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‘Build Me An Ark’: The Tsunami Of Risk Of Tesla-Bitcoin-Cathie Wood Is Coming

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 Authored by Peter Garnry, head of Equity Strategy for Saxo Bank,

Summary:  

In today's equity update we are following up on our analysis of the Tesla-Bitcoin-Ark risk cluster showing an updated positions analysis, cross-correlations in the flagship Ark Innovation ETF, and an drawdown analysis. Yesterday, was another bad session for this risk cluster and Ark Invest had a day with outflows across all their ETFs highlighting that risk sentiment has changed. With the founder's bold move to increase the position in Tesla during the week the risk has gone up that this risk cluster could turn into an ugly forced selling dynamic causing pain in not only Tesla, Bitcoin, and Ark funds, but also US biotechnology stocks where Ark Invest is a major holder with high ownership in selected names.

A little over a month ago we first flagged the Tesla-Bitcoin-Ark risk cluster as something to take note off as short-term correlation between Tesla and Bitcoin was shooting up. A survey from Charles Schwab also confirmed our suspicion that there is a big overlap as these two instruments are among the top five holdings by millennials. Our analysis quickly led us to Ark Invest with its famous Ark Innovation ETF which had a big position in Tesla and its charismatic founder Cathie Wood is a big believer in the so-called disruptive innovation culture of Silicon Valley. This class of people believe firmly in technology as mainly good for society in all its aspects and that Bitcoin is a protection against future wealth confiscation which is most likely inevitable due to historically high wealth inequality.

This disruptive innovation culture is powerful. It is presented by some of the wealthiest people of this planet. Endless presentation about innovation and institutions like the Singularity University promote these views. Behind Bitcoin you find a huge online marketing machine sucking ordinary people into the game. Recently wealthy people such as Elon Musk has openly supported Bitcoin, first in writing and later in action adding $1.5bn to Tesla’s balance sheet and thereby significantly increasing its earnings volatility. The triangle of Tesla-Bitcoin-Ark and their respective momentum has reinforced each other creating a positive feedback loop luring more investors into these instruments. As we have seen this week the ‘tower of risk’ is beginning to show cracks.

Ark position update and Cathie Wood’s bold move and the risk to biotechnology

This week Tesla-Bitcoin-Ark all came under pressure from negative voices in governments over Bitcoin and beginning noise over real competition for Tesla in the coming years. The risk cluster was clearly moving together, and correlations started rising. On Tuesday, volatility picked up across the board and at one point Cathie Wood felt it was necessary to go public supporting her funds and said that she had increased their position in Tesla using big numbers in the future to justify increasing the risk. This is a bold move, but it increases the risk considerably. When you are at risk of seeing sizeable outflows, you should start reducing the most illiquid positions first while you can control the situation. Because if you are forced to do it by redemptions the game changes dramatically.

The tables below show updated Ark Invest positions as of yesterday’s close. There are still 26 stocks where Ark Invest holds more than 10% of the outstanding shares. This could become a serious problem if Ark Invest is suddenly caught in a negative feedback loop together with Tesla and Bitcoin. But also note how US biotechnology stocks are overrepresented in this list of stocks with high ownership in percentage of outstanding shares. If Ark Invest suddenly experience across the board outflows, like it did yesterday, then they can suddenly be the forced seller in US biotechnology stocks where they are the whale. This could cascade into the overall US biotechnology segment although the group is diverse.

Stocks held by Ark Invest funds with combined ownership above 10% of outstanding shares

Source: Ark Invest, Bloomberg, and Saxo Group

The table below shows the largest positions across all funds. Here Tesla has now jumped to 7% of AUM and the first five positions now account for 21.6% of AUM. The five biggest stocks are Tesla, Teladoc Health, Square, Roku, and Baidu. Square just recently reported disappointing Q4 earnings and announced the purchase of $170mn of Bitcoin increasing the risk and feedback loop further in this risk cluster. In the Ark Innovation ETF itself, Tesla is now 10.2% of assets and together with Roku (6%) and Square (5.4%) these three stocks represent 21.6% of assets. If you look at the 10 largest positions in the Ark Innovation ETF then the red thread is that they all come with very high equity valuations and thus low implied equity risk premiums. They are all also mostly equity financed, except for Tesla, which means that the WACC, cost of capital, predominantly come from the cost of equity. With low implied equity risk premiums, the risk-free rate dominates much more than for a company such as say Microsoft or Apple. This means that the rising interest rates could suddenly cause a huge shift in equity valuations. Not because the future is different but because the cost of capital has changed.

Top positions in terms of Ark Invest AUM across all funds

Source: Ark Invest, Bloomberg, and Saxo Group

Correlations on the rise and drawdown outlier

The best sign of risk going haywire is always fast rising cross-correlations whether it is on asset classes or single stocks. The chart below shows the 10-day moving cross-correlation in the Ark Innovation ETF since early 2020. It has recently moved to around 0.6 and while it is not a new record the direction is up and has been fast coming from only 0.2 from a few weeks ago. The next week will be critical for the Tesla-Bitcoin-Ark risk cluster as negative feedback loops can be violent and very unpredictable in their outcome.

Source: Bloomberg and Saxo Group

Another way of looking at risk is by plotting Ark Innovation ETF drawdowns against that of Nasdaq 100 since December 2015. The ETF has typically experienced a drawdown that is 1.22 times larger than that of Nasdaq 100. As of yesterday, the ratio stands at 2.44 and thus illustrates that something idiosyncratic is taking place at Ark Innovation ETF.

If outflows continue today and Tesla comes under pressure again then this indicator could very well hit a new record in terms of being an outlier signaling a negative feedback loop on risk has started.

*  *  *

See below for links to our research notes on the Tesla-Bitcoin-Ark risk cluster:

It is time to get cautious on the Tesla-Bitcoin-Ark connection – 22 January 2021

The Tesla-Bitcoin-Ark syndrome revisited – 9 February 2021

Tesla-Bitcoin-Ark positions have entered a dangerous tailspin scenario – 23 February 2021

Escobar: Putin, Crusaders, & Barbarians

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 Authored by Pepe Escobar via The Asia Times,

Moscow is painfully aware that the US/NATO “strategy” of containment of Russia is already reaching fever pitch. Again.

This past Wednesday, at a very important meeting with the Federal Security Service board, President Putin laid it all out in stark terms:

We are up against the so-called policy of containing Russia. This is not about competition, which is a natural thing for international relations. This is about a consistent and quite aggressive policy aimed at disrupting our development, slowing it down, creating problems along the outer perimeter, triggering domestic instability, undermining the values that unite Russian society, and ultimately to weaken Russia and put it under external control, just the way we are witnessing it transpire in some countries in the post-Soviet space.

Russian President Vladimir Putin during a meeting of the Federal Security Service Board in Moscow on February 24. Photo: AFP / Alexei Druzhinin / Sputnik

Not without a touch of wickedness, Putin added this was no exaggeration: “In fact, you don’t need to be convinced of this as you yourselves know it perfectly well, perhaps even better than anybody else.”

The Kremlin is very much aware “containment” of Russia focuses on its perimeter: Ukraine, Georgia and Central Asia. And the ultimate target remains regime change.

Putin’s remarks may also be interpreted as an indirect answer to a section of President Biden’s speech at the Munich Security Conference.

According to Biden’s scriptwriters, 

Putin seeks to weaken the European project and the NATO alliance because it is much easier for the Kremlin to intimidate individual countries than to negotiate with the united transatlantic community … The Russian authorities want others to think that our system is just as corrupt or even more corrupt.

US President Joe Biden speaks virtually from the East Room of the White House in Washington, DC, to the Munich Security Conference in Germany on February 19. Photo: AFP / Mandel Ngan

A clumsy, direct personal attack against the head of state of a major nuclear power does not exactly qualify as sophisticated diplomacy. At least it glaringly shows how trust between Washington and Moscow is now reduced to less than zero. As much as Biden’s Deep State handlers refuse to see Putin as a worthy negotiating partner, the Kremlin and the Ministry of Foreign Affairs have already dismissed Washington as “non-agreement capable.”

Once again, this is all about sovereignty. The “unfriendly attitude towards Russia,” as Putin defined it, extends to “other independent, sovereign centers of global development.” Read it as mainly China and Iran. All these three sovereign states happen to be categorized as top “threats” by the US National Security Strategy.

Yet Russia is the real nightmare for the Exceptionalists: Orthodox Christian, thus appealing to swaths of the West; consolidated as major Eurasian power; a military, hypersonic superpower; and boasting unrivaled diplomatic skills, appreciated all across the Global South.

In contrast, there’s not much left for the deep state except endlessly demonizing both Russia and China to justify a Western military build-up, the “logic” inbuilt in a new strategic concept named  NATO 2030: United for a New Era.

The experts behind the concept hailed it as an “implicit” response to French President Emmanuel Macron’s declaring NATO “brain dead.”

Well, at least the concept proves Macron was right.

Those barbarians from the East

Crucial questions about sovereignty and Russian identity have been a recurrent theme in Moscow these past few weeks. And that brings us to February 17, when Putin met with Duma political leaders, from the Communist Party’s Vladimir Zhirinovsky – enjoying a new popularity surge – to United Russia’s Sergei Mironov, as well as State Duma speaker Vyacheslav Volodin.

Putin stressed the “multi-ethnic and multi-religious” character of Russia, now in “a different environment that is free of ideology”:

It is important for all ethnic groups, even the smallest ones, to know that this is their Motherland with no other for them, that they are protected here and are prepared to lay down their lives in order to protect this country. This is in the interests of us all, regardless of ethnicity, including the Russian people.

Yet Putin’s most extraordinary remark had to do with ancient Russian history:

Barbarians came from the East and destroyed the Christian Orthodox empire. But before the barbarians from the East, as you well know, the crusaders came from the West and weakened this Orthodox Christian empire, and only then were the last blows dealt, and it was conquered. This is what happened … We must remember these historical events and never forget them.

Well, this could be enough material to generate a 1,000-page treatise. Instead, let’s try, at least, to – concisely – unpack it.

The Great Eurasian Steppe – one of the largest geographical formations on the planet – stretches from the lower Danube all the way to the Yellow River. The running joke across Eurasia is that “Keep Walking” can be performed back to back. For most of recorded history this has been Nomad Central: tribe upon tribe raiding at the margins, or sometimes at the hubs of the heartland: China, Iran, the  Mediterranean.

The Scythians (see, for instance, the magisterial The Scythians: Nomad Warriors of the Steppe, by Barry Cunliffe) arrived at the Pontic steppe from beyond the Volga. After the Scythians, it was the turn of the Sarmatians to show up in South Russia.

From the 4th century onward, nomad Eurasia was a vortex of marauding tribes, featuring, among others, the Huns in the 4th and 5th centuries, the Khazars in the 7th century, the Kumans in the 11th century, all the way to the Mongol avalanche in the 13th century.

The plot line always pitted nomads against peasants. Nomads ruled – and exacted tribute. G Vernadsky, in his invaluable Ancient Russia, shows how “the Scythian Empire may be described sociologically as a domination of the nomadic horde over neighboring tribes of agriculturists.”

As part of my multi-pronged research on nomad empires for a future volume, I call them Badass Barbarians on Horseback. The stars of the show include, in Europe, in chronological order, Cimmerians, Scythians, Sarmatians, Huns, Khazars, Hungarians, Peshenegs, Seljuks, Mongols and their Tatar descendants; and, in Asia, Hu, Xiongnu, Hephtalites, Turks, Uighurs, Tibetans, Kirghiz, Khitan, Mongols, Turks (again), Uzbeks and Manchu.   

Arguably, since the hegemonic Scythian era (the first protagonists of the Silk Road), most of the peasants in southern and central Russia were Slav. But there were major differences. The Slavs west of Kiev were under the influence of Germania and Rome. East of Kiev, they were influenced by Persian civilization.

It’s always important to remember that the Vikings were still nomads when they became rulers in Slav lands. Their civilization in fact prevailed over sedentary peasants – even as they absorbed many of their customs.  

Interestingly enough, the gap between steppe nomads and agriculture in proto-Russia was not as steep as between intensive agriculture in China and the interlocked steppe economy in Mongolia.

(For an engaging Marxist interpretation of nomadism, see A N Khazanov’s Nomads and the Outside World).

