Business

Opinion: Newcomers got an investment lesson during the pandemic. The Cost: $1.1 billion in options trading losses

The rise of options trading among average Americans during and since the pandemic has been hailed as a welcome introduction to the markets for newbies.

It is not. It was an absolute disaster for three companies and billions of dollars.

Small options trading grew 224% from late 2019 to mid-2021. This was at a time when stocks were plummeting and then soaring and the media was relentlessly reporting on meme stocks and outsized gains for “beach goerslike Mike McCaskill.

Anecdotes are not dates, and the dates are stunning.

Simultaneously with the dispatch of stimulus payments in mid-2020, the smallest option trades in relation to the total volume exploded. From 2002 to 2019, small traders accounted for about 15% to 20% of all options volume. From mid-2020 to today, this proportion has doubled.

During most of that period, retail options traders lost $1.1 billion from their businesses. That’s where some of the $817 billion in stimulus checks went — gone up in smoke in short-term call options.

Call it what it is: gambling

During the explosion in trading volume, small traders bought at-the-money or slightly out-of-the-money call options. Only about 4% of volume was concentrated in deep-in-the-money options, which can bring tighter spreads on liquid stocks.

As stocks rose following the pandemic panic, traders spent 69% of their volume on calls. Most notably, about 50% of all trades expire in less than a week. Stocks had to recover immediately and significantly to overcome the impact of trading costs, commissions and time decay. It was pure gamble and was particularly strong in meme stocks like GameStop GME,
-12.64%
and AMC AMC,
-6.32%.

blank

Hidden role of ignorance

When you buy an option to open, you have to pay the asking price, unless you place a limit order (which retail investors usually don’t do) or are lucky enough to have a broker who offers you a better price. From November 2019 to June 2021, retailers lost more than $4.1 billion on trading costs that included such bid-ask spreads.

In these trades, the bid-ask spread was as high as 12%. That’s an instant loss if an investor tries to reverse and sell the option at the bid price.

It was even worse for out-of-the-money options, which accounted for about 24% of the volume. These spreads averaged a whopping 28%. About 14% of the trades were “micro” sized, for $250 or less, up to an instant loss of $59.

The gamification of options trading means that some of the built in losses have been hidden or at least not properly disclosed. Most platforms highlighted their free commissions without mentioning that traders faced instant and significant losses on every trade.

While some brokers offer commission-free trading, others do not. During this period from November 2019 to June 2021, retailers alone lost an additional $800 million in commissions.

Gifts for Wall Street

Being new to the options market, many traders who bought in-the-money call options did not exercise them before their ex-dividend dates. As such, they were not entitled to the dividend distributions.

Maybe it was just laziness, but we’ll agree with them when in doubt. It’s quite an esoteric process, and who wants to think about boring dividends when GME is soaring?

If call option holders do not optimally exercise their dividends, the option writers can realize deadweight gains. What some did.

On the other side of these deals were three companies, excluding almost everyone else: Citadel Securities, Susquehanna, and Wolverine. Firms accounted for 85% of payments for order flow in the options market, thanks in large part to large trade flows from Robinhood HOOD,
-4.05%.

blank

what can be done

There is no single solution that can be passed down by regulators to fix all problems. The biggest reasons for the losses were due to basic human error – greed and ignorance.

Brokerage firms that offer options trading to retail investors could be more explicit about the cost of options trading, including bid-offer spreads.

When a trader enters a buy order for an option that will expire in a week or two, firms could create or improve risk disclosures that highlight the high probability of loss.

For traders currently holding call options in-the-money, brokerage firms should send alerts urging the option holder to exercise their options before ex-dividend days.

(Note: Most of the data for this article is from an eye port paper by Bryzgalova, Pavlova and Sikorskaya, published April 2022.)

Jason Goepfert is the founder and Chief Research Officer of Sundial Capital Researcha Minneapolis-based research firm.

https://www.marketwatch.com/story/market-newbies-got-an-investing-lesson-during-the-pandemic-the-cost-losses-of-1-1-billion-in-options-trading-11652111263?rss=1&siteid=rss Opinion: Newcomers got an investment lesson during the pandemic. The Cost: $1.1 billion in options trading losses

Brian Lowry

InternetCloning is an automatic aggregator of the all world’s media. In each content, the hyperlink to the primary source is specified. All trademarks belong to their rightful owners, all materials to their authors. If you are the owner of the content and do not want us to publish your materials, please contact us by email – admin@internetcloning.com. The content will be deleted within 24 hours.

Related Articles

Back to top button