Robinhood & Suicide (Regulation is coming)

I’m not sure if any of you have seen this. It’s a big story in the US. Specifically, as so many retail investors might be jumping into the markets. The interesting comment regarding this is the fact that Freetrade does not and has never considered any leveraged products on its platform. Any backlash on regulation or bad press is mitigated by this fact.

There are some interesting comments made by Scott and Kara on pivot if you want to have a listen.


@Viktor

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It wasn’t the leveraged products that seem to have been the issue, as he supposedly held both put and call options for a specific strategy, but rather he seems to have lacked fundamental knowledge with regards to how these products worked.

I don’t think the lesson to take away form this is to regulate and remove leveraged products but rather to expand education. You see this in the Freetrade forum with the number of people starting threads about ‘not getting the price shown’ when the issue lies with their knowledge rather than Freetrade’s systems. Investing is complicated and making it into a game removes something vital in my opinion.

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This is a really important read. Complicated products is a factor, but so too is gamification. I for one Never want to see little confetti poppers to “celebrate” a trade on Freetrade. It’s investing, not a game FFS. Apps like Freetrade and RH are important. They massively improve the status quo in a very meaningful way compared to traditional share trading accounts. But in creating easy access, all of the platforms need to be mindful of their responsibilities to protect vulnerable customers.

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I was in the pub about 6 months ago and there was a young guy (about 17/18) in there going on about how his mate had made loads from trading and that he was going to start doing it.
Basically this guy thought he could go from not knowing anything about the market straight into day trading and make easy money, that’s pure ignorance.
I agree its about education.

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It’s a really sad story. Without meaning to downplay the significance of the victim’s family’s loss- gambling is a huge problem and is the trigger for suicides, divorces, poverty and mental health collapses every day of every year all over the world. It should be a huge story all the time and we should work to educate people and limit the impact of it on people’s lives, rather than just blaming people for their weakness or blaming platforms for enabling them.

The fact that gamblers have had no sports to bet on, no jobs to go to, stacks of free money from the US govt and a seemingly limitless bull market courtesy of the Federal Reserve, seems to have caused massive stock market gambling from people like this.

It’s easy to blame whoever the poster child is at the moment - currently Robinhood - however ultimately we need to educate our friends, family and colleagues that piling more than you can afford to lose into any position is reckless gambling rather than investing and they are at extreme risk of losing all their money.

I don’t have any kids yet but I will be certain to make sure they understand this and if they do have an imbalance in their brain that predisposes them to speculating I will limit their bank and drill value into them for their first 18 years.

Obviously there will still be gamblers no matter what, it’s a behaviour that has been evolved through natural selection (imho), but we can at least educate each other to try to limit the downsides.

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All good comments but I think I might have misdirected or not explained the more significant issue that I see as a possible consequence to this event.

With “basic vanilla” buying and selling, you have the following possible extreme outcomes:

  • infinite upside
  • 100% downside

100% downside; This is a risk metric most people understand and are occasionally happy to take.

When it comes to more complex structured investment vehicles such as futures, options, you have the following possible extreme outcomes:

  • infinite upside
  • infinite downside (*depending on the LVR: Loan-to-Value-Ratio)

Infinite downside; This is a risk metric most people do not want to take. *And occasionally should not be allowed to take. (dependant on LVR)

As an example; before your approval for a mortgage on a house, your financial position and credit history will be scrutinized and screened by the lender. (I think LVR for UK home loans is 70% average? I could be wrong). So there is a regulator process to ensure safety, not only for the lender but also for the lendee. This regulator process was tightened after 2008 because of the irresponsible practises of some of the lenders. Obviously, with investments, the loan amounts could be much smaller, but the lending rates (LVR) are way more aggressive than home loans.

The biggest problem that has kept the lending rates and amounts intact is the fact that we are living in a world of 0% interest rates. The consequence of this is that financial institutions are more willing to lend money for these leverage, geared etc. products, as the delinquency rates are incredibly low. (We are at or very close to all-time highs: SPX). The addition of the extreme interest in online trading, recently, and incredible increase in volatility will unfortunately, exacerbate this issue.

However, we have not witnessed an “event” to curb or at least regulate lending from the financial institutions (in the 12 years I have worked in finance) when it comes to the infinite downside and the fact that the Federal Reserve announced 0% until 2022 two weeks ago, doesn’t deter the lendee and keeps them kicking the dept-can down the road.

I totally agree that education is a great tool and should be continuously improved and positively adds to the transparency we have seen within the financial industry in the last few years. However, I am in total alignment with the ideas of Freetrade on not allowing certain products on the platform to affect the future well-being of its users in a negative way.

All this really to say that I think Freetrade is in a great position, to reinforce this message. :grinning:

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Any option you buy or sell is unfortunately always leveraged. Its unfortunately built into the mechanics of how an option works. I hope that makes sense.

No it is not a leveraged product, the same way a legal contract is not a leveraged product. An option gives you the right, but not the obligation, to buy/sell a set number of shares at a particular price. There is no leverage at all. You are confusing the difference between the price of the options contract with the amount of shares it allows you to buy/sell.

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That’s if you buy the option. you can sell an option as well, which puts you on the hook to buy or sell the shares at expiry ( or just settle with cash). This can be a valid strategy but if you do it without being covered (e.g already owning the shares you might need to sell) you can end up with theoretically unlimited losses.

