Robinhood, Infinite Margin and Lacking in Wisdom

Nov 6
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Robinhood is facing another snag with its service as users on Reddit share ways to manipulate the app to receive exceeding large margin accounts using exploits.  Disclaimer: I am not advising you to engage in this behavior, there are major risks to engaging in this behavior, and this loophole is being described here for news purposes only, do not attempt to try the glitch I am going to describe, it is stupid and a bad idea.  So on to the details, this started a few days ago on a Reddit where users described a “cheat” to the Robinhood trading app that allows users to gain nearly “infinite leverage” with one user claiming to have $1 million in leverage on a deposit of only $4,000. They accomplished this by engaging in options trading. It looks something like this:

You would deposit $2,000 into a Robinhood account.

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The company in its infinite wisdom™ would “loan” you $2,000.

Now you would think there would be some sort of checks on the company’s part to ensure you are good for the loan, but in reality, all you need to do is answer a short series of questions to create an investment profile.  

Now in effect, you have $4,000 or 2:1 leverage.

You would buy $4,000 worth of stock.

Then you would sell call options against that stock, in this example let’s say you sold your calls for $3,900.  When the call was exercised you would receive the remaining $100. 

Robinhood, Infinite Margin and Lacking in Wisdom

So now you still technically own the stock but you have promised to sell it to another person.

Now your account looks like it has a cash balance of $3,900, and you have $4,000 in stock. 

So now Robinhood thinks you have a cash balance of $3,900 and decides to double up your margin again so now you can purchase $7,800 of stock and do the same thing. 

You would basically repeat this process over and over again to exponentially increase your margin.

Now the interesting thing is that, in general, you should not be allowed to do this, and while I am not a lawyer, Robinhood might be at fault for allowing you to do this.  The government has in place laws stating that the brokerage is supposed to account for any options in calculating the amount of margin they loan you.  Since then app not doing this, there will be some decidedly murky legal territory since, for the most part, the Government assumes that retail investors are incompetent, do not know what they are doing, and have created rules to try to prevent just this sort of activity. So the question is, does Robinhood have a duty to stop people from engaging in stupid behavior? The government says yes. The other side of the argument might be that people engaging in this behavior are doing so intentionally and maybe on the hook criminally as well. 

So again, I suggest you do not try this at home, this is not investing, you may be opening yourself up to not only ruining your financial future but you may possibly engaging in criminal activity and you could end up losing over $50,000 in a single day like happened to a particular Reddit user who purchased options expiring the next day hoping Apple shares would drop after their earnings call. This would be considered, "a very bad thing".  Save yourself the trouble of being in the train wreck and just read about it on the r/wallstreetbets instead.

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