Studies have shown two things: one retail investors are losing money trading, two that the market is in danger of a lack of protection from investors. Both of these findings have a couple different key points to talk about, and i think it's important to do so. So, let's dive right into it, guys welcome back to trace race, really freaking talk fast and don't eat ass, like they're, probably saying i'm not flashing, my expert so through to say the grain of salt. Let's get into the video today we're gon na be going over.

The findings that i have collected from an 87 page study that was uh conducted over a period of about two years or so this recently came out. It came out on april 12th of 2022 from uh svetlana briscolova, anna pavlova and taisia sikorskaya. Whatever these three people are uh talking about retail training options and the rise of the big three wholesalers, so what i have done is i've collected what i find to be the most important information out of this entire study and we're gon na go over that in A solid way give you some sort of conclusion. After going over a couple of different findings, one thing that i found to be interesting.

What i think is most important to talk about on a key point within this entire story, this entire study is arbitrage. Arbitrage is talked about 119 times in this 87 page article. If you don't know what arbitrage is? Here's a quick definition: you can pull from google simultaneous buying and selling of securities currency or commodities in different markets or derivative forms in order to take advantage of differing prices for the same asset. You can think of this as bit-ask slamming ping-pong ping-pong, ping-pong back and forth with level twos which are telling you what people want to buy for and what people are willing to sell for.

Well, that's mentioned 119 times within this article. That tells you that it's probably important right so since this is about retail trading options and the losses of retail investors as well as the big three i put up the two, but i meant three. You can only imagine that arbitrage has a lot to do with this well check this out. This is the risk to investor protection, as well as what affects retail profitability right payment for order flow arbitrage and high risk market maker trades on the market maker side.

On the retail side uh, we will go over those things in a little bit, but i've got a pretty interesting piece. That's pulled out of here the big three payment payment for order flow providers which we are going to go over later uh has a inherent problem. If, indeed, market concentration has become so high, the market makers choose to behave non-competitively. This has significant implications for investor protection.

What this is referring to is arbitrage and i'm going to give you a little bit of a teaser here. That's what this is in terms of what we're going to be talking about later through this video. But what this is saying is that the big three are not competing with other market makers, which is inherently telling you that there's not a capitalistic sort of approach to this, it's more of a duopolistic or a triopolistic or whatever you want to call this. It is uh, it is not inherently good for markets, it makes them quite fragile.

It makes them lean on individual parties and which is problematic when they utilize the strategy that we're about to go over, see. One strategy that was looked over in this case study from these market makers from these wholesalers. These big three payment for order flow providers is taking advantage of dividend date. Uh spreads that what they will do is run multi-leg spreads on a dividend day: option whether it be a call or be a put, and this strategy is actually inherently quite risky, especially considering that it's run by the big three.

This is not competitive. Remember what i just mentioned before - and this is a real implication for investor protection. What this does is potentially destabilize the market, as you read here, long and short positions that are so large have an operational error that may potentially destabilize the market, and this is actually quite sad considering that the barriers were created by the sec rule uh previously to Try and avoid this exact problem, however, as always with rules, whether it be in sports or markets or la, there are always ways to ride the freaking bottom of that goddamn line. And that's what you see happening within this.

So here's the claim, retail investors are losing and market makers pose a threat to markets. The study was conducted over two year period of time, let's dive into the findings of each of these starting with retail investors. So there is some inherent blame to lay on ourselves as retail investors, and probably the greatest finding that we have is that your average american is quite a degenerate, and i can't blame you. I mean i like to drink kraken i like to i like to go.

Play video games for 10 hours a day. I i i'd rip on nicotine vapes all the time, whatever it is, what it is uh, but this isn't core finding within this article. As you can see, these observations suggest the retail investors are entering the options market with an intent to speculate rather than hedge, and this is based on the types of plays that people will make, as well as the maturity or expiration dates. Behind these specific options trades.

We can then see that this problem, hence why we lose money, can have an addressable solution, at least on the retail side. So here's the the preferable trades that retail likes to make retail investors shares higher, in short, maturity options on the underlying with a large market. Capitalization and a higher trading volume in the previous week, a higher market capitalization just means that there's more dollars behind the actual stock itself than there are for a smaller, mid cap company. A large cap has uh, typically less risk than a smaller mid cap company uh.

Another thing that we can find is that uh retail trading is more prevalent in options or more liquid stocks and etfs, meaning they like things that move very quickly right. If you look at a chart, you see a lot of volume ripping up and down. People prefer to buy that that sort of ticker over something with less movement, which also implies a higher overall implied volatility. What does that mean? It means you're paying more for each contract, to put it as simple as possible.

