Losing is Optional: Retail Option Trading and Earnings Announcement Volatility

Abstract

We document the growth of retail options trading and provide evidence that retail investors are drawn to options by anticipated spikes in volatility. Retail investors purchase options in a concentrated fashion before earnings announcements, particularly those with greater expected abnormal volatility. In doing so, retail investors display a trio of wealth-depleting behaviors: they overpay for options relative to realized volatility, incur enormous bid-ask spreads, and sluggishly respond to announcements. These translate to retail losses of 5-to-9% on average, and 10-to-14% for high expected volatility announcements. Market makers are the primary beneficiaries, particularly in recent years coinciding with the COVID pandemic.

Keywords: Retail trading, option pricing, earnings announcements, volatility

JEL Classification: G11, G12, G40, G50