The sheltering sky

What about power? For Turk and Mongol nomads, who came centuries after the Scythians, power emanated from the sky. The Khan ruled by authority of the “Eternal Sky” – as we all see when we delve into the adventures of Genghis and Kublai. By implication, as there is only one sky, the Khan would have to exert universal power. Welcome to the idea of universal empire.

Kublai Khan as the first Yuan emperor, Shizu. Yuan dynasty (1271–1368). Album leaf, ink and color on silk. National Palace Museum, Taipei. Photo: Wikimedia Commons/National Palace Museum, Taipei

In Persia, things were slightly more complex. The Persian Empire   was all about Sun worship: that became the conceptual basis for the divine right of the King of Kings. The implications were immense, as the King now became sacred. This model influenced Byzantium – which, after all, was always interacting with Persia.

Christianity made the Kingdom of Heaven more important than ruling over the temporal domain. Still, the idea of Universal Empire persisted, incarnated in the concept of Pantocrator: it was the Christ who ultimately ruled, and his deputy on earth was the Emperor. But Byzantium remained a very special case: the Emperor could never be an equal to God. After all, he was human.

Putin is certainly very much aware that the Russian case is extremely complex. Russia essentially is on the margins of three civilizations. It’s part of Europe – reasons including everything from the ethnic origin of Slavs to achievements in history, music and literature.

Russia is also part of Byzantium from a religious and artistic angle (but not part of the subsequent Ottoman empire, with which it was in military competition). And Russia was influenced by Islam coming from Persia.

Then there’s the crucial influence of nomads. A serious case can be made that they have been neglected by scholars. The Mongol rule for a century and a half, of course, is part of the official historiography – but perhaps not given its due importance. And the nomads in southern and central Russia two millennia ago were never properly acknowledged.

So Putin may have hit a nerve. What he said points to the idealization of a later period of Russian history from the late 9th to early 13th century: Kievan Rus. In Russia, 19th century Romanticism and 20th century nationalism actively built an idealized national identity.

The interpretation of Kievan Rus poses tremendous problems – that’s something I eagerly discussed in St. Petersburg a few years ago. There are rare literary sources – and they concentrate mostly on the 12th century afterwards. The earlier sources are foreigners, mostly Persians and Arabs.

Russian conversion to Christianity and its concomitant superb architecture have been interpreted as evidence of a high cultural standard. In a nutshell, scholars ended up using Western Europe as the model for the reconstruction of Kievan Rus civilization.

It was never so simple. A good example is the discrepancy between Novgorod and Kiev. Novgorod was closer to the Baltic than the Black Sea, and had closer interaction with Scandinavia and the Hanseatic towns. Compare it with Kiev, which was closer to steppe nomads and  Byzantium – not to mention Islam.

Kievan Rus was a fascinating crossover. Nomadic tribal traditions – on administration, taxes, the justice system – were prevalent. But on religion, they imitated Byzantium. It’s also relevant that until the end of the 12th century, assorted steppe nomads were a constant “threat” to southeast Kievan Rus.

So as much as Byzantium – and, later on, even the Ottoman Empire – supplied models for Russian institutions, the fact is the nomads, starting with the Scythians, influenced the economy, the social system and most of all, the military approach.   

Watch the Khan

Sima Qian, the master Chinese historian, has shown how the Khan had two “kings,” who each had two generals, and thus in succession, all the way to commanders of a hundred, a thousand and ten thousand men. This is essentially the same system used for a millennia and a half by nomads, from the Scythians to the Mongols, all the way to Tamerlane’s army at the end of the 14th century.   

The Mongol invasions – 1221 and then 1239-1243 – were indeed the major game-changer. As master analyst Sergei Karaganov told me in his office in late 2018, they influenced Russian society for centuries afterwards.

For over 200 years Russian princes had to visit the Mongol headquarters in the Volga to pay tribute. One scholarly strand has qualified it as “barbarization”; that seems to be Putin’s view. According to that strand, the incorporation of Mongol values may have “reversed” Russian society to what it was before the first drive to adopt Christianity.   

The inescapable conclusion is that when Muscovy emerged in the late 15th century as the dominant power in Russia, it was essentially the successor of the Mongols.

And because of that the peasantry – the sedentary population – were not touched by “civilization” (time to re-read Tolstoy?). Nomad Power and values, as strong as they were, survived Mongol rule for centuries.

Well, if a moral can be derived from our short parable, it’s not exactly a good idea for “civilized” NATO to pick a fight with the – lateral – heirs of the Great Khan. 


Demographics Is (Dark) Destiny

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 Authored by Chris Hamilton via Econimica blog,

Some folks want to make economics seem complicated. It ain't. Any who, some charts depicting the US economy...through demographics.

First, 15 to 54 year old US population (blue line) and those employed among that population (green line). You may note the end of population growth among them in '07 and not only the end but a significant decline in employment among them since '07. This is the population segment that undertakes most of the credit (creating the new $'s via undertaking debt...vs. elderly who destroy $'s via deleveraging/paying off their loans), buys most the homes, spends the most, earns the most. The lack of growth among them is paramount in understanding what took place in '08 as potential new home buyers ceased to exist and banks gave credit to anyone to keep the party going...'08 (and what has come since) was an entirely predictable demographic caused crisis.

Same as above but plus Federal Reserve set Federal Funds Rate % (black dashed line) and it's relationship to marketable federal debt (red shaded area). When working age population growth ceased, the Federal Reserve implemented ZIRP (free money to the largest banks) and likewise free money to Congress. The explosion in debt since is entirely due to the Federal Reserve's encouragement via their interest rate policy.

Same as above but inclusive of Federal Reserve balance sheet (aka, QE...yellow line) and Wilshire 5000 (representing all publicly traded US equities...light blue line). Since the end of working age population and employment growth, virtually free money has been passed to the largest and best connected US institutions / individuals. This, alongside the Federal Reserve purchasing Treasury bonds (to artificially lower the cost of federal government borrowing and boost the supply of dollars chasing the remaining assets) and mortgage backed securities (to artificially lower mortgage rates) has resulted in an asset explosion. This explosion has rewarded asset holders with vast riches and punished young adults, the poor, those on fixed incomes. These folks in the latter group get none of the asset wealth effect but instead get the fast rising costs of living due to the asset appreciation. When the Federal Reserve continually suggests they aren't responsible for the exploding US inequality...it is a bald faced lie.

Same as above, but focusing on the 15 to 54 year old employment to population ratio (not the silly unemployment numbers the BLS puts out...just dividing the population by those employed among them...white line). The Federal Reserve has two Congressionally mandated jobs..."promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates." You can forget stable prices (as the Fed has, via a system of discounting inflation) and just focus on full employment. As you'll note, the US has achieved "full employment" four times since the inclusion of females into the workforce...'89, '00, '07, '19...each time with employment around 75% of the available population. But note the declining rates, resulting in greater debt, resulting in soaring asset bubbles (and once those failed) notice the soaring QE and zero interest rate policy...resulting in the greatest rise in asset appreciation in US history. Asset holders made rich (for being asset holders)...those with little or no assets made poor (for not being asset holders). Simple stuff.

Below, again 15 to 54 year old horizontally moving population plus falling employed among them, ever lower Federal Funds Rate, and ludicrously vertical Wilshire 5000. In case you are wondering, this asset explosion is not a naturally occurring phenomenon against over a decade of zero working age population growth and seven million fewer employed among them. Nah, this looks like a currency collapse in progress...and once it goes vertical (Wilshire, Bitcoin, etc.)...you know you haven't got much longer to go (although we likely have significantly further to go in the vertical explosion...before the whatever it is that follows).

The two charts below throw Bitcoin into the mix, putting it's meteoric rise into context against demographics and the Federal Reserve's demographically driven Treasuries buying spree (and the concurrent hard stop of foreign buying of Treasuries).

While nobody can say whether immigration will return to high levels, fertility rates and births are scraping record lows...and simply gauging the feeder population that is the 15 to 24 year olds (chart below of population / employed among them), you should have a fairly good idea of why a return to a growing working age US population isn't likely.

Finally, here's how this plays out regarding the most fundamental of human needs...shelter or housing...plus I'll stretch out to the 15-64yr/old population and employed among them versus annual housing starts and the Federal Funds Rate (%). The Federal Reserve purchasing of MBS / QE has artificially pushed mortgage rates to record lows to induce an artificial housing frenzy amid a secular turn to outright declining potential buyers and soaring quantity of potential sellers (elderly who already own homes). If I didn't know better, I'd think the Fed hates young adults and is setting them up to be the bag holder of an awful oversupply of very expensive housing when the bottom invariably falls out...again.

Some say these are the seeds of the second American revolution as a class of unelected, undemocratic central bankers enrich a tiny majority at the expense of the majority...but I just like making colorful charts.

Extra Credit - 15 to 74 year old population / employees

For those curious how this looks on the widest possible cross section of population/potential employees, the following are the same charts but showing the 15 to 74 year old population and employees among them.

Last chart is pretty important, because it really highlights the declining participation of the aging population...suggesting that "full employment" will be significantly lower than '06 and '19 at much greater expense and require significantly greater QE to enable it all.

Invest (wtf) accordingly.

Bill Gates Goes Full Captain Planet, Wants To Change ‘Every Aspect Of Economy’ While We Dine On Fake Meat

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 From Zero Hedge:

Microsoft founder Bill Gates is pushing drastic and 'fundamental' changes to the economy in order to immediately halt the release of greenhouse gasses - primarily carbon dioxide - and 'go to zero' in order to save the planet from long-prognosticated (and consistently wrong) environmental disaster.

Changes we'll need to make in order to realize Gates' vision include:

  • Allocating $35 billion per year on climate and clean energy research.
  • Electric everything.
  • Widespread consumption of fake meat, since cows account for '4% of all greenhouse gases.'
  • Retooling the steel and cement industries, which Gates says account for 16% of all carbon dioxide emissions, to inject up to 30% of captured C02 into concrete, and create a different type of steel.
  • Widespread adoption of next generation nuclear energy to supplement wind and solar.

And since producing plants to make fake meat emits gases as well, Gates has backed a company which uses fungus to make sausage and yogurt, which the billionaire calls "pretty amazing."

"When you say fungi, do you mean like mushroom or a microbe?" asked Anderson Cooper in a recent "60 Minutes" interview to promote Gates' new book, "How to Avoid a Climate Disaster."

"It's a microbe," replied Gates, adding "The microbe was discovered in the ground in a geyser in Yellowstone National Park. Without soil or fertilizer it can be grown to produce this nutritional protein -- that can then be turned into a variety of foods with a small carbon footprint."

(Speaking of which, it appears that we're already rounding the corner on C02 emissions)

More via CBS News:

Gates isn't just looking to cut future carbon emissions, he is also investing in direct air capture, an experimental process to remove existing CO2 from the atmosphere. Some companies are  now using these giant fans to capture CO2 directly out of the air, Gates has become one of the world's largest funders of this kind of technology. 

But of all his green investments, Gates has spent the most time and money pursuing a breakthrough in nuclear energy -- arguing it's key to a zero carbon future.

He says he's a big believer in wind and solar and thinks it can one day provide up to 80% of the country's electricity, but Gates insists unless we discover an effective way to store and ship wind and solar energy, nuclear power will likely have to do the rest. Energy from nuclear plants can be stored so it's available when the sun isn't shining and the wind isn't blowing. 

Gates also admits he's a hypocrite - telling Cooper "I probably have one of the highest greenhouse gas footprints of anyone on the planet," adding "my personal flying alone is gigantic."

He's atoning for his climate sins by purchasing plant-based aviation fuel, switching to an electric car, using solar panels, and buying carbon credits to the tune of $7 million per year.

Gates' climate pivot is getting a full-court media press. As Paul Joseph Watson of Summit News writes:

Bill Gates has been lauded as the man to “save the world” and help the planet reach zero carbon emissions in a new report by Wired Magazine, despite such standards not being reflected in the billionaire philanthropist’s own lifestyle.

The article investigates how Gates plans to achieve a “zero carbon” world and promotes his new book which argues “it’s time we make real societal, economic and logistic changes to our way of life to avoid disaster.”

According to Gates, the planet needs to reach zero carbon emissions in order to “avoid catastrophe.”

