How Retail Investors Trade Options

Subscribe to newsletter

Options trading is often thought of as a professional’s domain. However, with the advent of online trading platforms, retail traders now have access to the same tools and information as professional traders. This has changed the dynamics of the options market, as retail traders can now trade options on a level playing field with professionals.

However, a question remains to be answered: do retail options traders have the same knowledge, experience, and discipline as the professionals? Reference [1] examined this question,

We document rapid increases in (i) retail investor trading in options, and (ii) payment for order flow (PFOF) for options transactions received by the U.S. retail brokerages, coming from so-called wholesalers/internalizers—market makers, who execute the brokerage order flow. Exploiting new reporting requirements and transaction-level data, we isolate wholesaler trades and propose a novel measure of retail investor trading in options. We find that retail traders prefer cheaper, weekly options, the average quoted bid-ask spread for which is a whopping 12.3%. The inflow of retail investors also coincides with an increase in calls left suboptimally unexercised on cum-dividend dates. Market makers (and other arbitrageurs) benefit from these mistakes via the so-called ‘dividend play’ trades, producing (virtually) riskless arbitrage profits.

Subscribe to newsletter https://harbourfrontquant.beehiiv.com/subscribe Newsletter Covering Trading Strategies, Risk Management, Financial Derivatives, Career Perspectives, and More

In short, retail traders lack knowledge about options pricing theory and the risks associated with trading options.

The authors also found that the market makers operate in a non-competitive environment,

They [market makers] forgo about 50% of these profits, leaving money on the table for option writers. This behavior disproportionately benefits the Big Three wholesalers, who execute most of the retail transactions in options and often serve as option writers. Our findings are therefore consistent with the non-competitive behavior of market makers and other arbitrageurs.

The findings are very interesting. It’d be useful to look at how retail traders have changed the volatility term structure and dynamics of the option market.

References

[1] S. Bryzgalova, A. Pavlova, T. Sikorskaya, Retail Trading in Options and the Rise of the Big Three Wholesalers, 2022, Working Paper.

Further questions

What's your question? Ask it in the discussion forum

Have an answer to the questions below? Post it here or in the forum

LATEST NEWSCirium Enhances Industry-Leading On-Time Performance Advisory Board with Three Esteemed Aviation Leaders
Cirium Enhances Industry-Leading On-Time Performance Advisory Board with Three Esteemed Aviation Leaders

LONDON — Cirium, the world’s most trusted source of aviation analytics, has appointed three prominent aviation experts to its Airline and Airport On-Time Performance Advisory Board. The move underscores Cirium’s commitment to maintaining its position as the global gold standard for airline and airport performance…

Stay up-to-date with the latest news - click here
LATEST NEWSBiden visits Angolan port city of Lobito to tout railway plans
Biden visits Angolan port city of Lobito to tout railway plans
Stay up-to-date with the latest news - click here
LATEST NEWSExclusive-Northvolt seeks to sell electric industrial battery business by year-end
Exclusive-Northvolt seeks to sell electric industrial battery business by year-end
Stay up-to-date with the latest news - click here
LATEST NEWSVolkswagen recalling 4,616 vehicles in US over battery overheating concerns
Volkswagen recalling 4,616 vehicles in US over battery overheating concerns
Stay up-to-date with the latest news - click here
LATEST NEWSSnowline Gold Intersects 386.0 m of 1.1 Grams per Tonne Gold From Surface Including 120.5 m of 2.0 Grams per Tonne Gold With Additional Strong Intersections Near Edges of Valley Resource
Snowline Gold Intersects 386.0 m of 1.1 Grams per Tonne Gold From Surface Including 120.5 m of 2.0 Grams per Tonne Gold With Additional Strong Intersections Near Edges of Valley Resource
Stay up-to-date with the latest news - click here

Leave a Reply