While I am not 100% opposed to new regulation on these complex products, I do want to caution that this could cause unintended consequences. For example, if I could not access leverage through options or through leveraged ETP's, both of my brokers currently charge me 8% or more on margin interest.
How does this help me to pay over 7% more than the Fed Funds rate? It helps and protects only my brokers. I know Black Scholes Merton, and you input the risk free rate there and not the risk free rate plus 7%, so it is far cheaper for me to borrow with options. For example, for securities with decent liquidity, I could buy a call and sell a put at the same strike and expiration date, which is a synthetic long without any gamma, vega, theta, or rho exposure and thus borrow for far closer to the risk free rate, because options commissions and the bid ask spread are much smaller now than ever before. Similarly, leveraged ETP's can borrow far cheaper than 8% right now.
Other people might choose to access "leverage" through more speculative assets, such as increasing their exposure to crypto or SPACs. Crypto and most SPACs have no earnings, no sales (for most SPACs), they are both filled with scammers at worst, and probably wildly overpriced at best, so how does this help unsophisticated retail investors and traders?
I bought call options on VXX, a volatility ETP, in the spring of 2020 and did very well. It was options, based on an ETN, based on VIX futures, based on the complex calculation of the VIX index, which is in turn based on a variety of S&P options, based off of a stock index. It is all so dazzlingly complex, so I fear you might ban me doing this in the future, but it gave me and others the ability to hedge or speculate with a defined risk and it just worked, as advertised, in a rapidly falling market.
It's not supposed to make money in flat or rising markets. I have lost money in VXX too at other times and that's okay. Even if the next time I might lose more money, I would be able to hedge my risk, and that's a very good thing. I don't understand why possibly taking away my ability to hedge or speculate with defined risk could make things safer for me? (Yes I am aware of the current VXX problem with creating too many shares.)
I know the formula for calculating "volatility drag" or "leverage decay" with leveraged ETP's. I am okay with paying this, at certain times, because it provides me with positive convexity and positive skew, like with buying options. With options, you pay theta instead of volatility drag. Positive skew reduces my risk too I might add. And all leveraged or inverse ETP's have positive skew and convexity.
If you must add new regulations, I would prefer that you had some sort of additional disclosure or a test which I could pass instead of arbitrary rules based on net worth or similar. If you must ban something, ban crypto ETP's. But please don't because it has an attractively large correlation to the market, and shorting them will give me a nice hedge.
Thank you kindly for reading my long comment and thank you for caring about us small retail investors and traders!
Nathan Kos Comment On Regulatory Notice 22-08
While I am not 100% opposed to new regulation on these complex products, I do want to caution that this could cause unintended consequences. For example, if I could not access leverage through options or through leveraged ETP's, both of my brokers currently charge me 8% or more on margin interest.
How does this help me to pay over 7% more than the Fed Funds rate? It helps and protects only my brokers. I know Black Scholes Merton, and you input the risk free rate there and not the risk free rate plus 7%, so it is far cheaper for me to borrow with options. For example, for securities with decent liquidity, I could buy a call and sell a put at the same strike and expiration date, which is a synthetic long without any gamma, vega, theta, or rho exposure and thus borrow for far closer to the risk free rate, because options commissions and the bid ask spread are much smaller now than ever before. Similarly, leveraged ETP's can borrow far cheaper than 8% right now.
Other people might choose to access "leverage" through more speculative assets, such as increasing their exposure to crypto or SPACs. Crypto and most SPACs have no earnings, no sales (for most SPACs), they are both filled with scammers at worst, and probably wildly overpriced at best, so how does this help unsophisticated retail investors and traders?
I bought call options on VXX, a volatility ETP, in the spring of 2020 and did very well. It was options, based on an ETN, based on VIX futures, based on the complex calculation of the VIX index, which is in turn based on a variety of S&P options, based off of a stock index. It is all so dazzlingly complex, so I fear you might ban me doing this in the future, but it gave me and others the ability to hedge or speculate with a defined risk and it just worked, as advertised, in a rapidly falling market.
It's not supposed to make money in flat or rising markets. I have lost money in VXX too at other times and that's okay. Even if the next time I might lose more money, I would be able to hedge my risk, and that's a very good thing. I don't understand why possibly taking away my ability to hedge or speculate with defined risk could make things safer for me? (Yes I am aware of the current VXX problem with creating too many shares.)
I know the formula for calculating "volatility drag" or "leverage decay" with leveraged ETP's. I am okay with paying this, at certain times, because it provides me with positive convexity and positive skew, like with buying options. With options, you pay theta instead of volatility drag. Positive skew reduces my risk too I might add. And all leveraged or inverse ETP's have positive skew and convexity.
If you must add new regulations, I would prefer that you had some sort of additional disclosure or a test which I could pass instead of arbitrary rules based on net worth or similar. If you must ban something, ban crypto ETP's. But please don't because it has an attractively large correlation to the market, and shorting them will give me a nice hedge.
Thank you kindly for reading my long comment and thank you for caring about us small retail investors and traders!