Do Individual Investors Consciously Speculate on Reversals? Evidence from Leveraged Warrant Trading

We show that the design of speculative retail products strongly influences the aggregate exposure of retail investors. Using proprietary data on bank-issued knock-out warrants, we find that individual investors trading these warrants, on aggregate, speculate against the short-term trend of the underlying (they are contrarians). Our results indicate that contrarian trading is largely driven by product design: after declines in the underlying the leverage of call warrants increases relative to the leverage of put warrants, implying that if investors neglect leverage when allocating funds, their aggregate order flow becomes contrarian. Additionally, the effects of product design are amplified by individuals' selling decisions, that is, individuals are more likely to sell recently appreciated warrants back to the issuer bank compared to the recently depreciated ones, which finding is consistent with the disposition effect