One valid use for this is selling calls against shares you already own. if the shares don’t go up you make some income from the options. if they do go up you just sell them at expiry and take the profit

They changed the rules on Margin requirements over here a couple of years back. I don’t think it would be possible for a novice investor to open positions that big with any of the of the CFD/spreadbetting firms or brokers operating in the UK even if they were hedged

Robinhood should never have let him open those positions.

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Regulation and education in particular definitely needed. Some stuff is super risky like trading and spread betting, a warning that x percent of people can lose money just doesn’t cut it. When people trading such huge amounts, they should be vetted somehow - providers have a duty of care.

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How does an option meet any of these definitions?

The word ‘leverage’ has very specific meanings in finance terms which do not apply here.

I am not arguing that risks are limited but these are not leveraged products. The same way that an oil company could have no debt and no leverage but still lose an infinite amount of money in an oil spill.

I have invested in every round other R1 and long lurked on the forums and have never felt compelled to contribute before. I trade derivatives for a living.

Let me assure you that options are a leveraged product. Whilst there is no example of leverage as it relates to options in the example you highlight, when talking about options leverage refers to the fact that an investment can result in gains or losses that are many times that initial investment.

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That is not what leverage means. Your losses can be larger than your investment in many examples without any leverage whatsoever, as per my oil example.

I am not, for a single second, arguing that you cannot lose more money than you originally spent when purchasing the option but that does not make it a ‘leveraged’ product.

Whilst this might not fit the strict definition of leverage, it does fit the commonly accepted definition of a levered financial instrument.

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It’s not a strict definition, it’s the definition. An option is a product which offers an asymmetric risk profile and hence the ability to lose more than the cost of the option itself but there is no leverage.

Because it offers the ability to return (or lose) many times the initial investment this is why it is a leveraged product. Agreed, yes this is an asymmetric risk profile.

Would you contest that futures are commonly not a leveraged product?

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Okay so I could take $1,000 and buy 20 shares in XYZ company valued at $50 for a single share. Not leveraged, simple. Max loss is $1,000.

Or I could take that $1,000 and take out a margin loan and have $10,000 to invest and buy 200 shares in XYZ company at $50. Leveraged, simple. Max loss is $10,000.

Alternatively, I could take $1,000 and buy options. XYZ company is trading at $50 while it’s $50 strike price call options are asking for $2.00. In this case you buy 5 contracts of $50 strike call options on XYZ company shares which controls 500 shares. Max loss is $1,000. This is not done with leverage, as no money is borrowed. This is done through a financial instrument which means I do not actually own 500 underlying shares but merely the right to buy these shares at a given price and date. This means I forfeit dividends, voting rights etc. but I accept this inferior product as it allows me to buy more and therefore increase my position size and earn superior returns.

If you do not borrow money then leveraged is not the appropriate way to describe your position. A bet on a horse with 3/1 odds with deliver a return greater than the initial bet, does this mean I have leveraged my bet? The issue here is with the use of your term ‘investment’ which is not correct as well. An options contract is a bet, nothing more nothing less as you do not own the underlying asset.

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I should have made myself clear when I first posted. My interest was aroused by your post because I firmly believe the term leverage, when used in the context of trading, quite rightly has connotations which should be associated with higher risk. Dissociating option trading and elevated risk is dangerous (in my opinion) because selling options can result in enormous losses which far outweigh the initial expected profit assumed should the option expire out of the money. Therefore I think it is important to appreciate that options are leveraged products.

At the point your losses can exceed the initial amount of money you have deposited into your trading account, whether you are a 25 year old house husband in a rural village or the head of FICC at a tier one bank, you are leveraged.

If you wish to call an option contract a bet do so, is it still an investment? Yes. This is an ideological point. The expectation / motive is still the realisation of profit. If you buy shares in BP with a 5 year time horizon but I buy 5 year brent calls you’re investing but I’m just gambling?

Long story short my point is leverage in finance is a term that should warn us that there is higher risk, arguing that option trading is not leveraged in my opinion helps to sanitise the underlying instrument.

Curious to know what you think of the below page as it relates to options and leverage.

The term ‘leverage’ is commonly misused by people. A product can have an asymmetric risk profile without being leveraged. You can lose more money than you started with without ever touching leverage. The term ‘leverage’ only applies to very specific products based on the definition I posted above and should not be used in any other example.

I am not trying to disassociate options trading with risk, I am trying to disassociate options trading with the incorrect assertion that the products are leveraged. It is not appropriate to call an options contract an investment. The motive of profit is not the only requirement for something to be an investment. Otherwise, my example of horse racing betting would qualify as an investment. It does not. I have not invested in an underlying asset or company which grants me claim to profit.

With your example of Brent calls, you are buying them in the expectation of a future rise in value. However, you do not have a claim to an underlying asset or company until you exercise those options. You are betting that you can exercise them at a lower price than the oil is trading at. If I bought the BP shares I would be investing compared to your gambling. That does not mean my investing will produce better returns or is morally superior but they are two different things.

Leverage and high risk do not go hand in hand. I can buy a share which has a higher risk profile than borrowing to buy a house. Yes there is risk in both, but there is not inherently a higher risk in borrowing to buy a house than there is in buying a share. It depends on the house and the share in question. One should always be aware when one sees the term leverage but if the term leverage is not present that does not automatically imply safety either.

I remember reading that Investopedia article at some point or another during discussion with a friend and I don’t agree with the use of the word leverage in it either. By definition, as posted above, it doe snot fit the description.

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