Of all the risky things amateur investors did while locked at home in the pandemic, dabbling in stock options was one that veteran investors were convinced would end badly.
They weren’t wrong.
Turns out, taking leveraged flyers on meme stocks mentioned on Reddit’s WallStreetBets trading forum is harder than it looks. New research from economists at the London Business School found that mom-and-pop day traders managed to lose more than $1 billion during the bull market. The bill climbs to $5 billion when the cost of doing business with market-makers is factored in.
The study, “Retail Trading in Options and the Rise of the Big Three Wholesalers,” shines considerable light on the fate of individual investors who became obsessed with side bets on the stock market in the era of zero-commission trading. Spurred by Reddit posts and urged on by Twitter and TikTok influencers, daily volume in bullish contracts set record after record as stuck-at-home tinkerers flocked to the contracts in an effort to juice up returns.
Researchers Svetlana Bryzgalova, Anna Pavlova and Taisiya Sikorskaya estimated that retail investors lost $1.14 billion trading options from November 2019 to June 2021, assuming a 10-day holding period. Trading costs ate up an additional $4.13 billion. To measure the performance of nonprofessional traders, the authors tracked options orders coded as originating with retail brokerages and sent to high-volume market makers known as wholesalers.
Piling In | Smallest of options traders piled into bullish bets during pandemic at record pace
A few factors were at play, said the authors, among them hapless market timing by the retail group. Super-wide bid-ask spreads in their options of choice ate up a large portion of the cohort’s potential gains.
Retail traders were a principal pandemic-era Wall Street story. At home with little to do during the early days of the Covid outbreak, many turned to wagering on the stock market. They placed bets on everything from sturdy tech companies to reopening plays and bankrupt firms. It all reached a peak at the start of 2021, when an army of day-traders bid up the prices of so-called meme stocks like GameStop Corp., whose shares skyrocketed more than 50% in a single session on multiple occasions.
The study is one of the first big unpackings of that sensational chapter in modern market history. A sign that era is receding came Tuesday when Robinhood Markets Inc. said it is dismissing 9% of its full-time staff, after the online brokerage’s “hyper growth” has cooled.
But at the peak of the frenzy in 2021, small-time traders were buying more than 23 million call options a week, according to Options Clearing Council data compiled by Jason Goepfert at Sundial Capital Research. That’s way above any other period going back to 2000. Sundial defines small-time as a trader who buy or sells 10 or fewer contracts at a time.
The derring-do of newcomers was frequently called out by Wall Street. One tactic in particular -- buying out-of-the-money calls days or hours before they were likely to expire -- was pilloried as a newbie gambler’s mistake. In one celebrated instance, more than 50,000 contracts effectively betting that GameStop would surge sevenfold changed hands on Feb. 25, 2021. The option expired the next day.