FLASH FRIDAY is a weekly content series looking at the past, present and future of capital markets trading and technology. FLASH FRIDAY is sponsored by Instinet, a Nomura company.
It can be said that a financial market hasn’t truly arrived until it has been spotlighted, and quite possibly raked over the coals, by a mainstream, non-financial media outlet.
To wit, The Economist, the revered British weekly periodical whose broad remit spans current affairs, international business, politics, technology, and culture, recently wrote about retail options trading.
“Retail investors are losing billions buying stock options,” the March 2023 article headline blared.
“The latest fad is contracts with just hours left before expiration,” the subhead stated, implying that short-dated options have the staying power of dogecoin.
The Economist‘s view on retail options trading was decidedly less constructive than the one offered at the 2023 Options Industry Conference in April. At the OIC event, panelists discussed how retail options traders are more empowered than ever before, in terms of their market knowledge and savvy, as well as the technology and tools at their disposal.
To be sure, an industry conference is going to lean toward being promotional about an industry topic, because that’s how industry participants make money. But at the same time, a mainstream media publication has a vested interest in playing up the conflict and tension in a story, so an article about retail options trading is more likely to be framed as a debacle that’s leaving mom and pop wearing barrels.
The topic of retail options trading is a timely one, coinciding with the 50th year in existence for both Cboe Global Markets, the first marketplace for trading listed options, and OCC, the industry’s clearing organization.
By way of background, “most of the option trading prior to 1973 had been done by farmers and businesses seeking to hedge their agricultural exposure,” according to a 2009 The Street article. “Options were used in order to lock in prices for both selling and purchasing crops.”
“The birth of the Internet, and the rise of the online brokers, has given the individual investor the tools to trade stock options like never before,” the 2009 article continued. “Most online brokers offer free trading tools that in the past would have cost thousands of dollars. In addition, the commissions to trade options have never been lower. These factors have lead (sic) to the recent growth in the popularity of trading stock options, which by all accounts, appear to be here to stay.”
That article was prescient in that last bit, as indeed retail options trading continued apace through the 2010s before taking another leg up in the 2020s.
An academic paper strikes a good balance in the current retail options debate, somewhere in between options-are-wonderful and options-are-the-worst-thing-ever. The paper, Retail Trading in Options and the Rise of the Big Three Wholesalers, states that retail options traders are most likely here to stay, but they tend to choose some of the least efficient, highest-spread contracts, which often results in underperformance.
The London Business School researchers and authors of the paper – Svetlana Bryzgalova, Anna Pavlova, and Taisiya Sikorskiya – make a sensible case that retail options traders can use more regulatory protection, asking fair questions along the way.
“What drives retail investors’ particular choice of short-term option contracts over other types of contracts? Could gamified smartphone trading platforms encourage investors to trade more or to trade particular contracts?” the paper asked. “What should the minimum knowledge be for people to invest in options? Should platforms provide access to auto reminders, calculators, models, or other tools to help retail investors avoid leaving money on the table?”
“To this day, much is still not known in the financial industry and academia about retail investor behavior in options,” the paper continued. “While even a few years ago financial researchers and market participants could ignore this crowd, the presence of retail options traders has grown. Our paper calls for more research in this space and considerations for greater transparency in reporting in retail options, as with current requirements by FINRA in equities. With so much still unknown about retail options traders, we see numerous opportunities to learn even more about this new breed of investors.”
