It was a recent father-son (and dog) road trip. Several hours in the car, on our way to support daughter / sister, Emma, at her final regatta of the season. Head of the Hooch in Chattanooga, Tennessee. And, an opportunity for some undistracted conversation.
Among the many topics was our ongoing debate about how to trade Tesla (TSLA). Eddie has proven himself to be fairly decent scalper of this volatile name, so I usually ask how he is positioned and the levels he thinks are meaningful.
Anyway, it turns out, he is trading on the Robinhood platform – no more than a few shares at a time – and paying zero commissions which, of course, improves his net profitability. This is the main attraction on top of the fact that he can toggle between trading stocks, playing video games, watching YouTube, Instagramming with his friends and listening to music all on the same device. (No wonder he is always wiped out!)
So, this got me to thinking about some of the recent disclosures about how a big portion of Robinhood’s revenues are derived from payments for order flow (PFOF), how valuable the order flow of all the novice “Eddie’s” of the world is likely to be to brokers who make these payments, and also how it was reported back in June that the popularity of the mobile app group had passed E*TRADE in total accounts (4 million) over the past year.
Here’s some numbers and pictures representing what we have assembled so far:
Based our modeling of available data, Alphacution estimates aggregate PFOF – sometimes known as order flow revenue or order routing revenue – for the 5 years ending 2017 as follows. Needless to say, $605 million for 2017 is a sizable pie.
As for our Robinhood order flow revenue estimate, it is based on disclosed receivables from executing brokers (aka – order routing payments) in SEC Form X-17A-5 which includes balance sheet data. Leveraging and annualizing those few data points we could get our mitts on yielded the following, which is small in relation to the whole pie above – and likely to remain relatively small because Robinhood’s demographic of coveted (because they are the least price sensitive, but highest cost sensitive) millennials and other “Eddie’s” are not likely to ever trade all that much in this format:
Beyond this, it occurred to us to turn the tables and look at where all this dough is coming from. Problem is, the sources of the slices of this pie are quite opaque. For now, all we can easily observe has been disclosed by KCG which, for the past year, has been absorbed by Virtu.
In the charts below, Alphacution presents order flow payments for the 5 years ending 2017 plus an annualized estimate of what has already been disclosed by Virtu for the first 9 months of 2018. A quarterly chart that follows this demonstrates 1) when KCG ramped up its PFOF activities (but likely corresponds with the timing of the original GETCO-Knight Capital merger), and 2) that PFOF levels are not cyclical but – like most everything else in this zone of our map – dependent on volatility.
Lastly, here is where we can demonstrate that KCG / Virtu payments represent 9.4% of total estimated PFOF revenue for 2017 of $605 million – and less if we count Fidelity. This means that there are several other players making 90+% of the aggregate payments for order flow.
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