As one beleaguered stock after another suddenly soared in January, so too did queries on Google: “How to trade options on Robinhood.”
Robinhood Markets’s options-trading platform, barely three years old, is charting a meteoric rise in the Covid-19 pandemic, establishing the firm as the venue of choice for throngs of retail investing enthusiasts.
New disclosures show the app’s monthly volume of options executed tripled last year, making the firm the second-most active among peers behind Charles Schwab Corp., a 50-year-old stalwart that just bought TD Ameritrade. Offering options is so lucrative that they accounted for two-thirds of Robinhood’s reported revenue from order flow, a significant source of income. A single contract can generate more money than handling 100 shares.
But with that windfall comes mounting scrutiny of the role no-fee brokerages played in January’s chaos and how stringently they vet newbies eager to make options trades, which can amplify returns but also exacerbate swings in market prices. Skeptics, lawmakers and regulators have been aiming pointed questions at Robinhood.
Using its app, clients can unlock Robinhood’s most advanced level of options strategies in minutes by tapping their details into a smartphone. They can then instantly start placing wagers on some of the most complex U.S. markets available to the investing public. Approval for similar access can take days at competitors such as Schwab and Morgan Stanley’s E*Trade.
Concerns about Robinhood’s screening of options investors arose following news in June of the suicide of a 20-year-old user, after he saw a more-than $700,000 negative balance while using the app to bet on the contracts, according to an account by a family member. The tragedy stirred a debate over whether Robinhood was letting clients take risks they didn’t comprehend, prompting U.S. lawmakers to send a letter underscoring its responsibility to safeguard investing rookies.
Then in December, a Massachusetts financial watchdog blasted Robinhood’s screening of options applicants in a complaint the firm disputes. The office, overseen by Secretary of the Commonwealth William Galvin, accused Robinhood of encouraging the “gamification” of investing and said that when it comes to enabling options, the brokerage failed to ensure clients met its own criteria.
“Robinhood inappropriately, and in violation of company policy, approved customers for options trading despite those customers having no investment experience,” the regulator wrote in an administrative complaint.
Fighting Allegations
In a 50-page response to Galvin’s complaint last week, Robinhood said the office misunderstood the firm’s criteria for approval and that customers can be granted access if they say they have prior experience trading options. “When that information is considered, Robinhood believes all Massachusetts customers met the applicable options-trading criteria,” lawyers for the company wrote.
Robinhood is “committed to providing the best investing experience,” the brokerage said in an emailed response to questions for this story. “While options trading is not unique to Robinhood, we’re proud to offer an intuitive and cost-effective platform to help people understand and trade options, including enhanced educational materials.”
Options contracts give holders the right to buy or sell a stock at a specific price by a future date. The derivatives can be more lucrative than transacting in shares directly. That’s because the value of contracts can multiply while underlying stocks rise by mere percentage points. However, if shares don’t move as hoped, the contracts remain “out of the money” and can end up worthless.
That danger, and the use of options in more complex strategies, are why industry regulators require brokerages to vet their customers. Firms typically adopt a system of risk levels, granting investors access based on factors including wealth and experience.
‘You’re Level 3!’
The popularity of Robinhood’s options platform exploded last year as millions of people opened accounts at the brokerage to pass time and earn money during lockdowns. By December, the monthly volume of contracts executed on its platform jumped 197% from the start of the year, dwarfing the 54% increase on Schwab and TD’s platforms combined, as well as a 46% rise at E*Trade, according to data compiled by Bloomberg Intelligence from regulatory filings.
The nominal increase in that activity at Robinhood also outpaced other firms, the data show.