Gates’ efforts to reduce CO2 emissions may have an environmentalist sheen, but that goal also risks reducing living standards in the west, something that Gates isn’t likely to embrace for himself.

As we previously highlighted, while Americans are being told that the dream of owning private property is over under a future ‘Great Reset’, Gates and other billionaires have been buying up huge amounts of farmland.

Gates is now the biggest owner of farmland in America, according to a Forbes report.

While the mainstream media continues to champion Gates’ influence, he has received harsh criticism elsewhere.

As we highlighted last week, Lawyer Robert F. Kennedy Jr., son of Robert F. Kennedy and the nephew of former U.S. president John F. Kennedy, wrote a comprehensive report accusing Gates of engaging in neo-feudalism.

Kennedy warns that, “To cloak his dystopian plans for humanity in benign intentions, Gates has expropriated the rhetoric of “sustainability,” “biodiversity,” “good stewardship” and “climate.”

He also accused Gates of attempting to monopolise and dominate global food production, labeling it “a dark form of philanthrocapitalism based on biopiracy and corporate biopiracy.”

Kennedy was subsequently banned by Instagram after his report was published.

As we highlighted earlier, pro-Gates messaging has also found its way into children’s television programming.

*  *  *

Does Gates have a plan to force the rest of the world to adopt his vision?

Exposing The Robinhood Scam: Here’s How Much Citadel Paid To Robinhood To Buy Your Orders

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 From Zero Hedge:

Frankly, we've had it with the constant stream of lies from Robinhood and neverending bullshit from the company's CEO, Vlad Tenev.

With Tenev scheduled to testify on Thursday, alongside the CEOs of Citadel, Melvin Capital and Reddit, the apriori mea culpas have started to emerge - if a little too late - the former HFT trader spoke late on Friday on the All-In Podcast hosted by Chamath Palihapitiya, who had strongly criticized Robinhood over the trading restrictions, and Jason Calacanis, a Robinhood investor, and said that “no doubt we could have communicated this a little bit better to customers."

What he is referring to, of course, is Robinhood's outrageous decision to restrict the buying of 13 heavily shorted stocks on Jan 28 that had been driven to record highs, including GameStop, whose shares had surged more than 1,600%.

Tenev said the restrictions were necessary due to a large increase in collateral/deposit requirements by the DTCC, but that was not spelled out in automated emails sent to Robinhood customers early on Jan. 28.

Robinhood CEO Vlad Tenev

And then he decided to pull the oldest trick and deflect attention from his own mistakes by blaming "conspiracy theories."

"As soon as those emails went out, the conspiracy theories started coming, so my phone was blowing up with, ‘how could you do this, how could you be on the side of the hedge funds,’" he said.

What Tenev did not say, or explain, is why his company - which is merely a client-facing front of Citadel, which buys the bulk of Robinhood's orderflow to use it perfectly legally in any way it sees fit - was so massively undercapitalized that the DTCC required several billion more in collateral to protect Robinhood's own investors against the company's predatory ways of seeking to capitalize on the gamification of investing making it nothing more (or less) than a trivial pursuit to millions of GenZ and millennial investors, a point which Michael Burry made so vividly.

Incidentally we know why Tenev did not mention it: it's because Robinhood's back office is a shambles of a shoestring operation, one which never anticipated either such a surge in trading not a multi-billion collateral requirement; had Robinhood been a true brokerage instead of pretending to be one, and run merely to open as many retail accounts as it could in the shortest amount of time, thus generating the most profit in the quickest amount of time to allow its sponsors a quick and profitable exit, it would actually have been on top of this.

It's also why Tenev's ridiculous pleas for immediate settlement instead of the usual T+2 arrangement, which has not been an issue for any other brokers, is nothing but a strawman argument which he hopes to present in Congress.

Which brings us to a totally separate topic, and one which Teven will one way or another have to address: the fact that Robinhood is a de facto subsidiary of Robinhood, whose entire business model is to sell retail orders to a handful of HFT market makers first and foremost... Citadel. In doing so the only ones who benefited from the surge in retail trading are Robinhood itself, by pocketing millions more from selling orderflow to Citadel, Virtu, Two Sigma, Wolverine and other HFT frontrunning "market-making" venues, as well as Citadel which made billions by having an advance look at the biggest surge in retail stock and option orders flow in history, and being able to trade ahead of and around it.

And no, it's not a conspiracy theory Vladimir - it is the stone cold truth, as Jeffrey Gundlach suggested last week when he said "Robin Hood (sic) should be forced to change its name to Hood Robbin’.  I grow so weary of lies through nomenclature, which are ubiquitous these days" adding "To be clear, the name change would reflect Robinhood robbing the little guy, nothing else."

As an aside, how dare we allege that Citadel was buying orderflow to frontrun it? After all, that very allegation...

... coupled with the reminder that Robinhood engages exclusively in a practice called payment-for-orderflow (or PFOF)...

... which is what allowed Robinhood to provide "free" trading in the first place, that nearly destroyed us when last June Citadel's lawyer army threatened to sue us into the ground for suggesting precisely that?

Some key phrases of note from the above text:

  • "'Frontrunning' is an industry term of art that refers to an illegal form of trading."
  • "Citadel Securites does not engage in such conduct [i.e., frontrunning] and there was no factual basis whatsoever for ZeroHedge to publish such an incendiary, false, and reckless allegation to its 742,000 Twitter followers" [it's 771,000 now].
  • "ZeroHedge's statement obviously disparages the lawfulness and integrity of Citadel Securities' business pratices."
  • "Quite obviously, this most recent iteration of this same harmful allegation was not made in jest."
  • "We demand that ZeroHedge immediately retract this tweet by deleting it from ZeroHedge's Twitter page... A refusal to promptly take down these remedial steps will be seen as further evidence of actual malice and will only increase the already substantial legal risk faced by you and ZeroHedge."

Well, we now officially know all about Citadel's modus operandi because just a few days after we received that letter, none other than financial regulator FINRA, revealed that Citadel Securities was censured and fined for engaging in - drumroll - "trading ahead of customer orders" as Letter of Acceptance No. 2014041859401 revealed:

Now we admit that our financial jargon is a bit rusty these days, but "trading ahead of customer orders" sounds awfully similar to another far more popular "term of art", one which we know very well: frontrunning!

Jargon aside, some of the other highlighted words we are very familiar with, such as "hundreds of thousands"... and "559 instances" in which Citadel traded ahead of customer orders.

And while we may be getting a little ahead of ourselves here, it was Citadel's own lawyers that informed us on more than one occasion that:

"frontrunning" is an unethical and illegal trading practice."

So, what are we to make of this? Could it be that Citadel was engaging in at least 559 instance of what its lawyer called "unethical and illegal trading practice." Surely not: after all the lawyers would surely know very well how ridiculous and laughable their letter and threats would look if it ever emerged that Citadel was indeed frontrunning its customers.

But wait, it gets even funnier.

Back in April 2004, long before Citadel became the dominant market maker - and buyer - of retail orderflow controlling a whopping 27% of total US equity volume market share in 2020 according to Bloomberg and a staggering 46% of retail orderflow, it was Citadel's own General Counsel, Adam Cooper, who urged the SEC to ban payment for orderflow because it "distorts order routing decisions, is anti-competitive, and creates an obvious and substantial conflict of interest between broker-dealers and their customers."

As Cooper also revealed...

"broker-dealers accepting payment for order flow have a strong incentive to route orders based on the amount of order flow payments, which benefit these broker-dealers, rather than on the basis of execution quality, which benefits their customers. Furthermore,  the  parties  making such payments (either voluntarily or through an exchange-mandated program) are forced  to  find  other  ways  to  recoup  the  amounts  of  such  payments,  whether  through  wider  spreads  or  a  reduction  in  other  benefits  that  otherwise  could,  and  should,  be  provided to customers."

And the punchline:

Payment  for  order  flow  is  a  practice  that  on  its  face  is  at  odds  with  a  broker-dealer’s obligations to its customers.  A broker-dealer has a fiduciary obligation to obtain the best execution reasonably available for its customers’ orders under prevailing market conditions.    We  do  not  believe  that  a  broker-dealer  that  accepts  payment  for  order  flow  and does not pass such payments on to its customers (either directly or through reduced execution fees or commissions) can consistently fulfill its best execution obligations.

Which leads us to the one time Citadel was actually telling the truth:

Because  payment  for  order  flow  creates  fundamental  conflicts  of  interest  that  cannot  be  cured  by  disclosure,  the  Commission  should  ban  payment  for  order  flow  altogether.  It is crucial that this ban include not only exchange-sponsored programs, but also  payment  for  order  flow  arrangements  entered  into  privately  between  order  flow  providers   and   market   centers. 

Little did Citadel know that just 15 years later it would be the single biggest beneficiary of paying for orderflow, a practice which has allowed Citadel founder to amass a trophy collection of some of the most expensive real estate in the world.

We also know all this is true because we were also among the first to expose Robinhood as a client-facing front for Citadel back in 2018, when we wrote "Robinhood Is Said To Get 40% Revenue From HFT Firms Like Citadel" in which we said that...

"Stealing from millennials to give to the rich. Robinhood app sells user customer data to make a quick buck from the high-frequency trading (HFT) firms on Wall Street," that is what we wrote last month, in one of the first articles that expressed concern over the popular Robinhood investing app for millennials, which has shady ties to HFT firms and undermines its image of an anti-Wall Street ethos. 

The conclusion was a searing prediction of what would happen a little over two years later:

A few anonymous venture capitalists told Bloomberg that Robinhood has already begun to see the consequences of their cozy relationship with Wall Street firms, which has degraded the company's image. 

With six million clients, most of whom are millennials -- seeking an anti-Wall Street investing culture, could soon find out, that, they too, have been conned by Robinhood founders into thinking the app offers free investing. The lesson at play: nothing in life is free, even if it is from Silicon Valley.

That said, we were not the first to expose Robinhood's ways. That honor falls to our friend Joe Saluzzi and Sal Arnuk, who for over a decade have led the crusade against high frequency trading, and who in November 2014 wrote "Beware of Those Offering Free Retail Trades."

We are always suspicious when somebody offers us something for free.  Usually, the one offering the free service has other ways of making money.  For example, Google offers lots of free services like Gmail, Google Maps or Youtube. While the services are free, Google is still making money by targeting ads and selling data. The latest free thing which is creating quite a buzz (the hot term for this is “disrupting”) is free retail trading by a company called Robinhood.

What is Robinhood?  According to an article in the Irish Times yesterday:

“Founded by Stanford mathematics graduate Vlad Tenev and  Baiju Bhatt last year, Robinhood is a stock brokerage that charges no commission.”

Robinhood is offering free stock trades and no-cost real time market data.  How do they do it? According to the company:

– They don’t have brick and mortar companies and don’t spend millions on Superbowl ads.

– Technology has allowed them to eliminate much of the human intervention and paper confirms.

And how do they make money?  According to their website:

“Robinhood has two key revenue streams; charging interest for margin trading, and collecting interest on cash balances.”

Call us crazy but relying on generating revenue from margin interest and collecting interest on cash balances (where the account minimum is $0) sounds a bit risky and overly ambitious in a market which has been saddled with zero percent interest rates for the past 5 years.  That’s why we think Robinhood must have another way of making money. Could it be that the founders, Vlad and Baiju, are planning on taking advantage of the rebates and payment for order flow that are embedded in the equity market?  But how could two guys who graduated from Stanford in 2008 know that much about the market structure of the US equity market? From their website:

“After graduating from Stanford, roommates Vladimir Tenev and Baiju Bhatt moved to New York, where they built high-frequency trading platforms for some of the largest financial institutions in the world. They began to realize that electronic trading firms pay effectively nothing to place trades in the market yet charge investors up to $10 for each trade — and thus the idea for Robinhood was born. They soon ventured back to California to begin solving the problem of democratizing access to the markets.”

Seems like Vlad and Baiju know a lot more about US equity trading than we thought.  Heck, they may even know that when a retail limit order is sent to the DirectEdge stock exchange, that order could qualify for a special rebate if it is attributed and displayed as a retail order.  Here is how DirectEdge describe their retail attribution program​ :

“With this improvement, Members sending Retail Orders may elect to display those orders on the EdgeBook Attributed data feed with the generic retail identifier “RTAL” rather than their Market Participant ID (MPID).  Including a standard retail identifier gives retail brokers greater flexibility and choice to participate in the attribution program that has helped improve execution rates for retail orders.”

