Transcription
Last week, I made a video talking about institutional investment research, institutional confirmation bias analysis, talking about individual companies and where they thought the share price would go. While I was doing research for that video, I found possibly the most incredible thing ever. A different report and realized that this, this really requires its own standalone video.
From Barclays, "U.S. Equity Derivatives Strategy: Impact of Retail Options Trading." This is a 30-page report from the Barclays derivatives team about the strategy they developed to capitalize on new retail options trading volume. Quite literally, a specific blueprint of how to take money from the degenerates of Wall Street Bets. At the end, they offer two trading strategies that they actually use to drastically outperform the index. So, I thought it would not only be funny to read about how Barclays takes money from Robinhood traders, but also interesting to see if anyone could use their strategies to do the same.
Literally, the first sentence: "We show that retail investors have been driving a significant increase in option, mostly short-dated calls, volumes for large-cap stocks." I love that they throw that in there in the first sentence, just to clarify that we are talking about the retail crowd here. Don't worry, guys, you didn't need to clarify. I didn't even know Robinhood offered options with more than a week until expiration. I think, I think that's what you unlock when you get Robinhood Gold.
So, this was posted in September of 2020, not too long ago. Single stock option volumes have increased three times on a year-over-year basis. The increase is in short-term calls on large-cap tech stocks. Before we move on, reading this, it's littered with so much pretentious, complicated, and boring financial jargon. Then, I'm just going to summarize all the important parts with memes instead. If you want to read the whole thing, the link is down below.
I mean, come on. "Monetizing retail-driven options volatility dislocation." Can't you just say, "Taking money from broke people with Robinhood?" Instead, then I wouldn't need the goddamn Rosetta Stone to try to decipher all of this. That's like how you describe your trading strategy to your girlfriend's parents. "Yeah, I focus on looking for option volatility dislocation and large-cap equities." In reality, that's just you FOMOing into meme stocks with 500 IV, then losing all of your money and not eating for a week. "Yeah, I'm really big into minimalism." Brocism.
How does Barclays take money from you, and how can you use their strategies to take money from other people? So, there are a bunch of retail degenerates getting stimulus checks and entering the market. They now have access to Robinhood, zero commission options, and just a lot of fun ways to lose money. We can actually see in the report where most brokers enabled zero commission options trading. Combine this with stimulus checks, and interesting things are bound to happen. All of the new degenerates entering the market want to take risk. After all, what's the point of making a 20% return on a thousand dollars? There is none.
So, what do I need to do to leverage my money to the max? Short-term, cheap, out-of-the-money options should do the trick. These 15 out-of-the-money Tesla calls with two weeks until expiration should provide me sufficient leverage to meet my personal risk tolerance. May as well drop my stimulus check and student loans into this opportunity. Wouldn't want to miss out on a great trade.
Barclays claims that two interesting things happen because of degenerates yellowing their savings. They're kind of complicated, but I'll try to break them down simply. But first, a quick reminder that options are priced based on the market's anticipated future volatility. The higher the implied volatility, the more expensive they become.
So, what did those Barclays analysts find? The first thing that's happened is the volatility risk premium on some stocks has decreased. I think I've shown this chart in other videos. This is historic implied volatility versus realized volatility. The space in between is the volatility risk premium. Why should anyone give a... It shows that the market tends to anticipate volatility to be higher than what actually happens. With the new retail options buying, the spread between these two for some stocks has actually decreased. This means that realized volatility has been bigger than what the options market has anticipated. For other stocks, it's gotten bigger. Implied volatility and realized volatility have moved apart from one another.
If you have any options trading experience, you're probably already seeing big dollar signs. All I need to do is sell these expensive options and buy these cheap options. We'll get into that a little later. They also mentioned that their collection of 100 stocks with the highest retail option volume have outperformed the index. However, it's somewhat inconclusive, as they're the same stocks that have shown themselves to be resilient in the pandemic.
There is one other incredibly important way the retail degenerates influence share prices. I'm gonna try to explain this simply. Broke Robinhood trader uses Wendy's savings to buy worthless short-term out-of-the-money options. When he places his buy order, market-making man, who sold the options, needs to keep his neutral market position. In order to be completely neutral, he buys shares of stock. Now, if the call he sold increases in value, the profit from his shares make the position completely neutral. But by buying those shares, he also drove the underlying price higher. This triggers more Wendy's employees to pile their paychecks into deep out-of-the-money options. It literally can't go tits up. This causes the market maker to buy more shares and hedge his position against the calls he sold, which once again causes the share price to go up. This hedging share volume has increased significantly since the rise of commission-free options trading. The mystical gamma squeeze. It just means that weird things can happen when a lot of people are buying out-of-the-money options. Just something to keep in mind.
Let's look at the actual trading strategies Barclays recommends using to take money from the Robinhood traders. They offer two methods. The first is "monetizing elevated volatility using selective vol score based short delta hedge straddles on single stocks." See what I mean about needing the Rosetta Stone? They're basically saying that selling or going short volatility on certain stocks is a good idea. With certain options strategies, you can go long or short volatility, exactly how you might go long or short a stock. This is one of the great things about options. Now, we don't need to gamble on which direction a stock will go. Instead, we can bet whether it will go in either direction, a lot or a little.
They're suggesting selling straddles. If you think the market is pricing future volatility too low, you might buy a straddle by buying a combination of a call and put. The position isn't affected by any directional move in the share price. Instead, the strategy makes money if volatility increases, whether that be from a directional move up or down. This would be an example of going long volatility using options. You might also hear this referred to as long vega.
Barclays is selling straddles, or shorting volatility, on specific stocks. In doing so, they've significantly outperformed the market. However, what might even be more important is how they determine which underlying stock to sell these straddles on. They say they're looking for stocks with rich volatility risk premium, a wide spread between anticipated volatility and realized volatility. Essentially, they've made a ton of money selling retail degenerates overpriced options. You might be able to do the same.
In the report, they mention that they find these opportunities using what they call their "vol score" metric. Unfortunately, they don't go into exactly how it works, just the general idea. They're looking at the spread between the stock's implied volatility and the sector's implied volatility, as well as the implied volatility of this stock relative to its historic realized volatility. I think it's easier to imagine this visually. If we look at diagram A, we can see that they're looking for stocks that have a ton of volatility above the sector volatility, as well as stocks that have a wide margin between implied volatility and realized volatility. We can't know specifically how they're judging the relationship between these three things. I'm guessing that they're assuming that these stocks with such overblown implied volatility are bound to revert back to a lower volatility point in the future, more in line with sector volatility.
In this report, they say specifically that the volatility risk premium hasn't expanded uniformly across stocks with high retail option volume, but there are opportunities where it has, in a big way. When you find those opportunities, that's when you short volatility and take money from the retail degenerates. Retail traders blow life savings on out-of-the-money options, which creates spooky, weird price action. Sometimes this leads to expensive options that are disconnected from reality.
The other strategy they describe is buying long call spreads on stocks where implied volatility and realized volatility have converged. This would be buying a long call, then selling a deeper out-of-the-money call on a stock where this volatility risk premium is tighter. This strategy is less volatility-based. So, if you're using it, you want to make sure you're buying spreads on a company you actually believe in. Selling straddles is purely a volatility-based options strategy, but with a long call spread, your volatility exposure is not nearly as large as your directional exposure.
So, there you go. A real Barclays trading strategy that beats the market. Surprisingly, it doesn't seem impossibly complicated. It almost seems like an individual who put enough time into this could develop something similar. That's concerning. The last thing I need is more hope that the stock market will ever make me money.