ETF War Games

“Study the science of art. Study the art of science. Develop your senses – especially learn how to see. Realize that everything connects to everything else.” – Leonardo da Vinci

Market making in individual stocks has become so competitive that most hyperactive strategies – the ones that reside in Alphacution’s structural alpha zone – have turned to increasingly rely on some form of ETF arbitrage. This competitive dynamic is exacerbated by factors such as liquidity fragmentation, liquidity internalization, payments for order flow (PFOF), and the winner-take-all impacts of process automation (aka – scaling via technology).

For those proprietary trading firms with few, if any, options positions in their portfolio, cash ETF position concentrations (based on total 13F position counts) are represented as follows:

When we isolate the leading order flow wholesalers and consider aggregate cash ETF positions as a percentage of 13F gross value, one of the clues that rises to the surface (in concert with the findings in the prior chart) is the prominence G1 Execution Services (G1X), a unit of legendary derivatives powerhouse, Susquehanna International Group (SIG), in the ETF market:

Together, these charts show that, as of Q2 2020, G1X holds 51.1% of its 13F positions and 53.5% of its 13F gross value in cash ETFs; a relative position that is occasionally rivaled by Two Sigma Securities (TSS) and Virtu Financial.

With these prior visuals as setup, consider that the SPDR S&P 500 ETF (SPY) is often the largest 13F position – or, among the largest 13F positions – of all but a few market makers and hyperactive prop firms. For most, this relative positioning (which is often expressed in options, as well) serves as an exogenous portfolio hedge. For a few, it’s an endogenous component of the portfolio.

For Q1 2020, G1X’s second largest 13F position is SPY. For Q2 2020, G1X’s 13F filing shows no position in SPY; meaning, they were likely short. In either case, and given G1X’s clear strategic focus on ETFs, one might expect the individual components of the S&P 500 – particularly if cherry-picked via PFOF – to be extremely important…

Now, the elevated transparency provided by the new 606 reports has yielded a summer of explosive insights, as you can see littered throughout the Alphacution Feed since June. And yet, there is still much more cleverness going on below the surface of these data than we – or any other analysts – have been able to expose yet.

Despite its new level of detail, the 606 reporting is like a summary of activity – with additional layers of slicing and dicing occurring below that summary level. However, given the bucketing of S&P 500 stocks and a ranking of average order flow rates paid by wholesalers (over the 6-month period, January thru June 2020), we just might get a glimpse of something new:

Why is G1X paying so much more to Robinhood for S&P500 component orders than any other market maker pays to Robinhood – or any other retail broker?

Moreover, if S&P500 components typically trade at penny spreads, how does G1X expect to make any money paying a penny (or more) per share for flow?

Some hints: 1) To date, Robinhood appears to be the only retailer accepting PFOF based on a percentage of spread (as opposed to fixed rate), 2) spreads were wider in Q1 (especially March) than Q2 – so the idea of penny spreads may not apply at all times, 3) G1X may be bidding aggressively for a subset of S&P500 stocks, and 4) G1X is an affiliate of SIG; therefore, it need not always be profitable on a standalone basis for SIG to be profitable in aggregate.

Until next time…

By | 2020-09-04T00:53:23-04:00 September 2nd, 2020|Alphacution Feed|

About the Author:

Paul Rowady is the Director of Research for Alphacution Research Conservatory, a research and strategic advisory platform uniquely focused on modeling and benchmarking the impacts of technology on global financial markets and the businesses of trading, asset management and banking. He is a 30-year veteran of the proprietary, quantitative and derivatives trading arenas. Contact:; Follow: @alphacution.