A Real Cost of Free Trades: Retail Option Trading Increases the Volatility of Underlying Securities

43 Pages Posted: 13 Mar 2023

See all articles by Marc L. Lipson

Marc L. Lipson

University of Virginia - Darden School of Business

Davide Tomio

Darden School of Business

Jiang Zhang

University of St. Thomas - Opus College of Business

Date Written: March 9, 2023

Abstract

We examine the link between retail trading in options and the volatility of the underlying assets. Using Robinhood's introduction of options as a shock to retail trading, we confirm that option volume increased around this event and show that volatility similarly increased for: interlisted US securities, relative to their Canadian counterparts; optioned shares relative to optionless shares for firms with dual class shares; and more so for shares that would be become more attractive to retail traders as a result of the fee change (relatively high stock prices or low option prices). We provide further evidence suggesting the effect is permanent and that the underlying mechanism is related to market makers hedging their option exposure: volatility increases more for shares with higher option-embedded leverage; spreads and price impacts are lower; market maker volumes increase; and the volatility of retail option volume increases. Our results suggest that a shift in retail trading toward options drives an increase in the volatility of the optioned securities due to that actions of market makers hedging their exposure.

Keywords: Retail traders, Options, Robinhood, Volatility

JEL Classification: G01, G12, G13, G14

Suggested Citation

Lipson, Marc Lars and Tomio, Davide and Zhang, Jiang, A Real Cost of Free Trades: Retail Option Trading Increases the Volatility of Underlying Securities (March 9, 2023). Darden Business School Working Paper No. 4383463, Available at SSRN: https://ssrn.com/abstract=4383463 or http://dx.doi.org/10.2139/ssrn.4383463

Marc Lars Lipson

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4837 (Phone)
434-243-5021 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/lipson.htm

Davide Tomio (Contact Author)

Darden School of Business ( email )

100 Darden Boulevard
Charlottesville, VA 22903
United States

Jiang Zhang

University of St. Thomas - Opus College of Business

2115 Summit Ave.
St. Paul, MN 55015
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
427
Abstract Views
1,405
Rank
129,380
PlumX Metrics