Interactive Brokers 1Q17 Earnings Call Notes

Thomas Peterffy

Hard to make money in low volatility without a lot of flow

” This quarter we made the difficult decision to wind down our options market making operations…Recently, we have come to the conclusion that, in a low volatility environment that may go on indefinitely, it is difficult to earn a profit as a market maker without substantial order flow to interact with. Interestingly, that was the very same reasoning that drove us in the early 90s to expand our market making systems to providing brokerage services in the first place.”

Without the market marker we will focus on brokerage

“Without the market maker, we will focus all of our attention and energy on building our brokerage business. We think our greatest opportunity and the best use of our strength is in Electronic Brokerage. To capture this, we will to use the equity from the market maker to bolster the financial credibility of the Electronic Broker for future growth.

Historically low volatility has affected commissions throughout the industry

“However, market volatility remained at historic lows, and this has affected commissions throughout the industry, including at Interactive Brokers. The average VIX for the first quarter was 11.72. This compares with last year’s strong 20.60 in the first quarter. Yet despite this 43% drop in the VIX, our total DARTs declined much less, down 12% versus last year, and they are up 3% from the fourth quarter.”

Low volatility may be partially created by writing covered calls

I don’t want to repeat myself, but on a CNBC interview, I explained what I think is going on, or what I see going on. And it is partly due to the exchanges rebating fees to traders who put in resting limit orders. So to very high volume traders, we charge $0.10 per 100, and the exchange rebates $0.23 per 100. So these traders who trade back and forth, actually get paid to trade. Because we are rebating those $0.23 per 100 back to our customers. So now couple this with the rising popularity of writing calls against a portfolio of stocks. And the fact that our margin rates are so low, so many of our customers come to us, they borrow money on margin, they go long the big stocks, and they sell calls against it, even though the VIX is low so those calls are sold at a fairly low premium. So the traders come and buy these calls, and they trade against them in the sense that they delta hedge it. So they buy the calls, they go short the stock in the proper ratio. Now as the market picks up, they become long delta. And if the market picks down, they become short delta with these positions. So every time they even out the delta, that means that they sell into rising markets and they buy into dropping markets, and so they generate a trading profit and add to this the rebate from the exchanges. So to a large extent, this low volatility is structural, because of the popularity of selling covered calls, and the rebates from the exchanges.”

Schwab could easily cut its commissions to zero

“Well, on the one hand you are right, we don’t think that they will ever compete with us as far as total execution cost is concerned. But as far as advertising these goals, if they really were to cut the commissions to zero, as Schwab for example could easily do, I think we would have to go out and explain in advertisements more thoroughly as to what is going on here behind the scenes. Because interestingly enough, they advertise that their commissions now are $4.65 a trade, but we see that their commissions are more like $8 or $9 a trade. So – how do you figure out what’s happening?”