The Barclays Trading Strategy that Outperforms the Market

The Barclays Trading Strategy that Outperforms the Market
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Institutional Investment Research

Last week, I created a video discussing institutional investment research and institutional confirmation bias analysis, specifically focusing on individual companies and their anticipated share price movements. During my research for that video, I stumbled upon a report from Barclays titled “U.S. Equity Derivatives Strategy: Impact of Retail Options Trading.” This extensive 30-page report from the Barclays derivatives team outlines their strategy for capitalizing on the surge in retail options trading volume. It essentially serves as a blueprint for profiting from the trading activities of retail investors, particularly those associated with forums like Wall Street Bets.

The report, published in September 2020, begins by highlighting the significant increase in option volumes, particularly short-dated calls, driven by retail investors for large-cap stocks. The language used in the report is filled with complex financial jargon, prompting me to offer a summarized version using memes for better accessibility. If you wish to delve into the full report, the link is provided below.

The key focus of Barclays is on monetizing retail-driven options volatility dislocation. In simpler terms, they provide insights into how they profit from the trading behavior of retail investors, particularly those using platforms like Robinhood.

The report points out that retail investors, armed with stimulus checks, are entering the market with access to commission-free options trading. These investors are often drawn to short-term, cheap, out-of-the-money options as a means to leverage their money significantly. Barclays claims that two interesting outcomes occur due to this influx of retail investors into the options market.

Stock Decreases

Firstly, the volatility risk premium on some stocks decreases. Options are priced based on the market’s anticipated future volatility, and a higher implied volatility leads to more expensive options. With retail investors engaging in significant options buying, the spread between implied volatility and realized volatility has decreased for some stocks. Additionally, for certain stocks, the gap between implied and realized volatility has widened, presenting opportunities for options trading strategies.

Barclays also notes that their collection of 100 stocks with the highest retail option volume has outperformed the index. However, this outperformance is somewhat inconclusive, as these stocks have also proven to be resilient during the pandemic.

One crucial way retail investors influence share prices is explained by the report. When retail traders buy short-term, out-of-the-money options, market makers who sold these options need to maintain a neutral market position. To achieve this neutrality, market makers buy shares of the underlying stock. As these shares are bought, the underlying price is driven higher, triggering a cycle where more retail investors join in, further impacting the market maker’s position.

In summary, the report unveils Barclays’ strategy for profiting from retail options trading and suggests potential trading opportunities arising from the behavior of retail investors in the options market.

The Options Market

He sold, once again causing the share price to rise. This hedging share volume has significantly increased since the rise of commission-free options trading. The mystical gamma squeeze refers to the occurrence of peculiar events when a substantial number of people are buying out-of-the-money options. It’s essential to keep this in mind when navigating the options market.

Let’s delve into the actual trading strategies recommended by Barclays to capitalize on retail options trading. They propose two methods, with the first involving monetizing elevated volatility using selective volatility score-based short delta hedge straddles on single stocks. Despite the complex language used, the essence is that Barclays suggests selling or going short volatility on specific stocks. Options strategies, similar to going long or short on stocks, can be implemented. Selling straddles, for instance, is akin to shorting volatility, anticipating that the market is pricing future volatility too low. This strategy profits if volatility increases, regardless of the direction of the share price.

Barclays has successfully outperformed the market by employing the strategy of selling straddles or shorting volatility on specific stocks. The key is to identify stocks with rich volatility risk premium – a considerable spread between anticipated and realized volatility. This approach entails making money by selling overpriced options to retail investors.

Identify Opportunities

The report mentions their use of the volsscore metric to identify opportunities. Although they don’t delve into the exact workings of this metric, it is inferred that they assess the spread between a stock’s implied volatility and the sector’s implied volatility, as well as the stock’s implied volatility relative to its historic realized volatility. Visually, they seek stocks with high volatility compared to the sector and a substantial gap between implied and realized volatility.

Barclays emphasizes that the volatility risk premium doesn’t uniformly expand across stocks with high retail option volume, but there are significant opportunities where it does. When such opportunities arise, shorting volatility becomes a profitable strategy, taking advantage of retail traders investing in overpriced options.

The second strategy outlined by Barclays involves buying long call spreads on stocks where implied volatility and realized volatility have converged. This strategy is less volatility-based, focusing more on directional exposure. It entails purchasing a long call and selling a deeper out-of-the-money call on stocks where the volatility risk premium is narrower. Unlike selling straddles, this strategy involves less exposure to volatility.

In conclusion, Barclays presents real trading strategies that have proven to outperform the market. Surprisingly, these strategies, while complex, do not seem impossibly convoluted. It raises the possibility that individuals with sufficient dedication could develop similar strategies. However, it’s crucial to approach such endeavors with caution and realistic expectations in the unpredictable stock market.


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