Soros, Icahn, Buffet, Lynch. What do all of these investors have in common? They all consistently dominated the market index in their era, producing unheard-of levels of alpha. Over time, finding opportunities to generate excess returns from the market average has become harder and harder. Nowadays, more complex and innovative strategies are needed to make a little money, and this is what we are going to explore today.
We’re breaking down how one of the UK’s biggest banks, Barclays, developed one of the most interesting, data-driven trading strategies out there, one that’s been quietly outperforming the market during chaotic, retail-driven times.
Spotting the Signal in Retail Noise
Successful trading strategies in the modern day always revolve around one of two things: either trading approaches are based on taking advantage of profiting off of market inefficiencies, or a whole lot of dumb luck. For massive institutions, with large amounts of capital and corporate and legal responsibilities, they cannot continually rely on dumb luck to make money, so they employ specialised teams of stock market geniuses to come up with new ideas and trading algorithms to beat the market instead (yeah boring I know…). So this is what Barclays did, and the trading activity that they got up to during the COVID-19 pandemic lockdown period was rather interesting.
First, traders realised that the volume of trades on stock option derivatives had increased 3x on a year-on-year basis, mainly on short-term options on large-cap tech stocks. In layman’s terms, Barclays noticed how many ‘irrational’ new investors were entering the market, likely on the back of social media trends such as the GameStop frenzy and YOLO-ing stimulus packages into Tesla calls. With increases in trading volume being far more significant than the increase in open interest, Barclays concluded that these were speculative trades, not ones based on sound reason.
Barclays, with this newfound knowledge, found two very interesting ways of using irrational retail trades to their advantage…
Profiting From Overpriced Options
So, options are priced partly based on the market’s anticipated implied volatility, which is a forward-looking prediction of how much an underlying asset’s price might swing during the period of the option. The higher an option’s implied volatility, the more expensive it becomes.
Here’s where things get interesting, Barclays realised that the volatility risk premium, the difference between implied volatility and realised volatility, was decreasing on some stocks. This graph shows that investors typically tend to predict that volatility will be higher than what it actually is, which would make a stock ‘expensive’. If the trading team could successfully find expensive stocks and cheap stocks (stocks with low risk premiums), then an interesting arbitrage opportunity could arise.
Another interesting factor happens when lots of retail investors are hoping on the same new investing frenzy. When the latest TikTok user hops on a trend out of FOMO, they buy an option to leverage themselves, the market maker who sold them the option needs to keep a neutral position, so he buys shares of that underlying security, let’s say Tesla stocks (For no apparent reason whatsoever…). By buying Tesla shares, the market maker drives the price up, and the retail investor sees a profit, so they buy more options, causing the market maker to take a neutral position again and buy more Tesla stocks, again driving up the price… I’m sure you can see the subsequent pattern. This trend is pushing up the implied volatility of stocks and increasing the risk premiums on them, making them ‘expensive’.
This is where Barclays’ new trading strategy is being derived from. They decided to sell straddle options. You would typically buy a straddle if you thought there were going to be large shifts in a stock’s price, regardless of direction. Barclays, which is selling these straddles, is betting that there will not be large, volatile jumps in the market. At this point, you may think that this makes no sense, but that is where the brilliance of this strategy comes into play. Barclays concludes that this overinflation of stock volatility cannot go on forever, and so is essentially betting that it will decrease to a sector average. Essentially, Barclays bank has made money by selling retail investors overpriced options.
The Call Spread Spray
Barclays’ second move was a little more optimistic. The bank saw opportunity in “Resilient” tech stocks, which had strong fundamentals but were trading at very high valuations. Instead of buying the stock outright (which exposes you to all the downside), they chose a safer, smarter route: the long call spread.
So, what’s a long call spread? It’s when you buy a call option at a lower strike price and sell a call at a higher strike price. You’re betting the stock will go up, but not infinitely, just enough to sit somewhere between those strike prices.
This setup lets Barclays profit from upside potential while limiting the cost of the trade and the losses if it goes wrong. Why is this clever? Because during this retail-driven frenzy, implied volatility was already pretty high. So outright options were expensive. By pairing the call with a sold one, Barclays lowered the cost and reduced exposure to volatility.
Think of it as a ‘premium institutional’ way to YOLO, except Barclays does it with spreadsheets, not Reddit.
Risks and Realities: Why Execution Matters
Before we all go rushing off to sell straddles and call ourselves market geniuses, it’s important to add a reality check. The first Barclays strategy, selling straddles to profit from overpriced implied volatility, may sound smart on paper, but it’s not without serious risk.
This kind of strategy relies on the assumption that volatility will stay low or mean-revert. But as financial history has shown us, such as the Barings Bank collapse of 1995, selling options without plenty of hedging can be catastrophic. If volatility spikes unexpectedly, losses can grow quickly.
While the Barclays team likely managed their risk through dynamic hedging or position limits, it’s a reminder that execution matters just as much as strategy. Selling volatility isn’t a set-it-and-forget-it approach, it’s an active position that needs constant monitoring.
On the flip side, the long call spread strategy is much less risky because you’re buying and selling options. This limits risk, but also caps reward.
The lesson? Even the smartest strategies require strong guardrails
Key Takeaways From Barclays Trading Desk
While you might not be managing billions or sitting on an options desk, there’s a lot to take away here:
- First, retail flow matters. It’s no longer just background noise. Understanding where it’s going and why retail investors are making trades can be the basis of real trading strategies.
- Second, a smart position will always beat irrational bets. Barclays didn’t take risky positions. They used spreads and straddles to express views with asymmetric risk-reward.
- And finally, knowledge is power. The entire strategy came from noticing a shift in volume patterns and understanding what it meant. That kind of thinking is what sets good investors apart from lucky ones.
