1) The user /u/ControlTheNarrative (CTN) made plenty of posts before losing the money where he made it very clear he knew exactly what he was doing. He had a post where he spelled out exactly how to gain the extra leverage and that his "personal risk tolerance" meant he could handle 25:1 leverage. Additionally, his response after the fact was something along the lines of "once I earn another $2000, I plan on doing this again". This kid didn't just click a wrong button and end up with the extra leverage, he was well aware of what he was doing.
2) Take this one with a major grain of salt, but based CTN's comments in the original posts and some comments by other users, it seems like this might not have been the first time CTN has used this exact trick to blow up an account. When the video was first posted, multiple commenters mentioned that he'd done it before and some of CTN's comments after the fact seem to hint at that. Again, take this with a huge grain of salt since I have nothing concrete to back that up.
The last time RH was in the news for some user losing way more money than they had (IR0NYMAN) I actually felt for the user a little bit and can understand why RH (supposedly) didn't go after the money after the fact. IR0NYMAN was creating box spreads, which can be a legitimate strategy, although they are very hard to find a situation where you can make money with them. That user stupidly didn't understand RH's rules around options exercise which is how he got screwed, but had he been able to hold all his contracts to exp (like European options allow) he actually would have been fine.
I can understand RH writing off IR0NYMAN's debt because it didn't seem like the user truly understood what he was doing, but this one feels different, IMO.
/pol/ and /b/ are only two boards out of about 80
Doesn’t RobinHood have these disclosures and gates?
I'm not sure if there are any consequences to lying about your experience, but in principle, you are claiming certain facts in writing, not just saying you read a disclaimer or educational material.
Whether RH goes after them is a totally different story though. You can't squeeze blood from a rock.
on a more serious node: RH should close the loops and be thankful that someone is finding these bugs for free - well almost
Trust is everything in fintech. Now that this story has moved from one obscure subreddit to Bloomberg I don't know how they start to reclaim it if they cannot calculate numbers correctly as a brokerage.
The consensus on /r/wallstreetbets is that Robinhood is a joke, which is pretty much the last thing you want to be thought of as a financial services provider.
This is the financial equivalent of forgetting to check password on a login form. It's that stupid.
Yeah, this is why the scenario is unique to most other r/wallstreetbets losses. With a good attorney the guy may come out of this relatively unscathed.
Yeah, but when this stuff becomes mainstream fodder it becomes more embarrassing to regulatory agencies if it is left unresolved in the public eye. The box spread thing wasn't on the frontpage of Bloomberg/CNBC AFAIK.
To me, it looks like a bunch of people on Reddit found a bug and then, extremely ill-advisedly, exploited it flagrantly in real-money accounts they controlled. Based on my understanding of the situation, which may be weak, I'd be a lot more worried to be one of these customers than I would to be RH at this point.
First, the user exploits the bug to build up a massive pool of margin. Roughly, this is equivalent to taking out a $50,000 loan from Robinhood
Second, the user buys $50,000 of soon to expire options. Roughly, this is equivalent to pairing with another (innocent) trader, each putting up $50,000, and flipping a coin for the pot.
If the user wins the coin toss, then Robinhood is fine: the user pays back the $50,000 he borrowed, keeps the $50,000 he won, and Robinhood nets some small amount of interest for their loan. However, if the user loses, Robinhood never gets back their $50,000 dollars. That money is now in the possession of the random trader who was on the other side of the coin toss, and there's no way to get it back because that trader legally won it. The user who ran the scam owes Robinhood $50,000 but that debt is close to worthless.
It doesn't really matter who is responsible. Even if Robinhood prosecutes everyone who perpetuates this scheme and sends them to jail, they'll still never see their money again.
Seems like a better game if the other party is not so innocent, or independent...
There's not much incentive here to do that, anyway; it doesn't increase your expected value over the original coin flip.
Either they have a working portfolio valuation model, and they missed this rather obvious case of linking a written call to its underlying, or they don't have a proper valuation model at all. If they actually do portfolio valuation by simply valuing each line and adding them, then it's not just wrong but gross incompetence. It would not be the first broker to blow up due to mispricing clients derivatives portfolios. The idea that a startup is letting millenials trade derivatives like this is absurd in the first place.
