Christopher Schwarz, University of California-Irvine
Abstract: We compare retail option trade execution by placing simultaneous market orders across six brokers. Although option trades are all anonymously executed on exchanges and therefore should be treated equally, we find that execution prices vary significantly: the average round-trip execution cost ranges from 0% to 7% across brokers. Wholesalers create differential pricing by not only systematically varying execution methods, but also the pricing within each method. A primary economic driver for differential pricing seems to be payment for order flow (PFOF). Our results have market design and disclosure implications.
Abstract: We assess the value of retail order flow by studying the performance of specialized retail market makers (RMMs) in the German equity market. RMMs earn an average (gross) Sharpe ratio of 17.85, which is more than twice as large as that earned by proprietary trading firms active in public limit order markets. A simple calculation suggests that RMMs' willingness to pay for retail order flow is around 60% of their revenues, or 1.76 bps of their trading volume. The profitability of retail market making is rooted in reduced exposure to adverse selection and inventory risk.
Discussant: Laurence Daures, ESSEC Business School
Dmitriy Muravyev, University of Illinois-Urbana-Champaign
Abstract: The recent surge in retail option trading sparked concerns about trading motives and large losses. We offer the first trader-level analysis of modern retail option trading using novel data of $15 billion in retail stock and option trades. Option trades constitute one-third of all trades, concentrate in few underlyings, and are dominated by short-term purchases. They incur modest losses compared to wide bid-ask spreads.
Retail investors use options to participate in high-priced underlyings, with little leverage or skewness-seeking in realized trade returns. Our investors are relatively sophisticated but exhibit remarkable heterogeneity, with main results holding across investor styles.
Discussant: Christopher Jones, University of Southern California