Talk about leading the lambs to the slaughter.  Retail orders that are being attributed are basically flashing bright lights telling the world that they are retail.

We’re not sure if Robinhood is planning on selling their order flow but it is certainly something that their customers should be asking them once they do start trading. While their website does not say anything about payment for order flow, in a CNBC interview from earlier this year, Vlad Tenev did say the company would be accepting payment for order flow:

 “So, Robinhood has many revenue streams on Day One. Those include margin lending, payment for order flow, interest on cash balances. We’ll have those on Day One,” Tenev said on CNBC’s “Halftime Report”.

Right now, Robinhood is still busy attracting some high profile investors which include Snoop Dog, actor Jared Leto, the venture capital fund Andreessen Horowitz and Google Ventures (Robinhood raised $13 million in their latest financing round).

Two points here: Vlad Tenev's entire background is HFT - he knew from day one that he could create a "free brokerage" if only he were to quietly sell all the orderflow to a generous sponsor, say Citadel. It's also why we find laughable his recent tweet asking, obviously rhetorically, "What exactly is high-frequency trading? And is it evil?"

Tenev then went on into a rambling, nonsensical defense of HFT and why it is not evil, concluding that "high-frequency trading is just what you get when you apply technology to trading and getting data moving faster between trading centers will enhance trading for us all"...

... what he did not say is that HFT is just a perfectly legal and widely accepted way of frontrunning retail orderflow (usually by the order of a few milliseconds, explaining the presence of lasers at the New York Stock Exchange in Mahwah), and then selling it to the highest bidder, something he knew almost a decade ago when he launched Robinhood. We almost wonder if he did so in some low-lit Chicago backroom while sitting across from Citadel's Ken Griffin (this would be the other Citadel, not the one from 2004 which found payment for orderflow loathsome and deserving to be banned, but a Citadel which now considered PFOF a source of almost unprecedented riches and profit).

The second point we would like to address from the Themis Trading 2014 post is that while back then it was unclear if RH sold their orderflow, we now know that not only is Robinhood selling your orders to other internalizers, but that sale represents the biggest source of RH revenue by orders of magnitude. And thanks to the company's just filed latest Disclosure Form 606 we know just how much Robinhood made from selling your orderflow to Ken Griffin.

The chart below shows Robinhood's monthly revenues for the full year 2020, broken down in the three key categories: i) S&P500 stocks, ii) Non-S&P500 stocks and iii) Options. And while Robinhood made a not-too-shabby $247 million in 2020 from just selling access to your retail stock orders to such non-directed orderflow venue as Citadel, Vitru, Wolverine, Two Sigma, G1X, Morgan Stanley and others, it is the sale of option orderflow that has emerged as Robinhood's golden goose, having generated an impressive $440 million in revenue in 2020.

Which then brings us to the punchline: Robinhood is kind enough to break down not only revenue by product (going down to such granular detail as market orders and limit orders), starting several years ago the company also started disclosing who its biggest clients were. And here it will come as no surprise that in 2020, Citadel accounted for more than half of all Citadel revenues, or $362.5 million, exactly 53% of the company's total revenues of $687.1 million.

Would it therefore be farfetched to say that Robinhood is nothing more than a client-facing subsidiary of Citadel, one which pretends to offer free trades to tens of millions of young, naive traders, but in reality merely allows Citadel Securities to trade ahead and/or against this orderflow for which it paid over $300 million... and to generate record revenues of $6.7 billion!

Probably not, but we won't have a definitive answer until we find out just how much profit Citadel made from buying all this critical data, which gives it an early glimpse into not only each discrete individual trade but also a sense of which way the retail horde is moving, critical and extremely valuable data which until last August was public and available to all (with a slight delay) courtesy of Robintrack, and which last August was inexplicably halted.

We are confident that this week's Congressional hearings will quickly get to the bottom of this critical question of just how profitable this orderflow - which it paid Robinhood $362 million to procure - is for Citadel, because anything less will confirm that this latest hearing is nothing but a kangaroo court meant to appease retail investors that someone in Washington is doing something... when in reality everyone knows that what Citadel wants, Citadel gets and there is no sign that Citadel will ever tire of making billions out of the same orderflow for which it paid subpennies on the dollar to Robinhood.

As for Robinhood's trite virtue signaling of taking from the rich and giving to the poor, all it took was 30 billion subpenny rebates from Citadel for the firm to remember who really calls the shots.

Crypto “Flash Loans” Allow Borrowing And Repayment In Seconds To Arbitrage Coin Prices

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 From Zero Hedge:

With the recent news that Tesla has now purchased $1.5 billion in bitcoin, there's going to be no shortage of people that follow Elon Musk and make their first foray into crypto as well. And, since a majority of the country is broke, it seems like a great time for what is essentially crypto lending to emerge. 

Enter "flash loans" - a new service where borrowers can very quickly take collateral free loans from lenders and use the proceeds for whatever they want, before quickly paying the loan back - sometimes in seconds. The most popular use for these loans has been arbitraging coin prices on different crypto exchanges, according to Bloomberg. But what makes these loans different is that they are "bundled into the same block of transactions being processed on the Ethereum digital ledger and are executed simultaneously".

The loans sometimes take just seconds:

In the example, the transaction gets submitted to the network, temporarily lending the borrower the funds. If the trade isn’t profitable, the borrower can reject the transaction, meaning that the lender gets their funds back in either case. As far as the blockchain is concerned, the lender always had the funds. The user pays blockchain processing fees.

“In a way, flash loans make everyone a whale,” said Nikola Jankovic of loan provider DeFi Saver. Another player in the flash loan space, Aave, says it has already processed $2 billion in flash loans just last year alone.

The outlook for the loans is robust, according to crypto investor Aaron Brown: “I can see them becoming big. The same thing exists conceptually in the traditional financial system. I can buy and sell things for many times my total wealth during a day, as long as by the end of the day everything nets out to a positive balance. It’s just with crypto there is no settlement delay, so to do the same thing you need flash loans."

“At the end of the day, flash loans are going to be everywhere,” Stani Kulechov, Aave's CEO, said. 

Jack Purdy, an analyst at researcher Messari commented: “They have the potential to greatly increase market efficiency as there are no longer high capital costs to exploiting arbitrage opportunities. When anyone in the world can execute these trades across disparate markets, it helps crypto prices converge, tightening spreads and reducing inefficiencies.”

On the other side of the "coin", however, the loans can also be used to manipulate coin prices. “Flash loans will continue to be associated with manipulation and hacks. But they’re not really essential to those things, they just mean manipulators and hackers no longer need capital,” Aaron Brown concluded.

Incoming SEC Chair Gary Gensler Could Be Worth Up To $119 Million

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 From Zero hedge

President Joe Biden’s nominee to be chairman of the Securities & Exchange Commission, Gary Gensler, who we profiled here and is referred to as "the sheriff", could have a net worth between $41 million and $119 million. 

Gensler was previously the chairman of the CFTC and a partner at Goldman Sachs. He disclosed his net worth as part of disclosures he had to file with the Office of Government Ethics, Bloomberg noted on Friday. A majority of his money was made at Goldman, where he joined in the late 1970's after graduating from the University of Pennsylvania. He became one of the youngest partners in Goldman Sachs history. 

Gensler's largest holding is a stake worth $25 million and $50 million in the Vanguard Total Stock Market ETF. He also disclosed that he had between $50,000 and $100,000 in capital gains from holding shares of Tesla, the only stock that is listed individually on his disclosures. He has since sold the position.

He also disclosed that he will participate in a benefit plan from Goldman Sachs which is expected to pay out $977 per month starting at age 71. 

Recall, we wrote about Gensler's nomination in mid-January. 

His arrival will likely be a stark difference from the last 4 years of Jay Clayton, as Gensler's resume includes going to war with major financial titans when he was head of the Commodity Futures Trading Commission - and winning. Financial lobbyists sometimes simply called him "the enemy" during the 2010 Dodd-Frank Act battle. 

Justin Slaughter, a consultant at Mercury Strategies, said: “The sheriff is coming to the preeminent financial regulator in the world. It means regulation and enforcement are about to get much tougher.”

When he arrives at his post, Gensler will not only have to deal with a Fed-induced stock market mania, but also tensions with China and the growth of private equity. 

Graham Steele, who served as an aide to Senator Sherrod Brown of Ohio, said: “He developed a reputation for being adversarial to Wall Street because he came from the industry and understood the business so he could push back against their arguments when they were hollow.”

Ian Katz, an analyst at Capital Alpha Partners in Washington, commented: “What’s really unnerving to a lot of people is that it’s pretty clear that he doesn’t need them. He doesn’t need to go back there for a job, he’s made his money. He’s not terribly interested in who he ticks off or not and that’s very powerful.”

