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

Overall those are hardly impressive statistics, but the turnaround in Virtu’s results as volatility returned to the market, show how the company could provide a hedge against rising volatility. In the first 3 quarters of 2018, Virtu showed $1.44 billion in revenue compared to about $563 million in 2017. Based on Virtu Financials preliminary 4thquarter 2018 results, total adjusted EBITDA for 2018 was just over $600 million, compared to $251.4 million in 2017, an increase of about 130%. Total adjusted net-income in 2017 was $92.1 million while in 2018 it is estimated to end up being $346.6 million. As a result ,Virtu stock soared 47% in 2018, what a difference a change in volatility makes. 

However, despite this surge in stock price, Virtu financial is still valued at a similar multiple that it has been in previous years. Presently with a market cap of $4.9 billion, the stock is priced at about 8x its trailing twelve month (TTM) adjusted EBITDA  and 14x TTM normalized adjusted net income. In January 2018, Virtu had a market cap of $3.5 billion, meaning the stock was valued at about 14x TTM adjusted EBITDA and 38x TTM adjusted net income. At the same point in 2017, the stock was valued at 8.32x and 16.4x respectively. In 2016 those numbers were at 8.5x and 11x. In other words despite the surge in the stock price, based on earnings the stock is still valued fairly. 

An added bonus to Virtu Financial is that the company continues to expand into the lucrative brokerage business through its recent purchase of Investment Technology Group (ITG) for $1 billion. Although the deal still needs the approval of the regulators, if it closes, it will diversify Virtu’s business and deepen its move to trade for institutional clients. Virtu also stands to benefit from the wave of consolidation that has hit the high-frequency trading industry. The poor trading conditions of the previous years, as well as rising costs, have forced many mid-sized players to sell out to stronger competitors. It is now expected that the industry will be dominated by a few large firms, which have the advantage of trading larger volumes and a multitude of different strategies. Virtu Financial is set to be one of those firms. However, the main opportunity in Virtu is the company’s success in capitalizing on periods of volatility. 

(Click on image to enlarge)

Chart overlay of Virtu Financial stock and VIX from January 2017 to January 11, 2019. Virtu stock tends to be positively correlated to volatility.

As the chart above shows, Virtu stock seems to be positively correlated to the VIX. This makes sense given the company’s reliance on volatility to generate strong earnings. As such Virtu stock allows investors to bet on increased long-term volatility without being forced to endure the violent daily moves of the actual VIX. As to where volatility is going, historical data as well as macroeconomic trends seem to point to continued market choppiness.

From a historical basis, the market calm that existed prior to 2018 appears to be a rare occurrence. The average long-term daily change in the S&P 500 is estimated to be around 0.66% twice as much as the daily move in 2017. Although that level is lower than the daily swing in 2018, it seems to indicate a return to the extreme calm markets for a sustained period of time is unlikely. Meanwhile, the VIX averaged between 16-17 in 2018, below the estimated average of 18 to 21. That means even though volatility seemed to “blow up” in 2018, on an annual basis it still remains below its average.

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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.