by Editorial Team, AdvisorAnalyst
For years, the investing world has treated retail options traders as the mark at the poker table. Small accounts. Overconfident. Buying lottery-ticket call options that expire worthless. Losing money on average. The academic research mostly agreed: retail options flow is noise, and smart money should ignore it.
A new research paper by researcher Zijun Liu, Master of Financial Management, at Australian National University says: not so fast.
What the Researcher Did
Liu looked at a large dataset of retail options trades from November 2019 through June 2021 — a period that includes the COVID crash, the Robinhood boom, and the meme-stock frenzy. Using a well-established method for identifying which trades came from retail investors, he built a simple daily signal: on any given day, which stocks are retail investors buying call options on the most?
He then asked: if you bought the stocks with the heaviest retail call buying yesterday, and shorted the stocks with the least, how would you do?
The answer was surprisingly good.
The Core Finding
That simple strategy earned +25.75 basis points per day — roughly a quarter of a percent, every single trading day, on average. Over a full year, that compounds into a very significant return. The Sharpe ratio — a standard measure of return per unit of risk — came in at 1.76 annually. For context, a Sharpe ratio above 1.0 is considered strong. Above 1.5 is exceptional.
More importantly, this wasn't just luck or a fluke from a crazy market period. The result held up under every stress test Liu applied.
"But Isn't This Just Because the Market Went Up?"
This is the first question any serious investor asks. Maybe the strategy just loaded up on high-beta, momentum-chasing stocks during a bull run.
Liu checked. He ran the returns against all the standard academic risk models — the Fama-French factors that account for market exposure, company size, value, profitability, and momentum. After accounting for all of those, the strategy still earned +26.82 basis points per day. The risk models explained essentially nothing.
In fact, the strategy had a negative relationship to the overall market — meaning it actually held up better when markets fell. It also ran against momentum, meaning it wasn't simply chasing stocks that had already gone up. As Liu noted, a strategy that beats the market, hedges downturns, and runs counter to momentum is genuinely unusual.
The Interesting Pattern: A Two-Day Peak
Here's where it gets nuanced. The gains from this signal don't just keep compounding indefinitely. Liu tracked what happened at different holding periods:
- Day 1: +20 bps
- Day 2: +62 bps (the peak)
- Day 3: +54 bps
- Day 5: +52 bps
- Day 10: +49 bps
The return peaks on day two, then slowly fades — but never fully disappears. This pattern tells a story: retail call buying pushes a stock's price a little too far, and then the market slowly corrects it back toward fair value. Not all the way back — but partway.
Think of it like a crowd rushing into a restaurant because it got a great review. Prices on the menu go up a bit due to demand, then settle back down once the buzz fades.
So Why Does This Happen?
Liu considers three explanations:
Theory 1 — Market mechanics. When retail investors buy call options, the dealers who sell those options have to buy the underlying stock to hedge their exposure. That buying pressure moves the stock price. But this should reverse quickly as the options expire. The pattern Liu found reverses too slowly for this to be the full story.
Theory 2 — Retail investors actually know something. Maybe some retail traders have real insights and express them through options because options offer more leverage for the same dollar. But if this were true, the gains should keep drifting higher as the information gets priced in — not fade after day two.
Theory 3 — Attention and lottery behavior. This is the explanation that fits best. Retail investors pile into call options on exciting, high-attention stocks — treating them like lottery tickets. That buying pressure temporarily inflates the stock price. Eventually, the more sophisticated investors push the price back toward reality. The two-day peak followed by a slow fade is exactly what you'd expect from this mechanism.
It Wasn't Just GameStop
A reasonable worry is that these results were driven entirely by meme stocks — GME, AMC, and their cousins. Liu removed fourteen of the most prominent meme tickers from the analysis. The signal barely budged — the statistical strength dropped by only 18%. The effect is broad and real, not a GME artifact.
The results also held up outside the peak Robinhood boom period. In fact, the signal was stronger in the periods surrounding the boom than during it.
What This Means for Advisors and Investors
1. The options market is a sentiment gauge. When retail investors are aggressively buying calls on a stock, that stock tends to outperform over the next day or two — not because retail is always right, but because their collective buying pressure moves prices. Ignoring that signal entirely may mean leaving information on the table.
2. The edge is short-lived. The signal peaks at two days and fades. This is not a buy-and-hold insight. It's relevant for short-term positioning, risk management around high-attention names, and understanding when a stock's recent move might be driven by retail options flow rather than fundamentals.
3. Retail flow is not pure noise. The old assumption — that retail options traders are just losing money and creating static — is too simple. Collectively, their activity moves markets in predictable ways, even if the individual trades are often losing bets.
4. Watch for the 0DTE era findings. Liu's data ends before the explosion of zero-day-to-expiry options that now dominate options market volume. His next step is testing whether the signal gets even stronger in that environment. If it does, the implications for short-term return forecasting grow considerably.
The bottom line: retail options traders aren't smart money. But they're not invisible either. When they pile into calls on a stock, something real happens to that stock's price in the next 48 hours — and understanding that dynamic is now a legitimate part of the toolkit.
Footnote:
1 Liu, Zijun, Retail Option Imbalance and the Cross-Section of Stock Returns (May 17, 2026). Available at SSRN: https://ssrn.com/abstract=6781743 or http://dx.doi.org/10.2139/ssrn.6781743