But the $8 billion question is: are we talking about an obscure bug, a missed case in an otherwise perfectly sound valuation and risk management model, or is it actually a case of dodgy valuation and risk modelling? Which implies that many well-meaning clients are also seeing the wrong portfolio value, and trading with invalid margins?
Again, I don't have the details so I don't want to speculate too much, but apparently they've had similar "bugs", so it's possible that their entire valuation and risk model is dodgy. It has happened to more reputable organizations.
If their stuff was generally sound except for this, they would have shut down margin trading until the bug is fixed.
I don't think small bugs in high quality shops would fall under this argument.
For brokers in particular, they are highly regulated and I can't imagine them not ending up with a nasty investigation+large fine from regulators over this.
I was pointing out millenials in particular because it's the population targeted by those startups, whose business models is more or less implicitly: millenials have no clue about money and finance. Which is true, but also unethical.
Older millennials are approaching 40. The majority of hacker news members are probably millennials
I don't know if it would be bad PR... The guy very deliberately leveraged himself because he thought he'd gain social approval from his peers at r/wallstreetbets
It's a great public service announcement for: just put your money into index funds and stop trying to gamble on stock earnings.
Some people are richer, either because they have good jobs, inherited or had prior success, so they lose more and the community enjoys their posts more.
The idea that you would do something stupid that costs you more money than you could afford (and possibly gets you into more trouble) just so that a group of people can laugh at you and make jokes at your expense is ridiculous, but I get that some people really crave that sort of attention. It goes a bit far to say that they get "social approval" from the community though.
If I believe index funds are going to have a positive return, why not try to lever it up as high as possible? For example TQQQ (triple leverage) looks pretty enticing compared to QQQ.
https://www.investopedia.com/articles/financial-advisors/082...
Can you explain why that is? I would have expected that your gain or loss from the leverage funds relates only to the difference in price between when you purchased and when you sold (multiplied by the leverage).
Hence why it's reset daily, as the other two responses explain.
And in case it's not been made clear enough: it's the very opposite of a sound investment. It's very much a risk management / trading instrument. It's something you would trade as a hedge or leg of a complex trade; not something you want to hold by itself.
SSO is 2x leveraged SP500
https://finance.yahoo.com/quote/SSO
Check out the chart since 2007 versus the SP500 index to today. I'm seeing 211% return for SSO, 113% for SPY.
Just remember that we've pretty much been in a full on bear market ever since the last recession. Whether or not terrible things would have happened to SSO if we experienced a true recession/crash and whether or not you would actually recover/beat SPY, I have no clue and am not qualified to say.
But, based on the cherry picked '07-'19, yes, SSO (2x SPY) beats SPY (1x SP500) 211% to 113%
https://smabie.github.io/posts/2019/10/04/vol.html
In short, assuming a normal distribution, your max leverage ratio should be the future expected returns divided by the expected variance.
I’m not at a computer right now so I can’t run the math on real S&P returns, but assuming 10% returns and 10% vol and a normal distribution, the highest leverage ratio you would ever be able to justify is 10/10^2 or 10x leverage.
In my blog post I looked at the beginning of 2018 up to present. The ideal leverage ratio according to my equation (I’m sure it’s not novel, but haven’t been able to find anyone else talking about it), is 2.99x.
Of course, the more skew or kurtosis the distribution has the less accurate this equation becomes.
Right now I’m working on a hypothetical S&P ETF that adjusts leverage bases on forecasted volatility and returns. Almost impossible to get right, but my preliminary model has outperformed (not risk adjusted) any fixed leverage I’ve thrown at it.
Second, my analysis was from the beginning of 2018 to present. Using that data, the ideal leverage ratio is 2.99x.
Third, the ret/var model put forth in the post assumes a log-normal distribution. The less log-normal the returns are, the less accurate it becomes. Excess kurtosis or skew will definitely affect the accuracy of the model. So the model would probably be fine if the market was up-up-up or down-down-down, I haven’t encountered any periods in which the non-normality of the distribution is so severe that it completely breaks the model.
