Investors Are Using Robinhood, Other Platforms to Jump Into Options Trades, Worrying U.S. Regulators

WASHINGTON—The flood of everyday Americans into options trading has drawn a skeptical eye from U.S. regulators, who are considering possible rule changes for the era of smartphone brokerage apps.

Around 39 million options contracts have changed hands on an average day this year, up 35% from last year and the highest level ever, according to Options Clearing Corp. data as of the end of November. Retail traders recently made up around one-quarter of all options activity.

Gaining approval to buy and sell options through some brokerages, such as

Robinhood Markets Inc.,

is significantly easier than at others. Such discrepancies, combined with the recent trading surge, has left U.S. regulators questioning whether the rules governing individual investors’ access to the options market need to be revised.

The Financial Industry Regulatory Authority, or Finra—Wall Street’s self-regulatory arm—plans to publish a request for comment in coming weeks to solicit feedback from market participants about trading in options and other complex products, a spokesman for the body said. Such requests are often the first step regulators take when considering potential rule changes.

Options give the holder the right, but not the obligation, to buy or sell an underlying security, such as shares of a public company. They have long been used by experienced traders for sophisticated strategies such as hedging portfolios or betting that certain stocks will experience a burst of volatility.

The recent flood of individual investors into equities and options trading has transformed the market. Relatively inexperienced traders can use options to chase bigger returns and take on more risk than they could achieve by simply buying a stock.

“Now, the ability to trade options is just a few clicks away, and investors can easily trade without direct contact with their brokers,” Securities and Exchange Commissioner

Caroline Crenshaw

said in a recent speech. “Given these changes in market access, it may be that the options account approval rules are due for a review.”

The SEC reached out to industry participants earlier this year to discuss requiring additional disclosures on how options orders are executed, people familiar with the matter said.



Photo:

Ariel Zambelich/The Wall Street Journal

She said that when the current options-approval rules were written—in 1980—investors had direct contact with a human broker who could explain the impact of various strategies and the risks they entailed.

Separately, the Securities and Exchange Commission reached out to industry participants earlier this year to discuss requiring additional disclosures on how options orders are executed and whether investors are getting good prices on their orders, people familiar with the matter said.

New regulations to limit individuals’ ability to trade options could spur pushback from the financial industry, which has worked for decades to expand U.S. investors’ access to options and other sophisticated markets.

“If Finra tries to tighten the suitability rules, I think that would be a massive mistake,” said Scott Sheridan, chief executive of Tastyworks, an options brokerage. “People should have access to any trading tool in the toolbox, as long as they have the money to meet the capital requirements.”

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While options have grown in popularity, they can also be risky. An unfavorable swing in the price of an underlying stock can make some options worthless, or oblige a trader to sell shares at a loss. Options pricing can give professionals a leg up on individual investors because of the complicated math needed to estimate the probability of turning a profit.

“Retail traders can be lured into options trading because of the leverage, but the winners are almost always the lightning fast computers that are trading against them,” said Tyler Gellasch, executive director of Healthy Markets, an advocacy group that represents large investors.

Because of the risks, brokers have long been required to perform extra due diligence before approving someone to trade options. This includes obtaining information about the customer’s financial background and investment experience, and making sure the customer has been apprised of the risks.

Representatives from the Securities Industry and Financial Markets Association, a lobbying group for brokers and asset managers, have met with officials at Finra and the SEC in recent months to discuss potential changes. The group recommended standardizing the different levels that brokers use when approving customers to trade options.

In June, Robinhood agreed to pay nearly $70 million to resolve sweeping allegations by Finra that focused in part on its options-approval procedures. According to the regulator, Robinhood qualified thousands of accounts to trade options even though clients didn’t meet the eligibility criteria.

The GameStop frenzy put the spotlight on a growing group of investors who seek and share trading information on social media platforms like YouTube and TikTok. Three investors explain how these online communities are helping them chase the market. Photo illustration: Adam Falk/The Wall Street Journal

The brokerage’s app still asks new users if they would like to enable commission-free options trading once their account is opened. The “Yes” button is highlighted in green; the “No” button is white. Approval can be obtained in a few minutes by clicking through a set of questions about one’s assets and income, investment experience, and by attesting to having read a 100-page document.

“Robinhood’s options approvals process applies traditional rigorous review criteria in an automated manner, followed by additional checks and a layer of manual review in some cases,” a Robinhood spokeswoman said in an emailed statement. “Efficiency shouldn’t be misconstrued as a lack of rigor. Our platform is built with modern technology, as opposed to old-school methods that can be subject to human error.”

The company said at the time of the Finra settlement that it had enhanced its oversight of customers’ use of options, including through conducting monthly reviews to ensure clients meet eligibility rules.

Still, other brokers are more rigorous in reviewing customers’ applications to trade options. Some large brokerages, such as

Charles SchwabCorp.

, manually review all applications, a process that can take days even for people seeking the most basic level of options trading.

Robinhood, by contrast, approves investors’ applications instantly if their responses to the questionnaire meet the company’s criteria.

Regulators are also evaluating greater disclosures tied to options prices. An SEC rule requires exchanges and trading companies that execute individual investors’ orders to disclose metrics on execution quality, or the prices at which stock trades are executed relative to broader market prices. But the rule doesn’t apply to options.

“It’s a very opaque market. There’s a lot of revenue generated from options trading,” said

Mark Davies,

chief executive officer of S3, a software company that works with trading companies on regulatory disclosures. “The SEC and public at large are blind to execution quality.”

Write to Paul Kiernan at [email protected]

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