Benn Eifert is an expert in options trading, a complicated field that involves calculating delta, gamma and other exotic variables that help predict price movements. In 2020, he's watched a flood of amateurs rush into his niche of finance—a phenomenon he last saw more than two decades ago.

"The '90s were the last time retail investors were active and aggressive like this. Lots of older folks in Silicon Valley recall that time. Talk to your patent lawyer, and he was probably trading options in the '90s," says Eifert.

Like the current wave, the 1990s spike in amateurs trading options was spurred by a huge run-up in the price of tech stocks. And like that last wave, this one will end in tears, according to Eifert and other veteran options traders, who say most newbies don't understand how derivates markets really work.

New players, ancient market

To understand the current mania among retail investors—and why they're poised to take a bath—it's helpful to look at the options market through a broader lens. Options are not a recent invention, of course. They've been around since biblical times, and their purpose is easy to grasp: They are a contract that locks in the right to buy or sell a given asset at a fixed price in the future, which is very useful if your business relies on a volatile commodity like grain or fuel.

That's why the airline industry has long used options contracts, in the form of puts and calls (the right to sell and buy at a given price), to hedge against swings in commodity prices. Likewise, gold producers use such contracts to create a predictable revenue stream even as the price of the yellow metal bounces up and down.

Since options contracts can be valuable in their own right—think of a call option that gives you the right to buy a share of Apple at $100 when the market price is $115—they've given rise to an industry of speculators as well.

The trader Eifert, who founded a firm called QVR that specializes in derivatives, says speculative options trading took off in the 1970s after two academics created the Black-Scholes model, which offers a formula to help price them.

Despite their complexity, amateur investors have been quick to glom onto options during bull markets, viewing them as a way to bet that a given stock will go higher. That's what happened prior to the dot.com bust of the late 1990s, when investors rushed to snap up shares of new tech companies—and also rushed to acquire options to buy and sell those shares.

The Robinhood effect

A similar rush has taken place this year as trading in calls of firms like Tesla and Apple has surged. The recent wave has seen individual investors account for as much of 75% of options trades on a given day, while sales of call contracts exceeded puts by 22 million in a recent week, according to figures cited by Bloomberg.

This influx of small traders has helped spur a 68% increase in call-options volume activity this year. According to a research note from Bank of America, this activity has "likely ... influenced the 2020 bubble" as retail traders buy options helped drive up the price of Tesla and stocks like Netflix and Burger King.

The recent options mania among individual investors has also led to new and unusual patterns in the overall options market.

"On the retail front, it's been very different than the past few years," says Karen Chang who heads an options trading desk at Bank of America. "Much of the retail volume is coming out of platforms like Robinhood where users can trade for free, especially in stocks like Zoom and Peloton."

The Robinhood influx, says Chang, has also led to a surge in short-dated options contracts as amateur investors seek to make bets on weekly stock movements. By contrast, institutional traders typically buy options that can be exercised over several months or more.

The army of amateurs also accounts for the imbalance in put and call options, says Chang, who says the ratio is typically more balanced. Another consequence has been individual stocks becoming more volatile as their price increases—an unusual phenomenon since higher stock prices normally imply that investors believe a company is becoming more mature and with more predictable revenue streams.

Chang isn't the only one to encounter unusual patterns in the options market. Roni Israelov, the President of investment firm Ndvr and the author of several academic papers on derivatives, says 2020 has brought a big uptick in options contracts for individual stocks.

Ordinarily, the bulk of option contracts for equities consists of wagers on the broader markets—bets on which way the Dow Jones will move, for instance. But the recent run-up in tech stocks has led to a stampede of small investors buying contracts for single stocks.

In many cases, Israelov adds, these investors may be in over their heads.

"Unsophisticated traders focus on where the stock price is headed, and then buy or sell a put or call," he says. "The harder, but more pertinent task is to forecast where the option price is headed."

"The loudest and frothiest element"

A big reason for the surge in retail options trading is that it's never been easier for the average person to buy puts and calls, or to attempt complex derivative strategies such as "strangles" or "straddles."

Whether such traders know what they're doing is another matter. Eifert, whose firm is known in trading circles as a "vol fund" (short for volatility) says the ease with which Robinhood traders can enter the options world is "totally shocking" to him. He believes that such trading is fine among amateurs—so long as they are doing it for fun rather than a way to build wealth.

"It's fine as long as your spending is commensurate with your entertainment budget. Is there any difference between losing $5,000 a year on Robinhood or going to Vegas?" he asks.

Eifert also points to a sub-culture of traders who have gained infamy for engaging in seemingly reckless options trading, and then sharing their gains—or in many cases huge losses—on social media platforms.

"The loudest and frothiest element is on Reddit and Discord," he says. "Those people are totally crazy. It's like a self-destructive video game community."

The "frothiest element" Eifert describes have also been posting their experiences to Twitter, including one amateur who described buying Peloton options after losing money on a Tesla call:

Took a hit on TSLA call, and pulled the trigger on 1 sizable PTON option pre-earnings... #day3 #gamble #OptionsTrading #Robinhood pic.twitter.com/yXVR7wnSoE

— FiboNacho Libre (@FiboNachoLibre) September 2, 2020

Eifert adds these kamikaze-like traders are not representative of most amateur options investors. Nonetheless, even the most diligent amateur risks taking a beating if they trade for any length of time.

"Table stakes"

The reason is that buying options is fundamentally different from investing in stocks, where retail investors can hold their own by researching a company and understanding a market of the sector.

In the case of options, making money from puts and calls relies less on understanding a company than it does on parsing factors like delta—the way an options price moves against an underlying stock price—or gamma, which measures the rate of change in delta.

Such calculations require strong math skills, but that's just the beginning. Eifert says a high proficiency in math is merely "table stakes" when it comes to trading options, which he calls a "piece of craftsmanship from front to back."

He's not the only who views options trading this way. Israelov of Ndvr notes that most professional traders have not only math skills and market experience, but bespoke software tools to gauge volatility.

Options trading, of course, isn't the only sector of finance where retail investors are competing against highly skilled pros. Even plain vanilla stock buying attracts legions of math whizzes deploying algorithms they believe will beat the market.

The difference is that options trading has a starker win-lose dynamic, one where amateurs are chum for the veterans. In a recent widely-shared essay about those dabbling in Robinhood options, veteran trader Ranjan Roy referred to them as "the gravy" for the rest of the industry. Israelov makes the same point, though more diplomatically.

"Options are a zero sum market. For every dollar made, there’s a loss," he says. "If you want to come out ahead, you need an edge from experience or a sophisticated set of tools. That's who retail investors are competing against."