(Un)skilled leveraged trading of retail investors

Abstract

We study the trading behavior of retail investors in the market of leveraged bank-issued retail derivatives designed to trade excessively, speculate and gamble on ongoing trends and market movements. We analyze whether retail investors have private information and benefit disproportionately or whether they gamble. We answer this question along three dimensions: (i) profitability, (ii) news trading, and (iii) sensitivity to implicit trading costs. We distinguish derivatives by the type of underlying (index vs. individual stocks). We find that raw returns are negative for derivatives with stock as underlying, and only partially positive for those with index as underlying. Nevertheless, riskadjusted returns show a poor performance with sharpe ratios below one. We show that retail investors are attracted by news, but do not have private information prior to news events. Finally, we categorize investors according to their sensitivity to implicit trading costs. We find that non-sensitive investors perform worse than sensitive investors.JEL Classification: G10, G14.

The Demand for Warrants and Issuer Pricing Strategies

“…These results show that individual warrant investors are not as uninformed or irrational as recent literature (e.g., Meyer et al., ) suggests for other segments of the retail derivatives markets. A significant share of investors is able to compare prices and even margins, and incorporates this information into their investment decisions.…”

“…As the main reason for trading is speculation (see, e.g., Bauer et al, , Schmitz and Weber, , Meyer et al, , Rieger and Hens, ), investors are usually required to make timely decisions. Only in rare cases does an investor observe the pricing of a warrant over a series of dates.…”

The Gamblification of Investing: How a New Generation of Investors Is Being Born to Lose

“…In the Netherlands, a study on options trading by retail investors concluded that most individuals incur substantial losses, with an average monthly negative return of −1.81% [72]. Profitability analysis of Germans trading leverage certificates of single stocks (which are structurally similar to CFDs) generated negative returns between −4.96% and −9.45% (for comparison, in the same period, the German stock index went up 30%); these products were also highly leveraged, with an average nine-fold increase in volatility and risk-taking, with every 1% move in asset prices translating into a 9% gain or loss for the investor [73]. High amounts of leverage have also been blamed for the losses experienced by more than 80% of clients trading CFDs [74].…”

Market Makerss Optimal Price-Setting Policy for Exchange-Traded Certificates

“…The reason for the first is that market makers do not have to balance demand and supply as they can satisfy any demand quantity because they issue the product themselves and simply "close" the certificate when it is sold back. The reason for the latter is that most investors in this market segment are uninformed (Meyer et al, 2013;Schroff et al, 2013). Even if an investor was informed, the resulting risk for the market maker is negligible as he hedges the certificate when an order arrives.…”

“…Recent empirical findings suggest that individual investors act uninformed in this market (Meyer et al, 2013;Schroff et al, 2013) and that the issuers' pricing policy is-besides standard behavioral biases-the key reason for investors' negative returns in short-term certificates (Entrop et al, 2012) and poor risk-adjusted performance in long-term certificates (Entrop et al, 2013a). In fact, theoretical models imply that investors' demand for certificates can hardly be justified by standard preferences (Breuer and Perst, 2007;Branger and Breuer, 2008;Bernard 1 Other studies reporting overpricing include for the US Chen and Kensinger (1990); Chen and Sears (1990); Baubonis et al (1993); Benet et al (2006), for Germany Stoimenov and Wilkens (2005); Muck (2006); Wilkens and Stoimenov (2007); Baule et al (2008); Baule (2011); Baule and Tallau (2011), for Switzerland Wasserfallen and Schenk (1996); Burth et al (2001); Grünbichler and Wohlwend (2005); Wallmeier and Diethelm (2009), and for the Netherlands Szymanowska et al (2009).…”