Inventory choices have gained recognition on Major Avenue this yr as a rising variety of retail investors began executing high-speed derivatives trades, however most of them are taking part in a shedding recreation given the dearth of entry to extra advanced methods.
A record of 39 million choices contracts have traded day by day on common this yr, rising 35% from 2020, in line with Options Clearing Corp. Retail investors account for greater than 25% of complete choices trading activity, because of quick access through commission-free on-line brokers, in line with information from Alphacution Analysis Conservatory.
A staggering majority of those small-time merchants are shopping for essentially the most fundamental name and put choices, which have a a lot decrease chance of revenue in contrast with superior methods that is probably not straightforward for investors to understand, equivalent to choices spreads.
For instance, 11% of Robinhood’s month-to-month lively customers made an choices commerce within the first three quarters of 2021. In the meantime, fewer than 1% executed a multi-leg choices commerce, which entails two or extra transactions on the similar time.
“Everybody in the business knows that if you’re only buying out-the-money calls, then you’re likely going to lose money over time,” stated John Foley, CEO of Options AI. “The question of democratization shouldn’t be ‘can I trade options?’ but ‘can I have straightforward access to the options strategies that Wall Street uses?’ The playing field is not level right now and no one is really focusing on that.”
Options are a type of derivatives contract that offers consumers the correct to purchase or promote a safety at a selected worth sooner or later sooner or later. A multi-leg choices unfold commerce entails shopping for and promoting choices of the identical underlying safety concurrently, a typical strategy to hedge danger. These multi-leg methods could also be barely cheaper as a result of the proceeds the investor makes from promoting the choice offsets a few of the buy value.
This is an instance of various trades utilizing Tesla choices primarily based on real-time costs noon Tuesday. On this case, a typical retail investor is paying extra for bets with a decrease probability of revenue when a less expensive possibility unfold with the next win chance exists.
Hottest brokers have between three and 5 tiers for choices trading that they grant investors entry to primarily based on their trading expertise, earnings and danger profile. As an illustration, choices spreads — which contain utilizing a number of choices to hedge danger — aren’t out there to most investors till they graduate to stage 3. So, primarily, new merchants must be taught choices by trial and error at first earlier than they’ll use methods that Wall Avenue execs have profited from for many years.
“The Robinhood investor is the most novice of the cohorts of retail investors,” stated Paul Rowady, director of analysis for Alphacution Analysis Conservatory. “The question is how do I influence new, often very young first-time investors using an application that’s frictionless and highly gamified? How do I get them to try options where based on the payment for order flows, these fees are a very lucrative component of their revenue model.”
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Robinhood generated $164 million from choices trading within the third quarter, greater than tripling its transaction-based income from equities trading. The brokerage had 22.4 million web cumulative accounts as of the third quarter, down from 22.5 million within the second quarter.
“Of course, we know options aren’t for everyone, and unlike some other brokerages, Robinhood does not allow short selling or uncovered options trading,” a spokesperson for the favored trading app stated. “Over the past year and a half, we’ve enhanced our options eligibility criteria, added more educational content on options both on our Learn website and directly in the app, improved our options displays, and introduced 24/7 live phone support through the app.”
1 million trades per day
The surge in retail choices trading activity is most outstanding within the so-called meme shares. Earlier this yr, a legion of retail merchants glued to on-line chatrooms managed to create massive short squeezes in names like GameStop and AMC Entertainment by piling into these shares and call options.
The Cboe analyzed all customer volume in the top 15 meme stocks on its four options exchanges by the original order size.
In January 2021 at the height of the meme stock mania, options trades with an order size between 1 and 10 reached more than 1 million trades per day in the top 15 meme stocks, and that count continues to climb into the end of 2021. One option contract represents 100 shares of the underlying security.
Retail investors’ increased engagement in options trading has garnered the attention from regulators.
The Financial Industry Regulatory Authority will publish a request for comment in the coming weeks, seeking insight from exchanges and brokers about options trading and the risks involved, a spokesperson told CNBC.
Finra said it’s considering whether changes to the options rules may be warranted, including rules around options account approvals, supervision and margin requirements.
— CNBC’s Nate Rattner contributed to this story.