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Every Options Trader is Not a Volatility Trader

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Every Options Trader is NOT a Volatility Trader

Most investors casually call themselves an "Options Trader" if they trade options. It's very important to understand that there are two different types of options traders.

  • Volatility Traders
  • Directional Leverage Traders

The industry would like you to think that there are an equal amount of each. There are not ... and it's note even close.

In this article, you'll get a sense of just how many Volatility Traders there are in the market.

How Many Volatility Traders?

By my estimates, the amount of Volatility Traders as a percentage of ALL investors is only 0.1%. This means that for every 1 million options traders, only 1,000 of them are Volatility Traders. The other 99.9% of options traders are Directional Leverage Traders. 

Here’s a back of the envelope calculation to reach those numbers.

Recall, there are three main groups of Volatility Traders: 

  • Hedge Funds 
  • Investment Banks 
  • Market-Makers

Let's take a look at each group.

Hedge Funds

Assume there are 10,000 Hedge Funds.

Keep in mind, only a small percentage of Hedge Funds use options. I will use a conservative estimate of 10%. This gets us to 1,000 Hedge Funds.

Assume that only 10% of those Hedge Fund who use options also trade volatility (another very conservative estimate).

This narrows the field to 100 Hedge Funds.

On average, there are 4 traders at each hedge fund. Most have 1 to 3 traders, while a few Hedge Funds have 20 traders.

That nets out 400 Hedge Fund Traders that trade Volatility.  

Investment Banks

Assume that each Investment Bank has 20 Equity Derivative Traders. This is a conservative estimate as the number of traders at the investment banks has steadily declined over the last 10 years. 

Now, assume there are 15 investment banks using equity derivatives.

This gets us to 300 traders at the Investment Banks (20 x 15 = 300), and a total of 700 volatility traders including the Hedge Funds. 

Market Makers

While the number of traders at the Investment Banks has declined over the years, the role of the market maker standing on an exchange floor has been decimated. On many exchanges, their presence has been completely wiped out.

For my estimate, I'll throw in 500 equity market makers on the exchanges (conservative) that trade volatility.

This increase the total to 1,200 Volatility Traders on the Institutional Equity side of Wall Street. There's more in Bonds, Foreign Exchange, and Commodities, but as you'll see, it's not matter in the grand scheme of things. 

How Many Directional Leverage Traders?

The Retail Trader

On the flipside, think about the millions of retail options traders. Very few of them are trading volatility. In fact, most are simply buying options and hoping that the stock goes in the direction that benefits their option. 

The average investor (let’s assume trading at Robinhood) may look at volatility or use it as a guide, but most certainly, they are not trading the Greeks and continuously removing all directional risk.

In fact, the retail investor is predominantly a Directional Leverage Trader.

Volatility Traders vs. Directional Leverage Traders 

Let’s assume Robinhood has 1 million customers trading options. This is a conservative assumption. If I divide the 1,200 Volatility Traders estimated above by 1,000,000 Robinhood traders, we get 0.12%.

Volatility Traders vs. Directional Leverage Traders

This closely matches our estimate. 

It also shows that >99% of options users are Directional Leverage Traders. 

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