E Opportunities In A Volatile Market: Virtu Financial And High-Frequency Trading

Chart showing High-Frequency Trading Revenue from 2009-2017. Industry revenues have fallen along with volumes and volatility.

High-frequency trading firms have been some of the biggest losers during the tranquil market period of the last few years. In 2009 industry revenue, according to consultancy Tabb Group, was $7.2 billion, in 2017 total revenue for the industry fell below $1 billion. This corresponded to a steady fall in trading volumes in the U.S. According to the Wall Street Journal Market Data Group, 8.31 billion shares a day were traded in 2010, by 2017 that number had fallen to 6.43 billion. Similarly, market volatility as is measured by the CBOE volatility index (VIX) continued to average lower and lower levels. According to Harvest Volatility Management, the VIX had an average level of 16.68 in 2015. It averaged 15.85 and 11.1 in 2016 and 2017 respectively. For reference, the average level of the VIX since 1995 is estimated to be between 18-21. In fact, 2017 showed the calmest market conditions in decades. The absolute daily percentage change for the DOW in 2017 was 0.31% while for the S&P 500 it was 0.30%, those were the smallest daily percentage changes since 1964. At the same time monthly market volatility was lower than any point since 1970. This caused a significant headache for short term traders like high-frequency firms, which suffered from fewer opportunities to trade due to falling volumes. As well as shrinking profits per trade due to low volatility. These factors coupled with increasing data costs and competition put the industry under pressure.

However, with all that being said, historical trends show that it is very likely that the market environment of the last several years was an anomaly. In 2018 volatility returned with a vengeance. The VIX soared 157% last year, as fears grew about slowing global economic growth, an ongoing trade war, and rising interest rates. Intra-day swings for the S&P 500 averaged 1.2% in 2018 and the higher volatility increased trading volumes by 11% to 7.2 billion shares daily. This change in conditions gave life to the suffering high-frequency trading industry and as expectations of an upcoming recession intensify along with political headwinds it appears as though the volatile conditions are here to stay. 

Chart of CBOE VIX index from 1990-2018. Volatility has been steadily falling since the Great Recession but has soared recently. Long term average level for the index is 21. 

Most companies in the high-frequency trading space are private, making it nearly impossible to get a detailed glimpse into the finances of the industry or benefit from its good fortune. Thankfully, one of the largest players in the space is public and gives investors a good opportunity to benefit from the high-frequency trading comeback. That company is Virtu Financial (VIRT). 

Virtu Financial is a high-frequency trading firm with a current market cap of $4.9 billion that trades in over 25,000 different securities at over 235 venues in 36 countries. As the only public high-frequency trading firm (whose IPO was nearly derailed by the publication of Michael Lewis’s book “Flash Boys”), the company has become a poster child for the industry. Indeed the company offers investors a rare glimpse into the fortunes of this once secretive sect of the financial services sector. Unsurprisingly, those fortunes have not been great in the pre-2018 market environment. From its IPO in July 2015 to the beginning of 2018 Virtu stock fell 21% while the broader market rallied nearly 30%. Over that period of time adjusted EBITDA fell from $352.4 million in 2015 to $251.4 million in 2017. Net income, meanwhile, fell from $272.8 million to $92.1 million. This is against a 25% rise in revenue, about $800 million in 2015 to just over $1 billion in 2017. Even this was not a result of actual business growth but rather an effect of Virtu’s merger with, fellow hhigh-frequencytrading pioneer, KCG Holdings.

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Disclaimer: This material has been distributed for informational purposes only and is the opinion of the author, it should not be considered as investment advice.

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Howie Sandberg 5 months ago Member's comment

Fascinating, thanks for bringing this area to my attention.