An options contract gives an investor the right, but not the obligation, to buy or sell an asset at a certain price. Sometimes investors use these derivatives to hedge—an options contract can be used as an insurance policy in case an asset falls in value, for example.

There are signs that individual investors are powering much of the trading surge, which is good news for retail brokerages. Since they no longer charge trading commissions, one of the main ways companies like Robinhood, E-trade, and Charles Schwab make money is by selling their customer orders to high-frequency trading outfits—also known as market makers—through a controversial process known as payment for order flow. (You can read more about that here and here.)

Options trades are much more lucrative for retail brokerages than stock trades are, according to data compiled by Piper Sandler, an investment bank. Take Robinhood: the financial upstart got paid about 0.0024 cents per share for its customers’ stock trades in the first quarter, making the company some $31 million. But it got paid 0.0048 cents for each options contract, raking in $60 million during that period. TD Ameritrade charges an even higher rate—it made $130 million from options in the first three months of the year.

“We intend to grow our derivatives business by educating our clients and helping them become confident, informed investors,” a TD Ameritrade spokesperson said via email. The brokerage said interest in learning about options has soared, making its “Trading Options” course its most popular education offering.

To understand why companies like Robinhood, the fastest growing major retail brokerage, make more on options than stocks, you have to look at the business model of market makers.

Think of market makers as sort of like used car sellers, says James Angel, a professor at Georgetown University who specializes in market structure. Their goal is to buy a car from you as cheaply as possible (their bid), hold it on their lot for a while, and then resell it at a higher price (their offer). If that car suddenly becomes more popular, they will make even more money. If for some reason that car becomes less popular, they could take a loss. That’s similar to what happens in financial markets, but stocks are traded much more quickly (nearly the speed of light) and frequently.

Market makers can earn more profit from options orders than from stocks (and therefore pay Robinhood and other retail brokerages more money for those orders), Angel says, because the spread between the bid and the offer tends to be wider. That’s in part because there’s less competition. Electric car company Tesla only has one stock that is listed on the Nasdaq exchange, and it’s traded by many types of investors, with a wide range of expertise and sophistication, whose constant trading imparts market information into the price. But there are many options contracts tied to Tesla stock that expire throughout the calendar—and there are far fewer parties analyzing and trading each of those.

“With options there’s more profitability because there’s less competition taking the other side of that trade,” Angel explained. “There’s not a lot of organic competition. You’ve got a handful of market makers willing to trade.”

Avoiding poker sharks

That said, there is certainly still competition in options trading, which is a complex world that can be riskier than the stock market. Investors like hedge funds can be the sharks at a card table. Market makers would rather avoid these pros, who likely know things the market maker doesn’t.

Market makers post lower bids and higher offers (a wider spread) when they think a smart hedge fund trader will show up. That’s also why market makers will pay up to single out the orders from uninformed day traders. Citadel Securities, one of the biggest market makers, paid Robinhood about $28 million for its customers’ options orders during the first three months of the year.

“Market makers are more than happy to buy order flow from the Robinhoods of the world because they understand that Robinhood traders are mostly unsophisticated newbies who don’t really have any special inside insight,” Angel said. “You really don’t want to be playing poker with people who are better than you are.”

Options also contain leverage that can magnify investment gains. A typical contract gives the trader the option to buy or sell 100 shares of a stock, at a fraction of the money it would take to actually buy 100 shares of stock. The lower cost of an options contract, and its structure, can amplify the market maker’s return on its trading capital.

There are guard rails in place to look out for retail customers. Regulations require that brokerages give their customers the best bid and offer available on an exchange, for example (this rule is known as the national best bid and offer, or NBBO). To reduce the incentive for brokerages to send customer trades to the market maker that pays them the most, rather than the one that gets their customer the best deal, companies like Robinhood get paid the same rate by all the market makers they work with.

Market makers understand the intricacies of electronic trading and can provide prices that are even better than the NBBO—known as price improvement. The question becomes who gets the money: the broker, the market maker, or the customer?

Overall, retail traders appear to be getting a better deal than they have in the past, said Robert Battalio, a finance professor at the University of Notre Dame. But as commissions go away, it’s harder for customers to price compare, and to understand whether they could do better with another brokerage. “Everybody is getting NBBO,” Battalio said. “It’s how much inside of that are you getting. How much price improvement are you getting?”

Welcome to the jungle

Why are regular people suddenly so into the options market?

Seth Golden, a day trader in Florida who launched Finom Group, a market research firm, says the number of queries he’s getting from newbie traders has quadrupled since mid-April. He thinks the interest is a confluence of brokerage advertising, social-media hype, and excitement that’s spreading by word of mouth.

Brokerages increased their advertising campaigns slightly this year. Five of the biggest brokerages raised these expenditures by about 1.3% in the first quarter from a year earlier to $183 million, according to research firm Kantar. But the company’s data shows that the big brokers, from Charles Schwab to TD Ameritrade, reduced their spending in April, suggesting that the craze is being fueled by word of mouth, and perhaps by a growing fear of missing out.

Golden thinks a lot of new investors are looking to hit the jackpot. An option betting on a stock to rise to a certain price within a week (a weekly call option) can cost a few dollars or less. But while these options don’t cost very much, they’re also not very likely to pay out. (“You get what you pay for,” Angel said.)

Research suggests the surge in day traders could very well be from people looking for a cheap lottery ticket. A study by Alok Kumar, then a professor at University of Notre Dame, found that demand for risky, lottery-style stocks increases during times of economic turmoil. Research indicates that younger men in particular tend to be attracted to stocks with high upside, even if they have low probabilities of success. Some people are probably chasing a dopamine high, not unlike a gambling addict.

Markets, meanwhile, have been steadily drifting higher, even as the economy hobbles through one of the worst recessions in history. That has rewarded people who have bet on stocks climbing higher. “To the confoundedness of the experienced trader, it’s been working,” Golden said of trades betting on weekly call options.

That’s good news for traders—for now. ”They believe they’re skilled, and they’re not recognizing the potential of luck in this equation,” Golden said. “This is going to come back to haunt the folks who push the pedal too hard.”

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