By Jeff Kauflin, Antoine Gara and Sergei Klebnikov It’s just after midnight on Friday, July 31, and the Todd Capital Options Community, a $20-per-month subscription Slack channel favored by thousands of novice options traders, is buzzing with life. Unemployment is soaring and governments worldwide are desperately trying to fend off economic collapse. But members of this online enclave are partying, quite literally, like it’s 1999—the infamously frothy day-trading year before the dot-com bubble burst in March 2000. Despite the pandemic, Amazon, Apple, Facebook and Google have just released jaw-dropping financial results, a staggering $205 billion in combined quarterly sales and $34 billion in earnings during a stretch when U.S. gross domestic product plunged at an annualized rate of 33%. For weeks, the club’s youthful members have been loading up on speculative call options using the mobile trading app Robinhood. Now they’re ready to cash in. “Literally, NOTHING will make me sell my AMZN 10/16 calls tomorrow. I don’t care what happens. . . . I’m holding everything. Keep ya boi in your prayers,” says one user named JG. As dawn approaches, “NBA Young Bull” announces: “Good morning future millionaires . . . is it 9:30 yet?” For these speculators, the adrenaline rush turned to euphoria after Apple not only beat earnings expectations but announced a 4-for-1 stock split, luring more small investors to the iPhone maker’s stock party. At 9:30 a.m. Friday, when trading begins, the call options on Apple and Amazon held by many of these market newbies pay out like Las Vegas slot machines hitting 7-7-7 as both tech giants gain a collective quarter-trillion dollars in market value. Throughout the day and over the weekend, a stream of posts scroll by from exuberant Robinhood traders going by screen names like “See Profit Take Profit” and “My Options Give Me Options.” On Monday, August 3, the Nasdaq index sets a new record high. (see Robinhood Returns below) The physics of amateur trading: Baiju Bhatt (left) and Vladimir Tenev met as physics students at Stanford. Even the best modeling could not have predicted that $1,200 stimulus checks would propel them to billionaire status. The Physics of Amateur Trading: Baiju Bhatt (left) and Vladimir Tenev (pictured in 2015) met as physics students at Stanford. Even the best modeling could not have predicted that $1,200 stimulus checks would propel them to billionaire status. KITTU KOLLURI Welcome to the stock market, Robinhood-style. Since February, as the global economy collapsed under the weight of the coronavirus pandemic, millions of novices, armed with $1,200 stimulus checks and nothing much to do, have begun trading via Silicon Valley upstart Robinhood—the phone-friendly discount brokerage founded in 2013 by Vladimir Tenev, 33, and Baiju Bhatt, 35. The young entrepreneurs built their rocketship by applying the formula Facebook made famous: Their app was free, easy to use and addictive. And Robinhood—named for the legendary medieval outlaw who took from the rich and gave to the poor—had a mission even the most woke, capitalism-weary Millennial could get behind: to “democratize finance for all.” Covid-19 and the flow of government handouts have been manna from heaven for Robinhood. The firm has added more than 3 million accounts since January, a 30% rise, and it expects revenue to hit $700 million this year, a 250% spike from 2019, according to a person familiar with the private company’s finances. Not since May Day 1975, when the SEC deregulated brokerage commissions, giving rise to discount brokerages like Charles Schwab, has there been a more disruptive force in the retail stock market. Robinhood’s commission-free trading is now standard at firms including TD Ameritrade, Fidelity, Schwab, Vanguard and Merrill Lynch. And Robinhood’s merry traders are moving markets: Certain stocks—Elon Musk’s Tesla, marijuana conglomerate Cronos, casino operator Penn National Gaming and even bankrupt car-rental company Hertz—have become favorites, swinging wildly on a daily basis. For the first time ever, according to Goldman Sachs, options speculators like the ones Robinhood has cultivated have caused single-stock option-trading volumes to eclipse common-stock trading volumes, surging an unprecedented 129% this year. Lord of the Buys The Covid bull market has been a godsend for retail brokers, but Robinhood and its swarm of newbie traders is schooling the competition. AFWGV Source: Piper Sandler “I think you’ve seen a unique situation in the history of financial markets,” Tenev tells Forbes, working remotely from his home not far from Robinhood’s Menlo Park, California, headquarters, which resemble a beach house. “Typically when a market crash is followed by a recession, retail investors pull out. Institutions benefit. . . . In this case, Robinhood customers started opening new accounts and existing customers started putting in new money. This bodes positively for society and our economy if millions are investing when they otherwise wouldn’t have.” Like any skilled trader, Tenev is talking his book. His proclamations ring a bit hollow, though, once you look more closely at what is actually driving his digital casino. From its inception, Robinhood was designed to profit by selling its customers’ trading data to the very sharks on Wall Street who have spent decades—and made billions—outmaneuvering investors. In fact, an analysis reveals that the more risk Robinhood’s customers take in their hyperactive trading accounts, the more the Silicon Valley startup profits from the whales it sells their orders to. And while Robinhood’s successful recruitment of inexperienced young traders may have inadvertently minted a few new millionaires riding the debt-fueled bull market, it is also deluding an entire generation into believing that trading options successfully is as easy as leveling up on a video game. Stock options are contracts to buy or sell underlying shares of stocks for a set price over a specified period of time, typically at a fraction of the cost. Given their complexity, options trading has long been the realm of the most sophisticated hedge funds. In 1973, three Ph.D.s—Fisher Black, Myron Scholes and Robert Merton—developed an options pricing model that eventually won them the Nobel Prize in economics. Today their mathematical model, and variations of it, are easily incorporated in trading software so that setting up complicated—and risky—trades is no more than a few clicks away. Even so, making wrong bets is easy. According to the Options Clearing Corporation, more than 20% of all options contracts expire worthless versus 6% “in the money.” In June, Robinhood witnessed firsthand what can happen when such tools are marketed to inexperienced investors. While it’s impossible to discern every factor contributing to suicide, one of Robinhood’s new customers, a 20-year-old college student from Illinois named Alexander Kearns, took his own life after mistakenly thinking that one of his options trades put him in debt to Robinhood for more than $730,000. His death prompted questions from several members of Congress about the platform’s safety. Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model. Despite these problems, millions continue to flock to the addictive app, and Tenev and Bhatt sit on a potential gold mine reminiscent of Facebook in its pre-IPO days. Amid its Covid-19 business surge, Robinhood has raised $800 million from venture investors, ultimately giving it a staggering $11.2 billion valuation, affording its cofounders a paper net worth of $1 billion each. But in light of Morgan Stanley’s success with its $13 billion acquisition of E-Trade in February and Schwab’s earlier purchase of TD Ameritrade for $26 billion, some think Robinhood could garner a $20 billion valuation if it went public or were acquired. The problem is that Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model: selling the little guy to rich market operators with very sharp elbows. The rise of Vladimir Tenev and Baiju Bhatt is a familiar one in the era of technology disruption. They met as undergrads at Stanford University in the summer of 2005. “We had some astounding parallels in our lives,” Bhatt tells Forbes. “We were both only children, we had both grown up in Virginia, we were both studying physics at Stanford, and we were both children of immigrants because our parents were studying Ph.D.s.” Tenev’s family emigrated from Bulgaria, Bhatt’s from India. Tenev, the son of two World Bank staffers, enrolled in UCLA’s math Ph.D. program but dropped out in 2011 to join Bhatt and build software for high-frequency traders. That was shortly after Wall Street’s 2010 “Flash Crash,” a sudden, near-1,000-point plunge in the Dow Jones Industrial Average at the hands of high-speed traders. The extreme volatility exposed how financial markets had mostly moved away from the staid, but stable, New York Stock Exchange and to a smattering of opaque quantitative trading pools dominated by a handful of secretive firms. These so-called “Flash Boys,” who worked milliseconds ahead of orders from both retail and institutional investors, had emerged from lower Manhattan’s back offices and IT departments, as well as university Ph.D. programs, to become the new kings of Wall Street. Billionaires in Sherwood Forest: Forbes 400 members who feast on Robinhood customer trades (from left) Citadel Securities, owned by Ken Griffin; Two Sigma Securities, founded by David Siegel; Virtu Financial founded by Vincent Viola Billionaires in Sherwood Forest: Forbes 400 members who feast on Robinhood customer trades (from left) Citadel Securities, owned by Ken Griffin; Two Sigma Securities, cofounded by David Siegel; Virtu Financial, founded by Vincent Viola DAVID PAUL MORRIS/BLOOMBERG; MISHA FRIEDMAN/BLOOMBERG; WALTER MICHOT/MIAMI HERALD/NEWSCOM At the same time Tenev and Bhatt were getting an insider’s education in how high-frequency traders operate and profit, the outside world was in turmoil, recovering slowly from the battering of the 2008–2009 financial crisis. It all played into the official Robinhood creation story: When the 2011 Occupy Wall Street movement materialized as a protest of bailouts on Wall Street and foreclosures on Main Street, one of Tenev and Bhatt’s friends accused them of profiteering from an unequal system. Soul searching led the pair in 2012 to conceive Robinhood, a trading app with a name that was an explicit reference to leveling the playing field. The most obvious—and disruptive—innovation: no commissions and no minimum balances, at a time when even low-cost rivals like E-Trade and TD Ameritrade made billions on such fees. Initially, Tenev and Bhatt used the allure of exclusivity to capture interest. For their 2013 launch, they restricted access, building up a 50,000-person waiting list. Then they turned the velvet rope into a game, telling prospective users they could move up the waitlist by referring friends. By the time they launched on Apple’s App Store in 2014, Robinhood had a waitlist of 1 million users. They had spent virtually nothing on marketing. Bhatt focused maniacally on app design, trying to make Robinhood “dead simple” to use. iPhones flashed with animations and vibrated when users bought stocks. Every time Bhatt came up with a new feature, he’d run across the street with staffers from Robinhood’s Palo Alto office to Stanford’s campus, approaching random students, asking for feedback. The app won an Apple Design award in 2015, a prize given to just 12 apps that year. Millennial customers started downloading it in droves. By the fall of 2019, Robinhood had raised nearly $1 billion in funding and swelled to a $7.6 billion valuation, with 500 employees and 6 million users. Tenev and Bhatt, both minority owners of Robinhood with estimated 10%-plus stakes, were rich. Flow Rider Robinhood’s entire business is built on selling its customers’ orders to trading titans like Citadel Securities. At Schwab, so-called PFOF or “payment for order flow” only accounts for 3% of revenues. ETrade, 17%. qrFg Sources: Regulatory filings and industry experts. Then, in September 2019, Goliath bowed low to David. Over a 48-hour span, E-Trade, Schwab and TD Ameritrade, industry giants many times Robinhood’s size, cut commissions to $0. A few months later, Merrill Lynch and Wells Fargo’s brokerage unit followed suit. As this source of revenue evaporated, brokerage stocks plunged, and TD Ameritrade soon entered a shotgun marriage with Schwab, while E-Trade ran into the arms of Morgan Stanley. Two Millennials had done something that discount giants like Vanguard and Fidelity could never accomplish. They had dealt the final blow to the easy-money trading commissions that had fed generations of stockbrokers and formed the financial foundation of Wall Street brokerage firms. The secret sauce of Robinhood’s success is something its founders are loath to publicize: From the beginning, Robinhood staked its profitability on something known as “payment for order flow,” or PFOF. Instead of taking fees on the front end in the form of commissions, Tenev and Bhatt would make money behind the scenes, selling their trades to so-called market makers—large, sophisticated quantitative-trading firms like Citadel Securities, Two Sigma Securities, Susquehanna International Group and Virtu Financial. The big firms would feed Robinhood customer orders into their algorithms and seek to profit executing the trades by shaving small fractions off bid and offer prices. Robinhood didn’t invent this selling of orders—E-Trade, for example, earned about $200 million in 2019 through the practice. Unlike most of its competitors, though, Robinhood charges the quants a percentage of the spread on each trade it sells, versus a fixed amount. So when there is a large gap between the bid and asked price, everyone wins—except the customer. Moreover, since Robinhood’s customers tend to trade small quantities of stocks, they are less likely to move markets and are thus lower-risk for the big quants running their models. In the first quarter of 2020, 70% of the firm’s $130 million in revenue was derived from selling its order flow. In the second quarter, Robinhood’s PFOF doubled to $180 million. Given Tenev and Bhatt’s history in the high-frequency trading business, it’s no surprise that they cleverly built their firm around attracting the type of account that would be most desirable to their Wall Street trading-firm clients. What kind of traders make the most saleable chum for giant sharks? Those who chase volatile momentum stocks, caring little about the size of spreads, and those who speculate with options. So Robinhood’s app was designed to appeal to the video-game generation of young, inexperienced investors. Options Trades are Prime Steak for Robinhood’s real customers, the Algorithmic Quant Traders. Besides being given one share of a low-priced stock to start you on your investing journey, one of the first things you notice when you begin trading stocks on Robinhood and are authorized to trade options is that the bright orange button right above BUY on your phone screen says TRADE OPTIONS. Options are sexier than stocks because, like hitting a single number on a roulette wheel, they can offer more bang for the buck. Options trades also happen to be prime steak for Robinhood’s real customers, the algorithmic quant traders. According to a recent report by Piper Sandler, Robinhood gets paid—by the quants—58 cents per 100 shares for options contracts versus only 17 cents per 100 for equities. Options are less liquid than stocks and tend to trade at higher spreads. While the company says only 12% of its customers trade options, those trades accounted for 62% of Robinhood’s order-flow revenues in the first half of 2020. The most delectable of these options trades, according to Paul Rowady of Alphacution, may very well be so-called “Stop Loss Limit Orders,” which give buyers the opportunity to set automatic price triggers that close their positions in an effort either to protect profits or limit losses. In October 2019, Robinhood gleefully announced to its customers, “Options Stop Limit Orders Are Here,” a nifty feature which essentially puts trading on autopilot. “That [stop limit] order is immediately sold to a high-speed trader who now knows where your intention is, where you would sell,” says one former high-speed trader. “It’s like you’re writing a secret on a piece of paper and handing it to your broker, who sells it to someone who has an interest to trade against you.” Robinhood refutes the notion that its model preys on inexperienced investors and claims most of its customers use a buy and hold strategy. “Receipt of payment for order flow is a common, legal and regulated industry business practice,” says a Robinhood spokesperson who insists the app helped customers save $1 billion on trades this year. “We are focused on providing a platform that makes finance accessible and approachable and where people can make thoughtful, informed investing decisions.” Billionaire competitor Thomas Peterffy, the founder of Interactive Brokers, says stop limit orders are the most valuable orders a sophisticated trader can buy. “If people send you orders, you see what they are. You can plot them up along a price axis and see how many buy and sell orders you have at each of those prices,” he says. For instance, if a buyer sees sell orders bunched up around a certain price, it means that if the stock or option hits that price, the market is going to fall hard. “If you are a trader, it’s good for you if you can trigger the stop—you can go short and trigger the stop, and then cover much lower,” Peterffy says. “It’s an old technique.” In a sense, Covid-19 has been both a blessing and a curse for Robinhood. The pandemic forced millions of future Robinhood customers home to shelter in place, free from diversions like sports and armed with fast internet connections and free money from the government. The stock market, meanwhile, provided edge-of-your-seat excitement as it plunged and then soared, propelling superstars like Amazon and reviving walking-dead stocks like Chesapeake Energy. The result was unprecedented growth for the upstart brokerage. Robinhood now has more than 13 million registered customer accounts, nearly as many as venerable Charles Schwab, which after 49 years has 14 million funded accounts, and more than twice as many as E-Trade, with 6 million accounts. WEGva Robinhood Returns Robinhood may profit handsomely from its customers accounts, but that doesn’t mean some aren’t also reaping big rewards. Take the entrepreneur behind Robinhood Slack channel, Todd Capital Options Community, Charles L. Oglesby III, 33. The personal injury lawyer and former stock broker started the business as a hobby with friends who joined him in an investment club focused on stock and options trading, real estate, and even owning networks of vending machines for cash flow. A year ago, he posted a few educational videos on Youtube about options trading that went viral after he promoted them to his Instagram followers. He turned his videos into a tutorial series and charged $139 for access. Once the Covid-19 quarantines started his business exploded and for a month or so his videos were bringing more than $130,000 per week. In March Oglesby started his subscription Slack channel for DIY Robinhood traders, charging 19.99 per month. It now has nearly 4,500 members who pay him some $90,000 a month and hums with activity 24 hours a day, 7 days a week. On Slack, his members share trade ideas and have neatly organized threads like “call outs and research,” where they mine the upcoming earnings reports and option chains in hopes of discovering out-of-the-money call options that might yield a jackpot. There’s an “Options Wins” thread where members post screenshots of big trading wins, and an “Option Loss Analysis” channel to cope with bets that expire worthless. Oglesby even hired a few frequent posters to become “administrators” of the channel, paying them between $500 and $1,000 a month to curate ideas and host weekly conference calls over Zoom. The club is made in large part of working millennial-aged minorities, including a large number of women. Many have turned to trading options on Robinhood to help solve their crushing student loan debts, stagnant wages and address the yawing racial wealth gap. “A lot of these people are in a rush. The idea of compounding 6% off of $1,000 in savings, it’s just not going to do them any good,” says Oglesby.— Antoine Gara The company has also been a game changer for some of its clients. Taylor Hamilton, 23, an IT worker who graduated from the University of Pennsylvania in 2018, opened a Robinhood account and began trading in March. He began buying put options against plummeting travel-industry stocks like Delta and Uber, and later bought calls on Boeing and other beaten-down companies, correctly figuring that they would benefit from the government’s de facto bailout via the bond market. After four months and 300 trades, Hamilton has netted nearly $100,000 and paid down his $15,000 in student loans. “It felt like a once-in-a-lifetime opportunity,” says Hamilton, who reports that he has transferred most of his profits to his bank account to eliminate the temptation to trade away his gains. The pandemic has also exposed Robinhood’s warts. During the market’s 5% one-day swoon and subsequent rebound in early March, Robinhood’s customers were completely shut off from their accounts for nearly two days as the brokerage firm’s technology systems crumpled under the weight of a tenfold jump in order volume. Angry customers lashed out against Robinhood on social media, and more than a dozen lawsuits were filed against the company. In the last few months, Robinhood has quietly been restructuring. Tenev says it’s making major technology investments to increase capacity and add redundancy. A sizable chunk of its $800 million in fresh venture capital is going toward upgrades and adding engineers to the 300 already on staff. In the wake of the Kearns tragedy, Robinhood’s options-trading interface is also being overhauled. The company has pledged to help educate its customers on the highly speculative nature of the trades. That includes hiring an “Options Education Specialist” and “rolling out improvements to in-app messages and emails” that it sends to customers about their complex options trades. In August, the brokerage app said it would hire hundreds of new customer-service representatives in its Texas and Arizona offices by the end of 2020. According to insiders, there’s a sense of urgency at the company these days. For two years, Robinhood has been speaking publicly about an IPO. With interest rates near zero and the stock market roaring, the public-offering window is wide open, but it won’t be forever. A better option—especially considering Robinhood’s current problems—might be a quick sale to a full-service firm such as Goldman Sachs, UBS or Merrill Lynch. Such a sale would surely provide billion-dollar windfalls for its young founders, Tenev and Bhatt. And as any good trader knows, it’s much better to sell when you can than when you have to.

