Trading costs cited by the researchers may not have been easy to discern by many at-home traders. Platforms like Robinhood revolutionized so-called zero-commission trading -- they route trading orders to market-makers like Citadel or Susquehanna, who then pay the brokerages for the orders and, in return, provide cheaper trades for the Robinhood clients.
The no-fee trades lured a lot of new clients onto Robinhood and others. But the average bid-ask spread in options with less than a week to expiration is a “whopping” 12.3%, the LBS researchers found. The average quoted spread of retail trades across all maturities is more than 13%, compared with 11% for the overall market. Therefore, they might have underestimated the indirect trading costs in the options market, the researchers wrote.
“The more they trade, the more they lose because of these bid-ask spreads -- every time, they have to pay the round-trip trading costs,” said Pavlova in an interview.
Bryzgalova, an assistant professor at LBS, says among the types of contracts and stocks retail traders prefer, “these are all transactions that have lottery-like features.”
“They like skewness in payoffs, they like companies that recently have been traded a lot so they’re quite popular. They like, obviously, cheap contracts because many of them are cash constrained,” she said of patterns she observed among the retail crowd.
Retail traders tend to favor short-term options in particular, she added. “If you buy a call option, you pay some money for it today -- and then it either doesn’t work out, so you get zero, or there’s a small chance that you get something positive,” she said. “That’s why it looks like buying a lottery ticket to us,” she said, adding that there are other strategies investors can use that have different profiles in terms of gains or losses.
To be sure, the researchers say they had to work in certain premises since they did not have access to account-level data from a brokerage like Robinhood, meaning a rundown of when a trader moved into and out of certain positions. Therefore, they had to make assumptions about the holding period, as well as prices.
They found that stocks mentioned on WallStreetBets tended to be highly favored by retail investors. That, however, didn’t mean their bets paid off -- the list of top losers for retail trades include GameStop and AMC, though both of those stocks are in the top-five-winners basket for the market as a whole.
“So it is about market timing,” said Pavlova. “They were buying these names, but at the wrong time,” and are sometimes choosing the wrong contracts.
Perhaps most striking is that the market during this period racked up impressive gains, even accounting for a 35% Covid-induced decline during the first quarter of 2020. The S&P 500 rose more than 40% between November 2019 and mid-2021. And just about everything caught a bid during that stretch -- three of the index’s sectors each added more than 50%.
“Buying options is an easy way to lose money because of the highly-skewed payoff,” Pavlova said. “The options that they like, they lose money most of the time, and sometimes they get these really big wins -- but those are rare.”
This article was provided by Bloomberg News.