High iv or implied volatility means that it's more expensive to buy that color put versus a lower iv, which you would typically expect from a lower overall volume. Uh sort of mover, less volume typically means less volatility, not always, but most of the time. This is a generalized rule. Another thing we can find is this: retail is losing money on options compared to the broad market under the assumption of a 10 day holding period, meaning that you were holding that play for at least 10 days.

Retail investors lost 1.14 billion on their options, trades between november 2019 and june 2021 uh, while all other options trades gained 5.48 billion, and to me this comes down to something quite simple: uh. On the retail side, it comes down to strategy which is uh these. These types of plays that are being bought. It also shows the retail investor losses were concentrated in at the money or slightly in the money calls with a very short time to expiration uh less than a week.

So we could deduce from that a couple different things right: there was an opportunity for profit if it was in the money uh, but not always you got to be over break even pricing if you're writing to expiration it's a different sort of ball game and at The money - well, that's, that's! That's also a different ball game at the money. You don't quite have all that intrinsic value of an option that you typically would so. Why is this the case right? Let's check this out, we're going to dive into the market maker exploitation. Slash arbitrage in a little bit, but first i want to talk about the retail side of things: high risk short-term trades.

This is a big core piece of why i think retail loses. You can see here that performance seems to be lower on thursdays and fridays, which also coincidentally, line up with the expiration of most plays right. Most losses on thursday and friday would be because theta, which is time decay, so to speak, a theta being one of the greek values of an option and how they price uh, really we'll get bigger right. You got more theta as you get closer to expiration, meaning you lose more value, you lose more money, that's the easiest way.

You can put it closer, you get to expiration less money, you keep in your pocket, pretty straightforward uh and they also typically lose the most on meme stocks quote: unquote: small mid-cap companies as compared to large caps such as amazon or apple. So here's two intrinsic things that we can take away: uh we lose money the most when we have short expirations and we lose money the most when we're playing on small mid companies, meaning not a lot of money attached somewhere between 100 million dollars to 10 billion Dollars you could even go as high as uh that would be considered a small mid cap company. Why is this the case? Typically, volatility and short expirations have uh two things in common higher bid ask spreads which we're going to get into here in a little bit as well as more volatility, which typically means a higher implied volatility. You need a bigger move on these small mid cap companies.

Make sense so far next now winning trades on large caps not losing on meme stocks. You've got this high cost to trade, which is the bid and ask spread get this. This is actually a pretty wild statistic, but it is there uh. These costs are not as transparent as brokerage fees and are likely to be overlooked by retail investors.

We have lost 4.13 billion dollars in that time period that i had gone over up above uh from 2019 to 2021 4.13 billion dollars in trading costs. Whether this be a bid, ask spread whether it be a commission to a broker uh. All of these things add up, and that is what this is coming from - is a bid and ask spread. In fact, it comes out to five times the direct cost of retail trading, which is incredibly incredibly high.

If you were to actually uh ratio out and get the percentage of what this looks like, you were paying a 13.4 bid ask spread as compared to the overall markets 11.1 that doesn't sound like a big difference. But if you trade 100 times, that's a lot of money. What does this mean? It means that 13.4 of all of your money that you're making is going to who market makers it's going to citadel the big big bad villains. These guys are taking your money.

It's very profitable for them, where do they sort of put that money? Well, payment for order flow, which is also talked about in this piece, means that they are incentivizing their broker, which is selling you these contracts, so they get a cut and then your broker gets a cut and you just lose that 13.4 percent. That's where your money's going to citadel or another market maker and then to your broker. We give up a lot of money by looking for these large bid. Ask spreads: where do these typically come from? They come from low liquidity stocks and typically small and mid-cap companies, and you can watch these things right.

These are typically things that you can find uh by just looking at how much the ask and how much the bid is, the ask being what you buy it for the the bid being what you sell it for on any given day right pretty. This is pretty typically important. Another thing one-sided trading now this one, this one's a little bit, uh this one's more difficult right as retail investors. Typically, you want to see the market succeed and i can understand that entirely uh.

However, there are times when, as a trade, it doesn't make sense to be playing calls, and what we come to find is that retail investors strongly prefer calls to puts you got this awesome metric 69, 69 of calls and puts combined uh go to calls. You got 69 of all volume for options going to calls uh that's a lot and we're not we're not in a situation where uh, it's always going to make sense for 70 ish of plays to be a call, especially with a short-term expiration, a short-term maturity. A weekly expiration there's a lot more whiplash up and down you. Can you can get away with more of a generalized trend in a longer time frame, such as a leap or maybe a couple months swing a two three four month swing and get away with more of that 69 call aspect uh, but not so much on a Weekly perspective on a short-term exploration perspective, most of these trades are coming at the money or slightly out of the money, and this is actually something i was pleased to see.

