In a new academic study, Robinhood was found to provide significantly worse execution quality for retail options trades compared to other leading brokers.
The research, conducted by Xing Huang, Philippe Jorion, and Christopher Schwarz, highlights how disparities in price improvement and the use of payment for order flow (PFOF) negatively impact retail investors on the Robinhood platform.
Robinhood stood out as the worst-performing broker
The paper, “Some Anonymous Options Trades Are More Equal than Others“, investigated execution practices at six major retail brokers, including E*Trade, Fidelity, Schwab, TD Ameritrade, Vanguard, and Robinhood. Despite options trades being executed anonymously on exchanges, the study found that execution prices and price improvement varied widely across brokers.
Robinhood stood out as the worst-performing broker in terms of price improvement. On average, Robinhood customers received just 7% price improvement relative to the National Best Bid and Offer (NBBO). In contrast, the best-performing broker provided price improvements of up to 52%. Price improvement refers to when trades are executed at prices better than the NBBO, benefitting retail investors.
One of the primary reasons for Robinhood’s poor execution quality, according to the study, is its reliance on PFOF. PFOF is a controversial practice where brokers receive payments from market makers (wholesalers) to route customer orders to them. The study found a strong negative correlation between PFOF levels and execution quality, with Robinhood having one of the highest PFOF levels and the lowest price improvement.
Additionally, the study found that Robinhood rarely used Price Improvement Mechanism (PIM) auctions, the key tool for securing better execution prices for retail investors. Only 25% of Robinhood’s trades were routed through PIM auctions, compared to 76% at the top-performing broker. This reliance on auto-execution trades, which typically offer minimal price improvement, further compounded Robinhood’s execution shortcomings.
“The findings suggest that retail investors using Robinhood may be at a disadvantage compared to those on other platforms, primarily due to the broker’s high PFOF and limited use of price improvement mechanisms,” the authors wrote.
This research has significant implications for market transparency and regulatory oversight. The authors call for more comprehensive disclosure requirements for options execution, similar to those mandated for equity trades. As retail trading continues to grow, the need for brokers to provide clearer information on trade execution quality is more pressing than ever.
Policy Implications
The study’s results could fuel ongoing debates about PFOF and market fairness, particularly as regulatory bodies like the U.S. Securities and Exchange Commission (SEC) consider reforms to protect retail investors. The authors suggest that current disclosures on trade execution for options are insufficient and call for new regulations requiring brokers to provide detailed reports on how trades are executed, especially with regards to PFOF and price improvement.
As Robinhood continues to dominate the retail trading space, particularly among younger investors, these findings raise concerns about whether the platform truly serves the best interests of its users. In light of the study, investors may want to reconsider how execution quality affects their trading costs, particularly in the fast-growing options market.
Key Findings:
- Robinhood’s Price Improvement: Only 7% on average, the lowest among six brokers.
- High PFOF: Strong negative correlation with price improvement; higher PFOF led to worse execution.
- PIM Auctions: Robinhood used PIM auctions for only 25% of trades, while other brokers used them more frequently to secure better prices.
- Calls for Reform: Researchers recommend enhanced regulatory disclosures to improve transparency for retail options trading.
As the retail trading landscape evolves, studies like this may prompt changes in how brokers handle trade execution, ensuring that platforms like Robinhood deliver fairer outcomes for investors.
Brendan Callan, CEO of multi-asset trading firm Tradu, commented on the study’s findings, emphasizing the impact of hidden trading fees on retail investors. He stated: “For years, active retail traders have been getting a bad deal from major trading platforms. Most trading platforms are very transparent about their fees, but they are less up front when it comes to commissions and spreads. This is despite them being just as much of a cost and a drag on performance. As a result, traders have unwittingly long suffered from high and often hidden trading fees, negatively impacting their returns.
“Retail investors shouldn’t stick with their current provider simply out of habit. Instead, they should focus on platforms that offer seamless access to multiple markets, highly competitive and transparent fees, professional-grade tools, and outstanding customer service – this is the least they deserve.”
Unlike some brokers that rely on PFOF and opaque execution practices, Tradu promotes a clear and open fee structure, aiming to provide seamless access to markets without hidden costs that can impact traders’ returns. The platform’s professional tools are designed for both active traders and long-term investors, supporting their needs with robust charting, analysis features, and a user-friendly interface.
The study’s findings, alongside Callan’s remarks, shed light on the broader issue of transparency in the retail trading industry. As regulators like the U.S. Securities and Exchange Commission (SEC) consider reforms, the study suggests that brokers should provide clearer disclosures around execution quality and fees.
