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In March 2005, the options markets were the fastest growing segment of the retail community. At that time, Matt Andresen, President of Citadel Execution Services, told Traders Magazine that the continuing growth in trading volume will attract regulatory scrutiny.
Fast forward to July 2022 and it seems that retail investor market participation continues trending upwards. According to Steve Sosnick, Chief Strategist at Interactive Brokers, the options market had been a steadily growing business that accelerated during the pandemic.
“The unique combination of lockdowns, stimulus checks, and a bull market piqued a wide array of individual investors’ interest in options,” he said.
Total options volume for 2021 reached 9.9 billion contracts, which was a 32% increase compared to 2020, according to the Options Clearing Corporation (OCC). “We have seen an incredible increase in cleared contract volumes for options, partially driven by retail participation,” Julie Bauer, OCC Chief External Relations Officer, said.
Steve Sanders, EVP of Marketing and Product Development at Interactive Brokers, confirmed strong demand for options from their active trader and institutional investor clients. “In fact, compared to the year-ago quarter, 2Q22 options volumes from across the industry were up 8%,” he said.
Regulations
Over the years, the Financial Industry Regulatory Authority (FINRA) has taken steps to address complex products and options, including publishing guidance regarding sales practice concerns raised by complex products and options; issuing investor-focused alerts to highlight the risks of these products; adopting rules with specific requirements for particular complex products and for options; and examining members for compliance with SEC and FINRA rules.
A Spokesperson from FINRA told Traders Magazine that now is an “appropriate time to revisit this space and, always mindful of our mission of investor protection, to ask whether the current regulatory framework works in today’s environment”.
“Soliciting the views of all interested parties represents an essential step in answering that question,” a spokesperson said.
“If FINRA determines to propose any rule changes, we would follow the typical rulemaking process, which includes additional opportunities for public comment, a thorough assessment of any economic impacts, filing the proposal with the SEC, publication of the filing for comment, and the SEC’s determination to approve or deny the proposal,” a spokesperson added.
Shane Swanson, Research Director, Market Structure and Technology, Coalition Greenwich, commented that “without a doubt”, the regulators will bring greater focus wherever there is growth in the retail markets.
“The regulatory pendulum seems posed to continue swinging in just one direction – towards more regulation,” he argued.
“As an industry, we are already pretty loaded up and adding more rules to review, comment on and / or implement in the near term is going to be quite an arduous task at this stage,” he added.
Meanwhile, Erik Swanson, CEO of Simplex Trading, thinks that there is a really strong and robust regulatory apparatus that exists already.
“I think that the regulators have a lot of tools to make sure that retail investors are protected,” he said.
“I also think that the industry does a really good job of trying to make sure that their customers are having a very positive experience,” he added.
Angelo Evangelou, Head of Market Policy & Government Affairs at Cboe Global Markets, agreed, saying that the existing regulatory framework is appropriately rigorous.
“FINRA and the U.S. national securities exchanges have issued robust and relevant guidance over the years with respect to options suitability. This time-tested guidance has served investors and the industry well,” he said.
He believes that the current regulatory framework for listed options is strong and changes are not needed.
“Reforms to existing rules and/or more rules are not necessary,” Evangelou said.
He added that the listed options onboarding process and the disclosure regime go beyond what is required in many other industries.
“The current options regulatory framework is time-tested and not broken; major surgery is not needed. It is important that investor access to listed options and the valuable benefits they provide is not diminished,” he stressed.
Education is key
According to FINRA, trading in options may pose risks if investors do not have the financial experience to understand options and options trading strategies.
Should retail traders be required to take tests to be approved to trade options? “I would not say that should be strictly necessary. But I understand the impulse to want to make sure that people understand the products that they’re trading,” said Simplex Trading’s Swanson.
Meanwhile Coalition Greenwich’s Swanson commented this is one of those ideas that sounds good in theory, but then you have to decide who creates the test, what the test covers, how to ensure the test isn’t biased, and a host of other potential issues.
“Generally speaking, the free market should remain freely accessible, but education is a critical component of the process,” he said.
“Ensuring that the right information is made readily available and easily understandable for new retail entrants is an ongoing obligation of the markets,” he added.
Evangelou said that the current regulatory framework for listed options is sound and that changes are not warranted. “Importantly, there should not be any minimum eligibility requirements, mandated testing, or mandated certification for investors to utilize listed options and realize their benefits,” he said.
Currently, most FINRA members rely only on the delivery of “Characteristics and Risks of Standardized Options” (also known as the Options Disclosure Document or ODD) issued by OCC to provide customers with information related to the risks of trading options.
Evangelou explained that the ODD serves as a prospectus for listed options, explaining the characteristics and risks of listed options, and is specifically required and designed to have information in it that addresses various topics for investors.
Additionally, he added, there is robust (and free) options education that is readily available in various formats for investors to easily digest.
“Both the industry and the investor each have a role to play in making sure that options are properly understood and utilized,” he said.
“Moreover, the options industry goes above and beyond countless other industries in terms of education and disclosure – retail traders should not be required to take tests to be able to tap into the utility of listed options,” he said.
In June 2022, OCC launched the ODD Quick Guide to help investors better navigate Characteristics and Risks of Standardized Options, which broker dealers are required to provide to investors before they can trade options.
According to Bauer, “more and more individuals are becoming investors, and investor education covers a broad set of topics to meet investors where they are”.
Simplex Trading’s Swanson said that before the big surge in retail trading, most retail investors didn’t really have much knowledge of options or hadn’t thought about trading options.
However, the industry has been doing an “excellent job” of providing educational tools for customers, to learn how options trading works, to gain an increasing level of sophistication and how they use options tools.
Sosnick added that some individuals recognized that options can be very useful tools for hedging and speculating during choppy and down markets too, but the explosive growth clearly abated.
“To the extent that individuals took the time to educate themselves about the various strategies that one can utilize across a range of market conditions, then volume growth should continue, even if it is hard to imagine that the pace of 2020-21 can be maintained,” he concluded.
