The risk of regulators restricting options trading is rising, and that could be a problem for Robinhood and others
Recent comments by FINRA and the SEC suggest that regulators may consider restricting the ability of brokerages to promote options trading to retail investors. If that were to happen, it could negatively impact the revenue of trading platforms including Robinhood (NASDAQ:HOOD), Schwab (NYSE:SCHW), SoFi (NASDAQ:SOFI), Interactive Brokers (NASDAQ:IBKR), E*Toro (NASDAQ:FTCV), and Morgan Stanley (NYSE:MS) owned E*Trade, as well as exchanges Cboe Global Markets (BATS:CBOE) and CME Group (NASDAQ:CME).
A spokesperson for FINRA − the Financial Industry Regulatory Authority, Wall Street’s self-regulatory body − said that it plans to publish a request for comment in coming weeks to solicit feedback from market participants about trading in options, the WSJ reported.
This follows comments by Securities and Exchange Commissioner Caroline Crenshaw that “it may be that the options account approval rules are due for a review”. In a speech, she said: “While some options strategies can help hedge an investor’s portfolio against losses, other options strategies can be incredibly risky and expose an investor to sudden and severe losses. And of note to me, many inexperienced investors – perhaps not well-positioned to jeopardize their savings – began options trading earlier this year. Given the risks associated with options trading, there are heightened obligations for brokers when approving options trading for retail customers. Such trading was, historically, quite limited. Now, the ability to trade options is just a few clicks away, and investors can easily trade without direct contact with their brokers. This likely was not anticipated when the options approval rules – which require brokers to exercise due diligence when approving customers for option trading – were originally issued. At that time, the norm was that retail investors had direct contact with their brokers who could explain the impact of particular strategies and the risks particular positions entailed. Given these changes in market access, it may be that the options account approval rules are due for a review, and I look forward to thinking this through with my colleagues. I am also thinking about the implications of this phenomenon more broadly, particularly the consequences of increased numbers of retail investors using leveraged investment strategies subject to margin calls that they may not be able to meet. That may not come to pass, but, again, it’s important to consider how to modernize our regulations to meet new trends.”
Restrictions on the ability of brokerages to promote options trading could significantly reduce the payments for order flow the brokerages receive, because payments for order flow are far higher for options than for equities. A 2020 analysis of SEC filings by Piper Sandler found that Robinhood (HOOD) makes the most from payment for order flow, receiving $0.17 per 100 equity shares and $0.58 per 100 options. Schwab (SCHW) receives $0.11 per 100 equity shares and $0.37 per 100 options, while E*Trade receives $0.15 per 100 equity shares and $0.46 per 100 options, and Ameritrade $0.15 per 100 equity shares and $0.58 per 100 options.
This follows recent news that The European Commission is expected to ban the practice of payments for order flow.
While options trading generates significant payment for order flow for the brokerages, Robinhood (HOOD) and E*Toro (FTCV) are more exposed to the risk of regulation of crypto trading. See Staking, PFOF and commissions: How Coinbase, Robinhood and other crypto platforms make money.