- Warren Buffett has warned against speculating on options, and accused Robinhood of encouraging it.
- The investor expressed similar concerns about futures trading in a letter to Congress in 1982.
- Buffett predicted mass gambling, heavy losses for investors, and damage to the stock market's image.
- See more stories on Insider's business page.
Warren Buffett has warned people against speculating on options and accused Robinhood of encouraging users to gamble on them instead of investing for the long term. The billionaire investor and Berkshire Hathaway CEO predicted derivatives would lead to risky trading and reckless brokers nearly 40 years ago.
Buffett penned a letter to John Dingell, the late Democratic politician who served in the House of Representatives for nearly 60 years, in 1982. The investor's missive resurfaced this week courtesy of 10-K Diver, a Twitter user who teaches finance and investing concepts on the platform.
The Berkshire chief wrote to Dingell to warn against introducing futures tied to the S&P 500 index. Buffett noted that investors could short the contracts to hedge against short-term volatility, but he cautioned that virtually everyone buying them would be gambling on stocks rising in the near term - not betting on the long-term performance of the underlying companies.
"The propensity to gamble is always increased by a large prize versus a small entry fee, no matter how poor the true odds may be," Buffett said. "That's why Las Vegas casinos advertise big jackpots and why state lotteries headline big prizes."
"The unintelligent are seduced" by low prices and huge upside, he added, pointing to promoters of penny stocks and brokers who allow trading on minimal margin. Similarly, gamblers would use S&P 500 futures to bet on the short-term direction of the index while avoiding margin requirements, he said.
Buffett also explained why introducing futures would lead to rampant speculation, and result in a net loss for investors.
"Since the casino (the futures market and its supporting cast of brokers) gets paid a toll each time one of these transactions takes place, you can be sure that it will have a great interest in providing very large numbers of losers and winners," he said.
Moreover, transaction costs would make futures trading a "negative sum game" for investors, he said. In contrast, investing in stocks is a "positive sum game" as the underlying companies grow and generate more money for their shareholders, he continued.
Buffett predicted that at least 95% of the activity involving futures would be "strictly gambling in nature." People would use small sums of money to bet big on short-term stock movements, and brokerages would encourage them to trade more and more to maximize their cut, he said.
Brokers would do better over time if they didn't let their customers fritter away their cash, but they're too short-sighted to care, Buffett continued. "They often have been happiest when behavior was at its silliest," he noted.
The Berkshire chief also warned that futures would tarnish the stock market's image, as many people would get "burned" by them and blame their losses on stocks.
Finally, Buffett argued the country needed more people investing for the long term, not more gamblers egged on by brokers. Large volumes of future trading would be "overwhelmingly detrimental to the security-buying public" and markets as well, he added.
Buffett's warnings about futures nearly four decades ago could easily be written about options today, as a new generation of traders continue to buy them based on memes and social media.