“It is action, not rest, that constitutes our pleasure.” – John Adams
Amidst the doom and uncertainty of any unfolding saga, there are always bright spots, if you know where to look. After all, every problem can be an opportunity in disguise. And so, besides the uptick in all things online relative to most things not online during a pandemic lockdown, the expectation has been that there would be some bright spots for listed market first responders – the market makers and high-turnover arbitrageurs – given the unprecedented volatility that erupted in global markets in late February. This week, Alphacution has begun to confirm some of those expectations as critical data necessary to fill in the picture of what actually happened below the unprecedented volatility headlines began flowing…
To create the proper gravity of perspective, let’s start with average daily volume (ADV) in US cash equity markets for March arriving at more than 15.6 billion shares. This is an all-time high and a level not even remotely approximated since the height of the Global Financial Crisis (GFC) in 2009 when ADV peaked at 9.8 billion shares. Based on a time series of market ADV from 2008 to the present, March 2020 volume was a nearly 10-sigma event on average ADV of about 7 billion shares. The chart below is a picture of what that kind of move looks like; a parallel representation of US cash equity, equity option and volatility markets for the 75 months beginning January 2014 and ending March 2020:
Now, while we have heard from many of the bank-owned market makers about the outsized profitability of their cash equity and option trading desks during March via Q1 earnings releases, the fortunes of proprietary market makers and high-speed traders has been much more anecdotal. That is until April 21 when one of only two remaining public high-speed trading firms – the Amsterdam-based ETP (exchange-traded product) group, Flow Traders NV (FT) – reported their Q1 2020 performance.
Here’s a first look at what “unprecedented” really means in this context:
Based on 25 quarters of disclosed performance beginning Q1 2014, Flow Traders reported Q1 net trading income (NTI) of $545.7 million for Q1 2020. Now, this is a nice number, but for most of us it means next to nothing until we add the modifier that it is a nearly 11-sigma print based on the performance of the prior 24 quarters…
Of course, no one has done more for the significance of the number “11” than the legendary English heavy metal band, Spinal Tap, but 11-sigma is in an entirely different category of superlative. In a business marked by intense and increasing competitive pressures, Q1 was more like a straight of winning lottery tickets spit out of the world’s stingiest slot machine. For instance, FT’s Q1 NTI for one quarter is equivalent to 20% of the NTI for the prior 10 years (see below) – and, in the process, making the “Volpocalypse” of Q1 2018 look like a foothill…
Needless to say, as a stand-alone, this is a fortuitous event. Being in the right place at the right time with the right tools never quite sounded so good. However, in a world where everything is interconnected and therefore each new piece of information is yet another foreshadowing canary, there is much more to be learned from these few new pieces of data below the surface.
Here’s a fusillade of figures to support that point: The European NTI ($336.1 million) is based on European ETP market share for the quarter of 34.3% (25-quarter average = 40.2%). Meaning, FT traded 34.3% of the total European ETP market value traded during the quarter, where the European ETP market was 5.5% of the global ETP value traded (based on 47.1% of global ETP listings). By contrast, FT’s Americas NTI ($149.0 million) is based on Americas ETP market share of only 2.0% (25-quarter average = 1.8%), where the US was 86% of the global ETP market on value traded (based on 36.5% of the global ETP listings). Not to be left out, APAC NTI ($45.2 million) is based on FT’s 2.4% market share of a regional ETP market that represents 9.6% of global value traded (based on 16.4% of global ETP listings).
Meanwhile, revenue capture analytics (based on NTI for value traded) illustrate a somewhat different story: For Americas NTI in Q1 2020, revenue capture is less than half that of the previous spike in Q1 2018 (or 7.9 bps vs. 16.6 bps) with a longer-term backdrop of steadily declining capture. In Q4 2019, Americas revenue capture was an all-time low 0.5 bps. That picture, along with Europe and Asia revenue capture history, is below:
These views beneath the surface suggest vastly different competitive dynamics and vastly different revenue potentials between the regional ETP markets. And, it’s these clues on competitive dynamics and revenue (estimation) potential, that make FT’s latest release so much more valuable to us than it would otherwise be by itself.
For example, on May 7, Virtu Financial is scheduled to report Q1 2020 earnings. Preliminary Q1 guidance from the company is NTI of $489 – 497 million. This would be a strong quarter on NTI for sure, but barely a 1-sigma print based on the historical recreation of a combined Virtu-KCG-ITG. In relation to FT, that NTI result range would also put Virtu in a similar revenue capture rate range of ~8 bps (based on the similar relationship between the Q1 2020 figures and the Q1 2018 figures for both firms):
Lastly, and more generally, it is clues like these that bring us incrementally closer to improving our estimation of trading revenue for the likes of Citadel Securities, SIG/Gx1, Two Sigma Securities, Jane Street and many others…
Until next time, stay safe out there…
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