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 From Forbes

By Jeff Kauflin, Antoine Gara and Sergei Klebnikov

It’s just after midnight on Friday, July 31, and the Todd Capital Options Community, a $20-per-month subscription Slack channel favored by thousands of novice options traders, is buzzing with life. Unemployment is soaring and governments worldwide are desperately trying to fend off economic collapse. But members of this online enclave are partying, quite literally, like it’s 1999—the infamously frothy day-trading year before the dot-com bubble burst in March 2000. 

Despite the pandemic, Amazon, Apple, Facebook and Google have just released jaw-dropping financial results, a staggering $205 billion in combined quarterly sales and $34 billion in earnings during a stretch when U.S. gross domestic product plunged at an annualized rate of 33%. For weeks, the club’s youthful members have been loading up on speculative call options using the mobile trading app Robinhood. Now they’re ready to cash in. 

“Literally, NOTHING will make me sell my AMZN 10/16 calls tomorrow. I don’t care what happens. . . . I’m holding everything. Keep ya boi in your prayers,” says one user named JG. As dawn approaches, “NBA Young Bull” announces: “Good morning future millionaires . . . is it 9:30 yet?” 

For these speculators, the adrenaline rush turned to euphoria after Apple not only beat earnings expectations but announced a 4-for-1 stock split, luring more small investors to the iPhone maker’s stock party. At 9:30 a.m. Friday, when trading begins, the call options on Apple and Amazon held by many of these market newbies pay out like Las Vegas slot machines hitting 7-7-7 as both tech giants gain a collective quarter-trillion dollars in market value. Throughout the day and over the weekend, a stream of posts scroll by from exuberant Robinhood traders going by screen names like “See Profit Take Profit” and “My Options Give Me Options.” On Monday, August 3, the Nasdaq index sets a new record high. (see Robinhood Returns below)

Welcome to the stock market, Robinhood-style. Since February, as the global economy collapsed under the weight of the coronavirus pandemic, millions of novices, armed with $1,200 stimulus checks and nothing much to do, have begun trading via Silicon Valley upstart Robinhood—the phone-friendly discount brokerage founded in 2013 by Vladimir Tenev, 33, and Baiju Bhatt, 35. 

The young entrepreneurs built their rocketship by applying the formula Facebook made famous: Their app was free, easy to use and addictive. And Robinhood—named for the legendary medieval outlaw who took from the rich and gave to the poor—had a mission even the most woke, capitalism-weary Millennial could get behind: to “democratize finance for all.” 

Covid-19 and the flow of government handouts have been manna from heaven for Robinhood. The firm has added more than 3 million accounts since January, a 30% rise, and it expects revenue to hit $700 million this year, a 250% spike from 2019, according to a person familiar with the private company’s finances. Not since May Day 1975, when the SEC deregulated brokerage commissions, giving rise to discount brokerages like Charles Schwab, has there been a more disruptive force in the retail stock market. Robinhood’s commission-free trading is now standard at firms including TD Ameritrade, Fidelity, Schwab, Vanguard and Merrill Lynch. 

And Robinhood’s merry traders are moving markets: Certain stocks—Elon Musk’s Tesla, marijuana conglomerate Cronos, casino operator Penn National Gaming and even bankrupt car-rental company Hertz—have become favorites, swinging wildly on a daily basis. For the first time ever, according to Goldman Sachs, options speculators like the ones Robinhood has cultivated have caused single-stock option-trading volumes to eclipse common-stock trading volumes, surging an unprecedented 129% this year. 

Lord of the Buys

The Covid bull market has been a godsend for retail brokers, but Robinhood and its swarm of newbie traders is schooling the competition.

“I think you’ve seen a unique situation in the history of financial markets,” Tenev tells Forbes, working remotely from his home not far from Robinhood’s Menlo Park, California, headquarters, which resemble a beach house. “Typically when a market crash is followed by a recession, retail investors pull out. Institutions benefit. . . . In this case, Robinhood customers started opening new accounts and existing customers started putting in new money. This bodes positively for society and our economy if millions are investing when they otherwise wouldn’t have.” 

Like any skilled trader, Tenev is talking his book. His proclamations ring a bit hollow, though, once you look more closely at what is actually driving his digital casino. From its inception, Robinhood was designed to profit by selling its customers’ trading data to the very sharks on Wall Street who have spent decades—and made billions—outmaneuvering investors. In fact, an analysis reveals that the more risk Robinhood’s customers take in their hyperactive trading accounts, the more the Silicon Valley startup profits from the whales it sells their orders to. And while Robinhood’s successful recruitment of inexperienced young traders may have inadvertently minted a few new millionaires riding the debt-fueled bull market, it is also deluding an entire generation into believing that trading options successfully is as easy as leveling up on a video game. 

Stock options are contracts to buy or sell underlying shares of stocks for a set price over a specified period of time, typically at a fraction of the cost. Given their complexity, options trading has long been the realm of the most sophisticated hedge funds. In 1973, three Ph.D.s—Fisher Black, Myron Scholes and Robert Merton—developed an options pricing model that eventually won them the Nobel Prize in economics. Today their mathematical model, and variations of it, are easily incorporated in trading software so that setting up complicated—and risky—trades is no more than a few clicks away. Even so, making wrong bets is easy. According to the Options Clearing Corporation, more than 20% of all options contracts expire worthless versus 6% “in the money.” 

In June, Robinhood witnessed firsthand what can happen when such tools are marketed to inexperienced investors. While it’s impossible to discern every factor contributing to suicide, one of Robinhood’s new customers, a 20-year-old college student from Illinois named Alexander Kearns, took his own life after mistakenly thinking that one of his options trades put him in debt to Robinhood for more than $730,000. His death prompted questions from several members of Congress about the platform’s safety. 

Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model.

Despite these problems, millions continue to flock to the addictive app, and Tenev and Bhatt sit on a potential gold mine reminiscent of Facebook in its pre-IPO days. Amid its Covid-19 business surge, Robinhood has raised $800 million from venture investors, ultimately giving it a staggering $11.2 billion valuation, affording its cofounders a paper net worth of $1 billion each. But in light of Morgan Stanley’s success with its $13 billion acquisition of E-Trade in February and Schwab’s earlier purchase of TD Ameritrade for $26 billion, some think Robinhood could garner a $20 billion valuation if it went public or were acquired. 

The problem is that Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model: selling the little guy to rich market operators with very sharp elbows. 


The rise of Vladimir Tenev and Baiju Bhatt is a familiar one in the era of technology disruption. 

They met as undergrads at Stanford University in the summer of 2005. “We had some astounding parallels in our lives,” Bhatt tells Forbes. “We were both only children, we had both grown up in Virginia, we were both studying physics at Stanford, and we were both children of immigrants because our parents were studying Ph.D.s.” Tenev’s family emigrated from Bulgaria, Bhatt’s from India. 

Tenev, the son of two World Bank staffers, enrolled in UCLA’s math Ph.D. program but dropped out in 2011 to join Bhatt and build software for high-frequency traders. That was shortly after Wall Street’s 2010 “Flash Crash,” a sudden, near-1,000-point plunge in the Dow Jones Industrial Average at the hands of high-speed traders. The extreme volatility exposed how financial markets had mostly moved away from the staid, but stable, New York Stock Exchange and to a smattering of opaque quantitative trading pools dominated by a handful of secretive firms. These so-called “Flash Boys,” who worked milliseconds ahead of orders from both retail and institutional investors, had emerged from lower Manhattan’s back offices and IT departments, as well as university Ph.D. programs, to become the new kings of Wall Street. 

At the same time Tenev and Bhatt were getting an insider’s education in how high-frequency traders operate and profit, the outside world was in turmoil, recovering slowly from the battering of the 2008–2009 financial crisis. It all played into the official Robinhood creation story: When the 2011 Occupy Wall Street movement materialized as a protest of bailouts on Wall Street and foreclosures on Main Street, one of Tenev and Bhatt’s friends accused them of profiteering from an unequal system. Soul searching led the pair in 2012 to conceive Robinhood, a trading app with a name that was an explicit reference to leveling the playing field. The most obvious—and disruptive—innovation: no commissions and no minimum balances, at a time when even low-cost rivals like E-Trade and TD Ameritrade made billions on such fees. 

Initially, Tenev and Bhatt used the allure of exclusivity to capture interest. For their 2013 launch, they restricted access, building up a 50,000-person waiting list. Then they turned the velvet rope into a game, telling prospective users they could move up the waitlist by referring friends. By the time they launched on Apple’s App Store in 2014, Robinhood had a waitlist of 1 million users. They had spent virtually nothing on marketing. 

