goes from $50 to $60, you're pretty happy because you can now buy that stock at $55, where on the market, it would be $60," he explained. It's not so great for the seller of the option, who will have to buy the stock at market value and sell it back at the option strike price of $55.
If the stock doesn't reach the option's strike price, the entire investment will be lost.
A drop in options trading fees, primarily on DIY investment platforms, has also attracted young investors to the space. On Wealthsimple, for example, investors can trade options for as low as one dollar.
Big banks have also started to lower their options trading fees as competition among investment platforms grows. Last month, the Bank of Montreal lowered fees for options traders making more than 150 trades per quarter.
"The pricing and cost of options trading has come down quite significantly over the years," said Sheluk. "These digital-only platforms have made it much more cost-effective."
But the biggest risk with options is that an investor can lose 100 per cent of their money, Sheluk said.
"I don't think many of the do-it-yourself investors truly understand how much risk they're taking with options trades," he said.
"It's extremely difficult to call the direction of the market or specific stock," Sheluk added.
But growing awareness and education have changed views among some young investors.
Bilaal Dhalech, a finance content creator and self-taught options trader, suggests investors educate themselves and learn about the risks.
Dhalech said many young investors are starting with as low as $50 or $100.
"There's still risk," he said. "But for most people, that risk is not a lot because it is not a lot of money."
Investors hoping to try their hand at options trading should be well-versed in the basics of investing, Dhalech, who founded bdinvesting.org, said.
"If you could pretty much answer any questions about long-term investing … I think you're definitely ready for options trading," he said.
"Always start with play money or fake money just so you understand what you're getting yourself into," Dhalech said.
Tiffany Woodfield, senior financial adviser at Raymond James Ltd., said establishing guardrails is important when venturing into an area highly susceptible to losses.
"Set aside how much you're willing to lose to just be prepared," she said.
Woodfield suggested running scenarios and knowing the consequences could save investors from losing everything.
"Options trading is not for everyone," she said.
This report by The Canadian Press was first published Nov. 5, 2024.
Ritika Dubey, The Canadian Press