Applying for access to options on Robinhood’s app is relatively frictionless. After tapping “continue” on a few screens and setting profile parameters such as income and risk tolerance, the app greets entrants to its most advanced level with a green fireworks graphic and congratulatory message: “You’re Level 3! You can now trade vertical spreads, calendar spreads, iron condors and more.”
In the Massachusetts complaint, Galvin said the firm granted more than 48,000 customers in his state some level of ability to trade options even though they had little or no investment experience. Robinhood wrote in its response that many customers approved for options don’t go on to trade them. While the firm has automated approvals, that system is overseen by a human, and afterward customers “are subject to review through manual spot checks,” the company said.
Schwab, in contrast, says it deliberately takes time to vet customers. Applicants for every risk level must submit a form online or by mail for review by company personnel.
“We’ve taken a conservative approach,” said Jeff Chiappetta, vice president of trading and education at Schwab. Approval won’t come “today or tomorrow,” he said. “There is a little bit of a time lapse.”
Still, its TD Ameritrade business has automated at least some parts of the vetting process. The firm says humans are involved in reviewing permission for advanced options trading.
Market Scrutiny
Financial watchdogs are ramping up scrutiny of retail investing after traders on Reddit and social media sent shares of GameStop Corp. and other companies skyrocketing in recent weeks, burning some hedge funds. Treasury Secretary Janet Yellen plans to meet with regulators Thursday to discuss the tumult’s implications for market efficiency and investor protection. Options trading is expected to face examination after the Securities and Exchange Commission vowed to root out any market manipulation.
While options don’t drive prices in normal conditions, they can amplify sudden jumps if market makers deluged with orders for the contracts rush to hedge themselves against losses by buying shares. Over the past 10 days, an average of 1.1 million GameStop options contracts traded daily, more than 22 times what was typical in 2020.
“Unquestionably, Robinhood has made it easy for ordinary people to open accounts, trade complex financial products and take significant financial risks—but what are the consequences for investors and the markets overall?” said Tyler Gellasch, executive director of the Healthy Markets Association, an industry group representing large investors. “The SEC, exchanges and Congress are about to spend a lot of time really examining these issues.”
Googling Instructions
To be sure, there’s no public data showing how much specific brokerages were involved in options trades tied to GameStop and other volatile stocks. But there’s no doubt Robinhood’s users were betting on the surges.
A variety of Google searches for trading options on Robinhood spiked to 12-month peaks in January. And an analysis by Atom Finance, an investment researcher, shows more than half of Atom users who traded at Robinhood on Jan. 27 were active in the volatile stocks the brokerage ended up restricting one day later. When Robinhood set out to reduce its exposure to those swings, it set limits on options contracts tied to those shares for days.
Robinhood makes money on options by selling orders to high-speed traders, a common industry practice.
Under the hood, its platform earned an average of about 64 cents per options contract executed in December, according to the data compiled by Bloomberg Intelligence—more than most major brokerages. In comparison, Robinhood earned about 36 cents for every 100 shares of S&P 500 companies that month.
That’s made the burgeoning options platform key to the firm’s earnings. Options trading accounted for $440 million, or roughly two-thirds, of the company’s order-flow revenue from equities bets last year, Bloomberg Intelligence data show. The firm earns money in other ways too, such as from stock lending and subscriptions to its premium service.
“The brilliance of Robinhood is they’ve created software that’s easy to use,” said Burton Malkiel, a professor emeritus of economics at Princeton University, who also serves as chief investment officer at robo adviser Wealthfront, another financial-technology firm. “They’ve been probably most successful in attracting these people who are swept up in the gambling pandemic.”
This article was provided by Bloomberg News.