Bhatt focused maniacally on app design, trying to make Robinhood “dead simple” to use. iPhones flashed with animations and vibrated when users bought stocks. Every time Bhatt came up with a new feature, he’d run across the street with staffers from Robinhood’s Palo Alto office to Stanford’s campus, approaching random students, asking for feedback. The app won an Apple Design award in 2015, a prize given to just 12 apps that year. Millennial customers started downloading it in droves. 

By the fall of 2019, Robinhood had raised nearly $1 billion in funding and swelled to a $7.6 billion valuation, with 500 employees and 6 million users. Tenev and Bhatt, both minority owners of Robinhood with estimated 10%-plus stakes, were rich. 

Flow Rider

Robinhood's entire business is built on selling its customers’ orders to trading titans like Citadel Securities. At Schwab, so-called PFOF or “payment for order flow” only accounts for 3% of revenues. ETrade, 17%.

Then, in September 2019, Goliath bowed low to David. Over a 48-hour span, E-Trade, Schwab and TD Ameritrade, industry giants many times Robinhood’s size, cut commissions to $0. A few months later, Merrill Lynch and Wells Fargo’s brokerage unit followed suit. As this source of revenue evaporated, brokerage stocks plunged, and TD Ameritrade soon entered a shotgun marriage with Schwab, while E-Trade ran into the arms of Morgan Stanley. 

Two Millennials had done something that discount giants like Vanguard and Fidelity could never accomplish. They had dealt the final blow to the easy-money trading commissions that had fed generations of stockbrokers and formed the financial foundation of Wall Street brokerage firms. 

The secret sauce of Robinhood’s success is something its founders are loath to publicize: From the beginning, Robinhood staked its profitability on something known as “payment for order flow,” or PFOF. 

Instead of taking fees on the front end in the form of commissions, Tenev and Bhatt would make money behind the scenes, selling their trades to so-called market makers—large, sophisticated quantitative-trading firms like Citadel Securities, Two Sigma Securities, Susquehanna International Group and Virtu Financial. The big firms would feed Robinhood customer orders into their algorithms and seek to profit executing the trades by shaving small fractions off bid and offer prices. 

Robinhood didn’t invent this selling of orders—E-Trade, for example, earned about $200 million in 2019 through the practice. Unlike most of its competitors, though, Robinhood charges the quants a percentage of the spread on each trade it sells, versus a fixed amount. So when there is a large gap between the bid and asked price, everyone wins—except the customer. Moreover, since Robinhood’s customers tend to trade small quantities of stocks, they are less likely to move markets and are thus lower-risk for the big quants running their models. In the first quarter of 2020, 70% of the firm’s $130 million in revenue was derived from selling its order flow. In the second quarter, Robinhood’s PFOF doubled to $180 million. 

Given Tenev and Bhatt’s history in the high-frequency trading business, it’s no surprise that they cleverly built their firm around attracting the type of account that would be most desirable to their Wall Street trading-firm clients. What kind of traders make the most saleable chum for giant sharks? Those who chase volatile momentum stocks, caring little about the size of spreads, and those who speculate with options. So Robinhood’s app was designed to appeal to the video-game generation of young, inexperienced investors. 

Options Trades are Prime Steak for Robinhood’s real customers, the Algorithmic Quant Traders.

Besides being given one share of a low-priced stock to start you on your investing journey, one of the first things you notice when you begin trading stocks on Robinhood and are authorized to trade options is that the bright orange button right above BUY on your phone screen says TRADE OPTIONS. Options are sexier than stocks because, like hitting a single number on a roulette wheel, they can offer more bang for the buck.

Options trades also happen to be prime steak for Robinhood’s real customers, the algorithmic quant traders. According to a recent report by Piper Sandler, Robinhood gets paid—by the quants—58 cents per 100 shares for options contracts versus only 17 cents per 100 for equities. Options are less liquid than stocks and tend to trade at higher spreads. While the company says only 12% of its customers trade options, those trades accounted for 62% of Robinhood’s order-flow revenues in the first half of 2020. 

The most delectable of these options trades, according to Paul Rowady of Alphacution, may very well be so-called “Stop Loss Limit Orders,” which give buyers the opportunity to set automatic price triggers that close their positions in an effort either to protect profits or limit losses. In October 2019, Robinhood gleefully announced to its customers, “Options Stop Limit Orders Are Here,” a nifty feature which essentially puts trading on autopilot. 

“That [stop limit] order is immediately sold to a high-speed trader who now knows where your intention is, where you would sell,” says one former high-speed trader. “It’s like you’re writing a secret on a piece of paper and handing it to your broker, who sells it to someone who has an interest to trade against you.” 

Robinhood refutes the notion that its model preys on inexperienced investors and claims most of its customers use a buy and hold strategy. “Receipt of payment for order flow is a common, legal and regulated industry business practice,” says a Robinhood spokesperson who insists the app helped customers save $1 billion on trades this year. “We are focused on providing a platform that makes finance accessible and approachable and where people can make thoughtful, informed investing decisions.” 

Billionaire competitor Thomas Peterffy, the founder of Interactive Brokers, says stop limit orders are the most valuable orders a sophisticated trader can buy. “If people send you orders, you see what they are. You can plot them up along a price axis and see how many buy and sell orders you have at each of those prices,” he says. 

For instance, if a buyer sees sell orders bunched up around a certain price, it means that if the stock or option hits that price, the market is going to fall hard. “If you are a trader, it’s good for you if you can trigger the stop—you can go short and trigger the stop, and then cover much lower,” Peterffy says. “It’s an old technique.” 

In a sense, Covid-19 has been both a blessing and a curse for Robinhood. 

The pandemic forced millions of future Robinhood customers home to shelter in place, free from diversions like sports and armed with fast internet connections and free money from the government. The stock market, meanwhile, provided edge-of-your-seat excitement as it plunged and then soared, propelling superstars like Amazon and reviving walking-dead stocks like Chesapeake Energy. The result was unprecedented growth for the upstart brokerage. Robinhood now has more than 13 million registered customer accounts, nearly as many as venerable Charles Schwab, which after 49 years has 14 million funded accounts, and more than twice as many as E-Trade, with 6 million accounts. 

Robinhood Returns

Robinhood may profit handsomely from its customers accounts, but that doesn’t mean some aren't also reaping big rewards. Take the entrepreneur behind Robinhood Slack channel, Todd Capital Options Community, Charles L. Oglesby III, 33. The personal injury lawyer and former stock broker started the business as a hobby with friends who joined him in an investment club focused on stock and options trading, real estate, and even owning networks of vending machines for cash flow. A year ago, he posted a few educational videos on Youtube about options trading that went viral after he promoted them to his Instagram followers. He turned his videos into a tutorial series and charged $139 for access. 

Once the Covid-19 quarantines started his business exploded and for a month or so his videos were bringing more than $130,000 per week. In March Oglesby started his subscription Slack channel for DIY Robinhood traders, charging 19.99 per month. It now has nearly 4,500 members who pay him some $90,000 a month and hums with activity 24 hours a day, 7 days a week. 

On Slack, his members share trade ideas and have neatly organized threads like “call outs and research,” where they mine the upcoming earnings reports and option chains in hopes of discovering out-of-the-money call options that might yield a jackpot. There’s an “Options Wins” thread where members post screenshots of big trading wins, and an “Option Loss Analysis” channel to cope with bets that expire worthless. Oglesby even hired a few frequent posters to become “administrators” of the channel, paying them between $500 and $1,000 a month to curate ideas and host weekly conference calls over Zoom.

The club is made in large part of working millennial-aged minorities, including a large number of women. Many have turned to trading options on Robinhood to help solve their crushing student loan debts, stagnant wages and address the yawing racial wealth gap.

“A lot of these people are in a rush. The idea of compounding 6% off of $1,000 in savings, it's just not going to do them any good,” says Oglesby.— Antoine Gara


The company has also been a game changer for some of its clients. Taylor Hamilton, 23, an IT worker who graduated from the University of Pennsylvania in 2018, opened a Robinhood account and began trading in March. He began buying put options against plummeting travel-industry stocks like Delta and Uber, and later bought calls on Boeing and other beaten-down companies, correctly figuring that they would benefit from the government’s de facto bailout via the bond market. 

After four months and 300 trades, Hamilton has netted nearly $100,000 and paid down his $15,000 in student loans. “It felt like a once-in-a-lifetime opportunity,” says Hamilton, who reports that he has transferred most of his profits to his bank account to eliminate the temptation to trade away his gains. 

The pandemic has also exposed Robinhood’s warts. During the market’s 5% one-day swoon and subsequent rebound in early March, Robinhood’s customers were completely shut off from their accounts for nearly two days as the brokerage firm’s technology systems crumpled under the weight of a tenfold jump in order volume. Angry customers lashed out against Robinhood on social media, and more than a dozen lawsuits were filed against the company.

In the last few months, Robinhood has quietly been restructuring. Tenev says it’s making major technology investments to increase capacity and add redundancy. A sizable chunk of its $800 million in fresh venture capital is going toward upgrades and adding engineers to the 300 already on staff. 

In the wake of the Kearns tragedy, Robinhood’s options-trading interface is also being overhauled. The company has pledged to help educate its customers on the highly speculative nature of the trades. That includes hiring an “Options Education Specialist” and “rolling out improvements to in-app messages and emails” that it sends to customers about their complex options trades. In August, the brokerage app said it would hire hundreds of new customer-service representatives in its Texas and Arizona offices by the end of 2020. 

According to insiders, there’s a sense of urgency at the company these days. For two years, Robinhood has been speaking publicly about an IPO. With interest rates near zero and the stock market roaring, the public-offering window is wide open, but it won’t be forever. 

A better option—especially considering Robinhood’s current problems—might be a quick sale to a full-service firm such as Goldman Sachs, UBS or Merrill Lynch. Such a sale would surely provide billion-dollar windfalls for its young founders, Tenev and Bhatt. And as any good trader knows, it’s much better to sell when you can than when you have to. 

Gamestopped – an analysis of the GME situation

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https://thequintessentialcentrist.com/issues/issue-97/gamestopped

Last week, in a historic sequence of events on Wall Street, the struggling mall-based videogame retailer GameStop (Ticker: GME) was the subject of an epic “short squeeze” ignited primarily by individual investors on the Reddit message board r/wallstreetbets (WSB). Members of WSB implored each other to purchase shares of GME; a buying frenzy ensued. The stock, heavily “shorted” by certain hedge funds and other professional investors increased to nearly $500, up from just ~$20 in early January. Additional stocks including AMC Entertainment (AMC), BlackBerry (BB), Bed Bath & Beyond (BBBY), and a few others were caught up in the buying hysteria. Hedge funds and other professional investors suffered severe losses. After the fact, certain WSB members and other retail investors were in a jovial, celebratory mood. Together, they bet against the supposed smartest people in the room…and won. It was an apparent victory for the little guy. Or was it?

What Happened

During the speculative mania’s zenith, the retail stock and options trading platform Robinhood enacted sudden changes to their platform. Without warning, account holders were banned and or severely curtailed from trading in the shares of GME and other heavily volatile stocks; only sell orders to liquidate existing positions were permitted. Immediately thereafter, a collective rage took hold.

Politicians on both sides of the aisle, Robinhood customers, market pundits, and even entertainers lashed out at Robinhood. In their view, the brokerage firm’s actions unfairly punished individual investors while professionals were left unscathed. Said David Portnoy, founder of the popular website Barstool Sports, “@RobinhoodApp entire business model is to cater to the exact people they are now trying to fck with and scare into selling. They will never recover from this.” As usual, Senator Elizabeth Warren (D-MA) blamed “hedge funds, private-equity firms and wealthy investors…for…treating the stock market like their own personal casino while everyone else pays the price.” Gavin Wax, President of the New York Young Republican Club accused Wall Street of “corporatizing the American dream and making a mockery of American freedom.” Curtis Sliwa, founder of The Guardian Angels, a “volunteer organization of unarmed crime-prevention,” apparently had a change of heart when he encouraged his followers to “get these hedge-fund monsters before they get us.” In a rare moment of unity, Alexandria Ocasio Cortez (AOC) (D-NY) & Ted Cruz (R-TX) both voiced their displeasure at Robinhood for helping hedge funds to the detriment of day traders. How ironic, for the first time in political history, AOC and Ted Cruz agreed…and they were both wrong. Let us be clear, the optics (and explanation) of what transpired were abysmal. That said, the statements above are categorically incorrect, highly irresponsible and were spit by people who share one important property in common. They have absolutely no clue what they are talking about.