I thought that this would be a more skewed. Uh percentage only 72 or only 24 were out the money 72 percent at the money. This is a little more nice to see. I don't mind that it'd be better if there was uh some in the monies as well uh, but, as we mentioned before, retail equals degen.

We have established that right, retail likes to take risks and that's not inherently a bad thing. It just is what it is. We we like to take risks. That's what the study is saying.

This is based on two years worth of data coming from uh regulated bodies and regulations that have allowed for these. These data collectors to pitch this information, so grand takeaways from retail. What? What uh? What are the core problems? What are the reasons that we lose money to me? It's been asked. Spreads you give profits back, one-sided trading.

I think this is a really big core piece of it. I think uh net losing on meme stocks, while winning on large caps, tells you that retail uh trades too much on small mid cap companies up for options, at least they trade too uh too frequently uh and then the most losses on thursday and friday. This tells us that most retail investors are trading short-term expirations, which means that simply moving to the right. Your expiration date will typically keep more money in your pocket and increase your odds of being profitable.

But there's more to the story than this. You've also got market maker exploitation arbitrage, and this is where the really goofy starts coming in all right. Market makers are able to make money off you with more than just the bid and ask spread, and this is kind of up this is uh. This is the really goofy stuff there's something called arbitrage which i mentioned before.

Uh has been exploited and mentioned 119 times in the entirety of this study. What you're going to find is that market makers actually have a strategy that only they can use in order to take advantage of inexperienced retail investors. The strategy is only available for transactions originating from the floor of the exchange, meaning the market makers are wholesalers themselves. The strategy involves establishing long and short option positions that are so large that an operational error may potentially destabilize the market.

So not only are they trying to take advantage of you and we can get on the nitty gritty of this, but it comes down to a form of arbitrage by taking advantage of dividend day place uh. I don't find that to be as important as this itself, because if this is one example, this is one case study. You can only imagine two things, one, it happens a lot and two market is at high risk. If the big three, which we're going to talk about right here, citadel susquehanna and wolverine, if these three guys control the market and they're partaking in things that can destabilize the market, add fragility to the market, uh and they're the only ones that can do it well, Where does that kind of leave the market and kind of a piss-poor boat, it does two things adds risk to volatility in the market, which, already right off the bat, is putting us at a disadvantage as retail and number two lack of competition.

Both of these things are inherently bad, which we're going to talk about, as we continue on so check this out. What are some of the the downsides to this uh? This problem, this exploitation and arbitrage, this taking advantage of uh by cell by cell by cell by cell, sometimes within seconds on particular place specifically focused on exploiting retail. That's that's. The key thing here is that market makers are trying to they target, particularly retail favored stocks and highly traded retail stocks in the options market to make money off of you.

Why they do it? Why bother there's lots of money in arbitrage check this out? The top five payment for order flow providers, accounting for over 90 of the total pf received by u.s brokerages, meaning that first off these, these wholesalers are making way more money. Citadel susquehanna and wolverine rose from 70 early 2020 to nearly 85 in the second quarter of 2021.. Uh there's actually a decline overall in stock purchases and an increase overall and options purchases, and they make more money on options. If you think about this larger bid, ask spread on options, means more money for market makers.

Less on stocks means less money coming from stocks. The goal of these uh different strategies - and this is just a single case study - is to take advantage of inattentive investors who failed to exercise their call options of dividend paying stocks when it's optimal to do so. This is one example, but you can take out who failed to blah blah blah blah blah blah blah blah blah you can you can you can exchange this for anything? This applies to a lot of different things. Uh.

This is what they do. They try to exploit and take advantage of inexperienced retail investors. Now to me this is an inherent problem. All right market makers already make a lot of money: they're, the biggest dogs in the game, they're the biggest dogs on wall street and what they see you as on main street, is an opportunity to transfer wealth from the little dude to the big dude, which means That you got to be sharp to play the game right.

That's that's a pretty inherent fact at least the way that markets currently stand, there's also a couple other conflicts non-competitive. We already talked about this, but puzzlingly market makers will sometimes leave profits on the table. As you can see here, sometimes they leave money on the table by failing to capture arbitrage, profits and some call options, contracts, uh exhibiting, non-competitive behavior. What's the point of this to me: it's one of two things to me: one: they don't see any other market makers as a threat or two they genuinely just don't give a they don't care that they just they took that money from you.

They they genuinely don't care. I could see either one being plausible, but this is inherently not a good thing. Not competitive means. There's not a capitalistic market means that there's more fragility in the market, more volatility in the market and more opportunity for retail to lose.