Leverage is almost always the secret sauce to institutional strategies. And if we’re talking about quant funds, without leverage they wouldn’t exist.
This sounds like perpetual motion to me. It's like Moore's law - no matter how long it's gone on for, it can't go on forever.
If everybody believes that, and people who actually control trillions of dollars do it on a massive enough scale, just borrow money and invest in stock, then it has to break things down at some point, doesn't it?
Banks are a little different and while the rules are complicated, big banks need to have around 3% of their total book at hand. Or in otherwords, they have around 33x leverage. Because of the leverage, banks need a very diversified uncorrelated portfolio in order to reduce volatility. No bank would stuff all of their money into equities, the risk of ruin is too high.
Also, there’s another perspective to look at your question: the efficient market hypothesis. In short, EMH states that in general, all investments have the same or trend toward the same risk/reward profile. That is, the ratio or slope of the returns vs volatility should be the same. With debt/credit, there are two primary options: you get paid back with interest or you don’t (let’s ignore bankruptcy). With equities you are assuming a lot more risk, the stock could go up or down or whatever. Since you are assuming more risk with equities than credit, it would violate EMH if you weren’t compensated for the extra risk.
This however, doesn’t explain why equities perform so much better than everything else. This is called the equity premium puzzle [2].
So maybe you’re right? No one really knows. Maybe the jig will eventually be up? Or maybe not, no one really knows.
- I don't want to invest on margin unless the interest rate is significantly lower than stocks generally return
- as a rule of thumb, 7% is a conservative estimate for stocks in the long run, while a typical broker charges close to 10%. So it seemed like a non starter.
- however, it is possible to find rates as low as 3-4%, so then the question becomes how much leverage to use?
- my logic was, what kind of drawdown is plausible if you invest at a market peak? It appears based on known history that -70% could happen. Therefore it would be best to limit leverage so that more than a 70% decline would be needed to cause a margin call.
- which seems to lead to borrowing no more than 25-27% of one's equity.
and yeah, there are failures, and they lose their shirts, and the beat goes on. but you're probably not going to make very much money (=> last very long) if your rate of return is the same order of magnitude as the collateral you're taking out. it's just not worth it from the POV of the bank.
I don't think they actually want you to trade on margin. It's just, some people are addicted to volatility / the chance of "sweet gainz" and they see "regular Joe" posting pictures of turning $1k into $100k by making "the correct lucky" options trade, so they are down to try to do it too.
I don't think that's Robinhood's message. It's just a side effect of having an easy to use app with no fees.
Have you used RH? I use it for exactly your example, every other paycheck I put some in VOO and a bit on some individual stocks. They push Robinhood Gold so hard. There used to be a glowing gold banner at the top of your portfolio advertising to join gold and get $10,000 today or whatever.
LOL WAT? If you are using the margin feature of your brokerage account it should be implicit that you understand you will lose more money than you have. Many people have bankrupted even due to a temporary fluctuation in pricing causing margin calls. This is true even if you don't trade options, just less likely so.
Personally I trade options but I don't enable the margin feature on my account. Then the worst case scenario is I lose everything I put into the account; I wouldn't lose the money I didn't put in my account.
Can. It is isn't a certainty for those that understand, but if you don't understand that will is probably correct.
You’re also on the hook for any excess losses that are not covered by cash in the account. They can and will go after the rest of your external assets.
Some states are better about protections against creditors than others. Don't live in a state with poor creditor protections (Florida is fantastic, Missouri is terrible).
So your 6% loan is now a 9% loan.
I never used credit from 18-25 aside from churning some credit cards.
And yes, Prime is low today.
Also, if you can make a play for real property: buy dirt. It's a good financial play to build equity/wealth.
Income and assets are king when underwriting a mortgage, credit less so (depending on investor desires of the mortgage backed securities).
https://www.hud.gov/sites/documents/4155-1_4_SECD.PDF (FHA Guidelines: Borrower Employment and Employment Related Income)
Maybe there's an upside for this guy after all. 2019 is weird.
The PR would be a disaster.