In truth, the happenings of last week were complex, multi-faceted, and extremely granular. They involved the plumbing of financial markets that very few people, except dedicated experts, fully comprehend. In fact, many people who work in finance themselves do not fully grasp the magnitude of terms such as T+2 trade settlement, margin calls, margin loans, collateral, collateral calls, implied volatility, and so forth, that are closely intertwined and imperative in maintaining an orderly process of buying, selling, and shorting stocks and settling those trades. In this post, we will try our best to explain, in plain English, what transpired and dispel many of the falsehoods that are circulating on (and off) line.

Capital Punishment: Why Robinhood Restricted Trading

Did Robinhood restrict trading to “screw the little guy,” as Curtis Sliwa so eloquently espoused? How about to bail out hedge funds that were caught in a short squeeze? Or to help Citadel and Point72, two firms that injected capital into a hedge fund called Melvin, that had suffered losses in GME? Or did Robinhood throttle back because they are in the view of Mr. Portnoy, “the biggest frauds of them all” and because “too many ordinary people are getting rich”? The simple answer(s) to all these questions is unequivocally “no.”

Robinhood curbed trading because a sudden onset of activity concentrated in a few stocks, combined with the volatility of those stocks, left them desperately short of cash. If they did not take decisive action, they risked insolvency. In fact, in addition to restricting trading, Robinhood simultaneously drew down all their existing credit lines. Worth noting is that drawing on credit lines is an expensive form of financing. Firms draw on credit lines when they must, not because they want to. Finally, to further strengthen their balance sheet, Robinhood raised billions of dollars of additional capital as expeditiously as possible.

But Wait, How Could Robinhood “Run Out Of Cash”?

When an investor purchases (or sells) a stock, they see (and have come to expect) the funds credited (or debited) to their account instantaneously. Typically, they can use those funds to purchase another security, withdraw the cash, and or for collateral. What they do not see is the backend complexities that must work seamlessly for the aforementioned to be facilitated.

Unbeknownst to most investors is that almost all stock trades take 2 business days to “settle.” In Wall Street parlance, this is called T+2 settlement. Because there is a lag from the time a trade is executed to the time it settles, an investor’s broker – in this case Robinhood – must ensure they have enough cash on hand to meet customer demands until the trade settles. And since so many customers were trading GME at one time, often on the same “side” of the trade, Robinhood’s cash position dropped precipitously.

Like all brokers, Robinhood allows qualified clients to trade on “margin,” or with borrowed money. Robinhood earns a fee for providing this financing. However, should one of their customers fail to meet a margin call (pay back the loan), Robinhood would be on the hook for the funds. Some customers were buying shares of GME using borrowed funds (or margin). If the shares of GME dropped by a certain percentage, a customer might face a “margin call,” meaning the balance in their account had fallen below a minimum maintenance level required by law. When this happens, an investor must deposit more funds into their account. If they fail to do so, their broker is obliged to liquidate some or all their remaining holdings to satisfy the margin call. If the cash derived from liquidating a customer’s account is not sufficient to cover the margin call, the broker (Robinhood) is responsible for the balance. A disproportionate amount of customers trading shares in one extremely volatile stock, GME, thrusted Robinhood into an extraordinarily difficult and highly unusual situation; too many customers might be unable to meet margin calls simultaneously, forcing Robinhood to draw down their cash reserves to fill the difference.

Finally, all brokers clear and settle trades through an intermediary called The Depository Trust and Clearing Corporation (DTCC). To better understand what DTCC’s function is, imagine it as a broker to all brokers, or a reinsurer to all brokers. The “buck” excuse the pun, stops with them. The DTCC demands cash collateral (think of it as an insurance premium) from all clearing brokers, including Robinhood. The amount of capital they require depends on various quantitative factors (think of how an insurance company prices a life insurance policy). When market conditions change, the DTCC can, and often does, demand more (or less) collateral from clearing brokers. Last week’s buying binge in a few highly speculative, volatile stocks prompted DTCC to raise cash collateral requirements to protect the financial system’s integrity. Because Robinhood had a disproportionate number of retail accounts trading in these securities, they had to come up with a lot of cash, and quickly. Robinhood was far from the only affected broker. Noted Thomas Peterffy, the well-respected chairman of the brokerage firm Interactive Brokers, (we were) "concerned about the ability of the market and the clearing systems, through the onslaught of orders, to continue to provide liquidity. And we are concerned about the financial viability of intermediaries and the clearing houses.”

Paying For Order Flow

Robinhood does not charge brokerage commissions for stock and options trading; customers can trade for free. Indeed, the lure of zero commissions has been a huge driver of demand for retail brokerage services throughout the financial services community. This then begs the question: How does Robinhood make money? One way is by charging interest to customers who trade on margin. Another way is through something called “payment for order flow.” Here is an oversimplification of how it works: Retail brokerage firms like Robinhood, Ameritrade, Fidelity, etc., route customer orders to sophisticated firms called market makers in exchange for cash payments. Two of the largest market makers are Citadel Securities and Virtu Financial. These firms and other market makers pay for this order flow for the simple reason that they can trade against it for a profit.

The merits of paying for order flow go well beyond the scope of this post. In short, detractors say there is an inherent conflict of interest. Advocates say it facilitates low or no cost trading for individual investors and the opportunity for “price improvement." In this post, we only mention payment for order flow to dispel some nonsensical arguments from a peanut gallery of ill-informed charlatans. Suppose Robinhood was out to “screw the little guy” and or involved in a conspiracy with other professional market participants to illegally profit at the expense of individual investors. Why would they restrict trading in their most heavily traded stocks and by doing so, have less customer order flow to sell and earn a profit from? They would not. Bottom line, the more Robinhood’s customers trade, the more order flow Robinhood can sell; the more order flow Robinhood sells, the more money Robinhood makes, not the other way around.

Legitimate Beef

The action taken by Robinhood and many other retail brokers last week was not only correct, but it was also well within their legal rights. Still, it is also worth calling out certain market professionals on their hypocrisy; for in the past, they have profited from the very thing they are now complaining about, which is a coordinated a short squeeze. This time, however, they were the ones nursing losses.

Said Nicholas Colas, co-founder of DataTrek Research, “Retail investor wolf packs are new, but if you’ve ever sat on a hedge fund trading desk you know squeezing shorts has been a Wall Street blood sport for decades.”

Most professional investors are honest, hard-working people that adhere to the rules and (try to) earn legitimate profits. They do not get involved in activities that stretch the bounds of legality. Still, we can certainly understand and appreciate why the general public has little if any sympathy for a few hedge fund managers crying foul because now, instead of them orchestrating and profiting from a short- squeeze by sharing information at an idea dinner or investment summit, it is retail investors on reddit doing something similar.

Short Sellers & Short Sightedness

True to form in acting reactively instead of proactively, the Senate Banking Committee and other regulators will hold hearings on the “current state of the stock market.” Among the topics of discussion will be restrictions or even banning the practice of short selling. This is a terrible idea.

Short sellers are good for the stock market. And despite what some ill-informed people say, short selling specialists protect individual investors in a myriad of ways. How? Traditional Wall Street analysts almost always (~90%) have “Buy” or “Hold” recommendations on stocks. One reason for this is because financial malfeasance is often extraordinarily difficult to identify. Short sellers are experts at rooting out nefarious behavior. They provide a vital service to individual investors, sniffing out corporate misdeeds such as aggressive accounting and even outright fraud. Their research helps keep companies honest and investors well-informed. Worth noting, it was not Wall Street analysts that alerted the investing public (and regulators) about the multi-billion-dollar frauds Enron, WorldCom and SinoForest. It was short sellers. Finally, during normal stock market corrections short sellers often purchase shares they have previously sold short to close out their trades. This helps stabilize the market during a downturn, when most market participants want to sell. Eliminate short selling, and you eliminate a natural buyer of stocks, at precisely the juncture when you need them most.

Renaissance Hit With $5 Billion In Redemptions After “Terrible” Returns

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 From Zero hedge:

At the end of January, when the Reddit revolt was wrecking havoc among hedge funds and forcing even market neutral quants to degross and delever, we pointed out something unexpected: according to the latest HSBC Hedge Fund performance tracker, Renaissance's public funds - RIEF and RIDA - had a dismal 2020, losing 20% and 32% respectively, while the Renaissance Institutional Diversified Global Equities Fund (RIDGE) lost 31% as Rentec's famous quant algos were thrown out of whack by swings the computers had never seen or experienced before (which is not to say that RenTec's private, internal "friends and family-only" Medallion fund suffered a similar fate, quite the opposite).

This prompted us to ask "what the hell is going on in Setauket" (where RenTec's HQ is located), a question which gained even more urgency once we found out that the dismal streak of the world's largest quant fund (RenTec manages around $60BN) had continued into 2021, when its funds were the top and 5th worst performers overall in January (while Senvest was by far the best on the back of its $700 million gain from going long GME stock).

It turns out we were not the only ones closely watching the dismal recent returns at the world's most profitable hedge fund, because as Bloomberg writes this morning, the "investing giant that just posted its worst-ever returns across its public funds, has been hit with at least $5 billion in redemptions", a staggering reversal in fortune for a fund which always had a line of people around the corner just waiting to get be admitted.

According to the report, after clients pulled $1.85 billion across the three hedge funds in December (RIEF, RIDA, RIDGE), they also hit the Jim Simons' money machine with another $1.9 billion in January, and are poised to yank another $1.65 billion this month. While those figures could be offset if there are any inflows in February or if investors decided to walk back any of their redemption requests, that does not seem very likely after the staggering underperformance of the quant hedge fund.

Of course, for RenTec founder and former codebreaker Jim Simons none of this matters, because while the public facing funds are a convenient hedge, in the grand scheme of things they are tiny; the real money at Rentec is made at Medallion - the iconic fund reserved for employees and insiders - and in 2020 it soared 76% last year, according to Institutional Investor.

This kind of discrepancy between internally managed funds and capital run for outside investors is truly unprecedented, and should prompt at least one regulator to ask what is going on. The last time they did, they found that another iconic fund - Michael Platt 's BlueCrest - had secretly transferred its best traders from managing outside capital to just running the firm's own money, while assigning crappy algos to "manage" outside money by piggybacking on internal trades after they were already put on (Platt received a $170MM slap on the wrist and all was forgotten).

In other words, as we explained in December, "when managing its own money, the macro fund would dedicate its best traders to come up with the top trades, and not only that but it would effectively frontrun its clients! Then, when the time came to manage client money, BlueCrest basically used a simply copycat algo to piggyback on its top trades but only after the management team was already in the positions, thus giving it substantial firepower to generate alpha simply by having billions in fund flows rush into the same trades it had already put on, creating a feedback loop. We wonder if BlueCrest also unloaded its own positions by selling them to its own clients."

Surely RenTec would never abuse its fiduciary duty so blatantly as to allow Medallion to frontrun the public fund trades... Surely.

Back in September, Renaissance told clients that its losses were due to being under-hedged during March’s collapse and then over-hedged in the rebound from April through June. That happened because its trading models “overcompensated” for the original trouble (translation: RenTec's models had no idea what they were doing).

Renaissance then again addressed its dismal returns in a December letter, which Bloomberg got access to:

“Although recent performance has been terrible and worse than prior performance would have suggested was likely for 2020,” the firm said, its model “anticipates that in track records as long as ours, some risk-return ratios every bit as bad as the ones we are now seeing are not shocking.”

The broader lesson is that “one should expect even good investments to perform horribly from time to time.”

Well, the returns may have been "terrible" for anyone who foolishly assumed that Simons & Co. would put the same care in managing outside money as they allocate to their own funds. Because while most outside investors have lost over a third of their investment in the past year, RenTec's internal Medallion fund is up nearly 80% in the same period. How much longer will this divergence continue, we wonder, before someone asks the obvious question: why?

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