Q2 PFOF Craziness: Robinhood Becomes Parody of E*Trade Commercial, Competes with TikTok for Attention…

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises, economist

Someday, sufficiently far into the future, when we have somehow broken free of the illusion, we are going to look back on this chapter in world history and wonder how we had entered into such a collective state of insanity in parallel with such profound technological advancement…

The Fed has all but said that it will prevent markets from declining (and plug whatever economic holes it needs to plug and lubricate whatever financial gears it needs to lubricate), no matter how much money it needs to print, debts and deficits be damned. This is not a characteristic of free markets, nor is it a feature of a capitalist system…

And so, as if gleefully hurling itself from a trampoline without a care in the world, US stock markets have resumed their drunken bacchanal, thereby successfully ignoring the fact that we are actually mired in a germ-infested pit of foam balls at an adult version of Chuck E. Cheese that is still somehow under review for a Michelin star…

Today, as only one of many symbols of this mind-twisting largesse, Dan Gilbert’s Detroit-based Rocket Mortgage – an affiliate of his Quicken Loan empire – raised $1.8 billion in a trimmed down IPO for a firm shamelessly touting “one-click mortgages” as if the global financial crisis (GFC) had never EVER happened. I’m sure you have a favorite example. They’re not hard to find these days…

In the movie adaptation of this chapter in history, I am imagining a pivotal scene reminiscent of the Mission Impossible franchise where the Russell Crowe version of the do-gooder Robinhood peels his face off to reveal Gordon Gecko, except as played by Jack Nicholson…

Anyway, with this imagery as backdrop for our setup, let’s take a first look at the Rule 606 reporting for Q2 2020 – in the context of H1 2020 – that has recently been disclosed by one of the hottest stories in the universe right now, Robinhood Securities, LLC:

Foreshadowing that Robinhood’s Q2 order routing revenue grew by more than 98% on a quarter-over-quarter basis from $90.9 million to $180.3 million, the monthly chart formats below imply that while March volatility plus the initial pandemic lockdown may have been the early 2020 catalysts for a dramatic uptick in trading on the Robinhood platform, it appears that persistent lockdowns and news of Robinhood’s growth after the Q1 606 reports in early June played a much larger role in continued growth than market volatility.

Here, the ranking of profitable product categories – options (63.0% of H1 total) followed by non-S&P500 securities (32.5%) followed by S&P500 securities (4.5%) – persisted throughout the first six months of 2020.

The breakdown of order routing revenue by order type continued – with emphasis on marketable and non-marketable limit orders, as Alphacution first illustrated here in our Feed post on trailing stop loss orders – throughout Q2, with one fascinating exception… (Bookmark that thought.)

And, the roster and ranking of broker dealers making payments for Robinhood’s order flow remained relatively consistent throughout Q2, with some notable exceptions including the emergence of Morgan Stanley & Co., LLC (MSCO) in late May and June (in the options category only).

When we put it all together for Q1, Q2 and H1-2020, we see that the first half of 2020 represented $271.2 million in order routing revenue, 63.1% of which ($171.0 million) came from options trading, 43.2% of which ($117.1 million) came from non-marketable limit orders (which Alphacution believes to be largely synonymous with various types of stop loss orders), and 46.5% of which ($126.2 million) came from order flow payments made by Citadel Securities:

Once we process and aggregate the Q2 606 data for the other retail players as initially showcased in the Feed post “From Citadel Securities to Tastyworks: The New Economics of Liquidity, Part I,” there will be more signals to interpret about the structure of markets, the ecosystem of market participants, and the dramatic pace of change ever since retail investors got stoned on a commission-free trading beginning in November 2019…

For now, let’s return to that bookmark from above: One of the new and strange clues from Robinhood’s Q2 606 report comes from the “other order type” category; a bucket that we interpret to be like the kitchen sink category that includes all order types that are not considered to be common or “vanilla.” In order words, this may be an exotic order type bucket; even more so than trailing stop loss limit orders…

Now, what’s strange about this bucket is that it’s mainly relevant to trading in non-S&P500 securities:

And, potentially stranger than that is the fact that Citadel Securities and Virtu Americas, a unit of Virtu Financial, jointly represent 94.6% of the order flow payments in this category for H1 2020, which may not seem so strange when you consider that the other brokers – TSS, G1X, and WEX – are option specialists. We would not expect option specialists to be fluent in exotic cash equity order types:

However, in order to understand the strangeness of this detail, consider that Robinhood is supporting an order type that only two of its short list of five preferred order routing destinations can handle (not including the emerging MSCO relationship). Moreover, while this “kitchen sink” order type category for non-S&P500 securities represents only 12.7% of Citadel Securities’ PFOF to Robinhood for H1 2020, it represents a rather substantial 42.6% of PFOF from Virtu…

Why does this off-the-run category seem to match up so well with Virtu?

Until next time…

By | 2020-08-07T00:38:44-04:00 August 6th, 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: feedback@alphacution.com; Follow: @alphacution.