GROWTH IN OPTIONS TRADING HELPS BROKERS BUT NOT SMALL INVESTORS

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Associated Press

Posted on May 27, 2013 at 9:00 AM

Updated Monday, May 27 at 9:00 AM

c.2013 New York Times News Service

Some of the brokerage firms that helped pique American’s interest in stocks are now luring them into something much riskier: stock options.

As the stock market soars to new heights, E-Trade, Ameritrade and Charles Schwab are advertising the potential rewards of options, which give buyers the right to buy or sell stocks at predetermined prices in the future. Options, like their cousins, futures, have traditionally been the domain of Wall Street traders. But the brokerage firms say futures and options can be profitable for ordinary investors, too — a claim that, while true, does not square with many investors’ actual experience.

“We’re looking for newcomers who want to get serious,” Schwab says on its website.

While relatively little research has been done on the success ordinary investors have in trading options, analysis done for The New York Times by SigFig, a company that tracks 200,000 retail investors, showed that people who traded options last year received only about one-fifth the returns of people who did not trade options: 1.1 percent compared to 5.1 percent.

The brokerage firms do not release data about customers’ trading, and they are generally hesitant to detail the expansion of this business, but it has clearly been an area of growth. An analysis of scattered data from company filings and presentations indicates that derivatives trading, which includes options, has risen at all the major firms since the financial crisis of 2008, which left many Americans with big losses in their investment portfolios.

At Ameritrade, which has been the most aggressive, derivatives trades accounted for about 40 percent of all customer trades last year — more than double what it was just five years ago. A vast majority of those trades were in options.

The growth has been a big help for the online brokers at a time when stock trading has fallen. The commission on the average options trade is more than twice that on the average stock trade, according to TD Ameritrade’s former treasurer, Michael Chochon. “We’re looking to continue to drive penetration in” options and futures, Ameritrade’s chief financial officer, Bill Gerber, said in a call with analysts in February.

The results have been less of a clear victory for customers. Renaud Piccinini, who monitored customer accounts for Ameritrade before he left the company last year, said options could be used wisely in some circumstances. But he said he saw investors taking up options trading and “blowing up” on an almost daily basis. He said Ameritrade carefully tracked the risks its customers were taking but did not warn them until they were close to losing it all, if then.

“We knew that they were taking risky bets,” Piccinini said. “We knew inside the firm, but there was resistance to sharing that with the customer.”Piccinini is now working with Chochon and two other former TD Ameritrade employees to create a program for retail investors, known as Prairie Smarts, that details the risks a prospective trade adds to a portfolio.

Steve Quirk, who oversees active traders at TD Ameritrade, said the former employees were criticizing the company to generate interest for their firm.

Quirk said TD Ameritrade gave investors a wide array of tools to gauge their risks, as well as significant education, before and after they started trading options.

“We hear from many, many clients that the more they understand about all the products that are available, the better equipped they are to deal with the market in any scenario,” Quirk said.

The companies began their big push into this area after the financial crisis, with the purchase of smaller brokerage houses that focused on options. At E-Trade, filings indicate that options trades rose to 24 percent of all trades last year from about 17 percent in 2010, and the total number of trades also increased.

Customers at all the brokers must take a number of steps before they are permitted to begin trading, and they must attest that they have read an official 186-page document laying out the risks of options. Almost anyone can go through this process, though, and the brokers have broadened the pool of potential customers by allowing investors to trade options in their retirement accounts.

E-Trade’s recent marketing material said: “Every investor should learn how options trading could benefit them.”

Options generally represent the right to buy or sell 100 shares of a stock at some point in the future — allowing for a small initial investment that can lead to either big gains or big losses.

Investors have bought in for a variety of reasons. Some believe they will be able to use the leveraged nature of options to supercharge their returns and make up for losses suffered during the financial crisis. Others see options as a way to insure their stock portfolios against future losses.

Academic research suggests, however, that on the whole, options traders do worse than stock traders, who, in turn, have been shown in many studies to underperform buy-and-hold investors. The most comprehensive study looked at 68,000 Dutch retail investors. It found that from 2000 to 2006 retail options traders lost an average of 4.5 percent each month, while people who just traded stocks lost 1.6 percent.

Daniel Dorn, a professor at Drexel University who has studied options investors, said studies of U.S. options traders had not found them to be significantly more successful than the Dutch traders.

“You can very clearly say in the aggregate, this doesn’t help individual investor portfolios,” he said.

The brokers said they guarded against customer losses by allowing only wealthier and more experienced customers to proceed to more complex trading strategies. Joe Vietri, the chief executive of Charles Schwab’s options subsidiary, OptionsXpress, said his company was careful about monitoring clients because Schwab wanted to keep them as customers for other parts of the business.

TD Ameritrade gives customer some tools that allow them to analyze the risks of individual trades. But Chochon, the former Ameritrade treasurer, said this was not enough to stop many customers from burning through money in their accounts. This put a strain on the company, he said, because it necessitated expensive marketing campaigns to capture new clients.

“The churn of those clients was really expensive because you had to bring in a new customer,” he said.

Quirk, at Ameritrade, denied that the company had trouble with clients burning out.

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