Get rich quick or risky business? Options trading is accessible, but not for everyone

Options trading has found its place in the do-it-yourself world of young investors, creating opportunities to cash in on high returns in the short term. But it can be a risky game, experts say.

Wider access to options trading on DIY platforms has democratized a part of the market that was once cornered by financial professionals. Combined with increased stock market talk on social media and market volatility, options trading has gained traction among large and large investors.

The trend really picked up during the pandemic, when many were stuck at home, and has continued since, with options trading rising 89.4 percent in 2023 compared to the year before, according to a report from the World Federation of Exchanges.

Social media and online commentary have increased demand for options trading, said Josh Sheluk, portfolio manager at Verecan Capital Management.

“People hear how well someone on Reddit did with a specific options trade and they want to try to do the same and get rich very, very quickly,” Sheluk said.

“It has become very attractive,” he added.

Options – a derivative whose value is directly linked to an underlying asset or stock – allow investors to bet on how a stock will move over a specific period of time. It is 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 rise by $5 within a certain period, Sheluk said.

“As a 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 for $55, when on the market it would be $60,” he explained. It’s not so great for the option seller, who will have to buy the stock at market value and sell it back at the $55 strike price.

If the stock does not reach the option’s strike price, the entire investment is lost.

A drop in options trading costs, especially on do-it-yourself investing platforms, has also attracted young investors to the space. For example, on Wealthsimple, investors can trade options for as little as one dollar.

Major banks have also started to reduce their options trading fees as competition between investment platforms increases. Last month, the Bank of Montreal cut fees for options traders who make more than 150 trades per quarter.

“The prices and costs of options trading have come down quite a bit over the years,” says Sheluk. “These digital-only platforms have made it much more cost-effective.”

But the biggest risk with options is that an investor could lose 100 percent of their money, Sheluk said.

“I don’t think many do-it-yourself investors really understand how much risk they’re taking on when trading options,” he said.

“It is extremely difficult to determine the direction of the market or specific stocks,” Sheluk added.

But increasing awareness and education have changed the views of some young investors.

Bilaal Dhalech, financial content creator and self-taught options trader, advises investors to educate themselves and learn about the risks.

Dhalech said many young investors start with as little as $50 or $100.

“There is still a risk,” he said. “But for most people, that risk isn’t great because it’s not a lot of money.”

Investors who want to try options trading should be well-versed in the basics of investing, says Dhalech, who founded bdinvesting.org.

“If you could answer almost all the questions about long-term investing … I think you’re definitely ready for options trading,” he said.

“Always start with play money or fake money so you understand what you are getting into,” Dhalech said.

Tiffany Woodfield, senior financial advisor at Raymond James Ltd., said setting up guardrails is important when moving into an area that is highly susceptible to losses.

“Set aside how much you are willing to lose so you are prepared,” she said.

Woodfield suggested that 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