But beyond that, there's also a broker conflict. Not only do market makers want uh you to lose, your broker does as well. Why check this out? It's not clear why the retail investing platforms have the right incentives to prevent their customers from making trading mistakes. Frequent trading proceed produces large order flow and hence large revenue from payment for order flow for retail, investing platforms, and what this is inherently telling you is, when you lose in an options.

Trade, your market maker, as well as your broker, are going to make a good amount of money. Now you might be asking yourself trey all this sounds like his payment, for overflow is a bad thing and uh, and we maybe we should just we should just say off with options all together, but i think what this comes down to and the conclusions that we're Going to draw are down below and it comes down to things that we can tangibly control and things that we cannot tangibly control and ultimately, the the choices in your hands on what you would like to do. I'm presenting you information. This was pink to me.

A couple times on twitter - and i thought this is actually a pretty interesting study where i learned some things so here we go. Let's check out the uh solutions that are plausible on each side of the the situation you said, the coin retail. What can retail do to prevent losses on each individual trade number one longer maturity, trades, less associated risk. I think that retailers needs longer expiration, trades and less yolos.

I think that makes sense. We can no longer argue about it. We can look and say that over the past two years, that retail has been trading options and that they have been losing on options, because this is uh regulated and uh government-backed data - it's just it's just the truth. It is what it is.

So we need to uh, extend our expiration dates. Two large cap trades over small cap trades, meaning uh a couple different things, bid-ask spread is going to be better and typically retail performs better, better performance. We don't have to trade small, mid cap companies with options you just don't. You can make money on large caps and actually retail has made more money on large caps, which would be counter-intuitive to some of the big moves that we've seen.

So i think that's an important thing to note trade small bid. Ask spreads this being the last thing look for plays that have small bid. Ask spreads are going to have a higher overall chance of success and a higher higher overall opportunity to make money, market makers and regulations, though i think this is also important uh, and it is because of these three things that could potentially change competition in markets. If you are able to destabilize the top three, which is citadel susquehanna and wolverine, you're, going to add less fragility to the markets and more competition in the markets, which is going to decrease that bid and ask spread, that's pretty important.

That's a core value behind how you're able to improve uh sort of the cost that you're paying up front. I think another thing is banning payment for order flow and upfront cost of trading. Now this is me personally. I can't speak for you.

Obviously, these are my opinions, but if you ban payment for order flow up front, you are going to get charged a fee. Right makes sense enough. However, it will do a very simple thing. You will know what you're paying a lot of people right now, there's not as much transparency in the options market as there is in equity right.

You don't get a whole lot of that from options. Market makers uh, it adds inherent transparency, so the retail investors are left with the choice. Do i want to actually trade options because right now, they're set up in a way? That's meant to be confusing. You don't know how much you're actually paying for things uh, you don't know where these costs and hidden fees are coming from.

The bid and ask spread can be confusing to some people banning for banning people and uh having upfront costs of trading you're gon na willow. That away you're gon na you're gon na have people who say i don't wan na. Do this anymore, you're gon na have people who say i'm willing to pay these costs, because now i know what i'm paying new regulations to arbitrage. This is huge.

This is a big one. I think we need new regulations for arbitrage, because this is very obviously taken advantage of by the top three wholesalers and market makers in the market. Pfop for options is very concentrated, with a share of the top three providers exceeding 85 toward the end of our sample, meaning that the top three market makers in the country are taking 85 percent of the payment for order flow money. It's obviously an inherent imbalance.

It's not a good thing. This affects arbitrage activity in the options market. You you get rid of this arbitrage activity where these guys are able to move entire markets and have so much liquidity that actually has the chance to destabilize everything if they mess up. Obviously, a problem they're riding online they're, riding online and they're, taking advantage of retail investors, and it's inherently proven through this study.

So you change that and i think you're going to keep more money in retail pockets. Why? Because market makers aren't going hunting for inexperienced retail traders, that's just the truth of the matter. If, indeed, market concentration has become so high that market makers choose to behave not competitively. This has significant implications for investor protection, competition in markets, ban p5, new regulations to arbitrage, you're going to fix the market side of the problem, and my final conclusion to be quite square with you is is quite simple: options are hard 99 of options.

Traders uh are not profitable over a long period of time and it's for a couple different reasons. Some of these, which we're just talking about in the study - and i think that if we can address these things and talk about them coherently, uh we're gon na learn something uh the other takeaway. If anything is, if you really want to make millions of dollars in the market billions, even perhaps you've got sort of two choices: one be a market maker or two start with a trillion, and that's what i've got for this video, so i'll catch you guys. All later appreciate you tuning in much lovely taps, peace,.