Yesterday’s house finances The services committee hearing about GameStop and Robinhood wasn’t great. Reuters has a good summary of one of its few interesting things, a rift between elected Inquisitors and Robinhood CEO Vlad Tenev over whether his company needs to raise additional capital to continue operating during the saga. GameStop; TechCrunch has reported on the matter since its inception, although it has been helpful to learn a bit more.
Lawmakers have also succeeded in extracting an interesting, much-awaited data point: the company generates more than half of his income Payment for Order Flow (PFOF), a controversial practice in which Robinhood is paid by market makers for executing transactions with customers.
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PFOF skeptics argue that the setup effectively transforms users of neo-trading services that monetize their order volume into sold product, leaving retail investors vulnerable to poor trade execution prices. Robinhood has had trade pricing issues in the past. But those who don’t see PFOF as an inherent problem argue that it gives consumers low-cost access to equity markets. It’s fair enough.
It doesn’t matter where you land in between – or even sure – these two poles are irrelevant. PFOF does not appear to be in significant danger of being regulated, and Robinhood’s use of the business model has enabled it to generate tremendous growth in 2020. As a prospect, Robinhood’s PFOF revenues have increased dramatically. ‘from just over $ 90 million in Q1 2020 to around $ 220 million in the fourth quarter.
How many users did it take to generate these PFOF sums? Tenev also told Congress in his written testimony that Robinhood has more than 13 million “customers,” although we are unclear on who counts as a customer. But those millions also don’t monetize. Some of those 13 million users are more lucrative than others.
To figure this out, let’s start by working out what fraction of Robinhood users are trading options. Here is Tenev, via his testimony:
[A]At the end of 2020, around 13% of Robinhood’s clients had traded basic options contracts (for example, puts and calls), and only around 2% had traded multi-level options. Less than 3% of funded accounts had margins.
This, combined with the fact that Tenev has allowed PFOF revenues to make up the majority of its revenues, leads to an interesting conclusion: a fairly small fraction of Robinhood users are responsible for the vast majority of its revenues. We can say that this is the case by recalling that when we look at the PFOF data, Robinhood’s income from transactions in S&P 500 shares is modest, its income from transactions involving non-S&P 500 shares is somewhat larger. and its income from options order flow the majority of reported income in recent periods.
For example, during the months of October, November and December, TechCrunch calculates that Robinhood’s PFOF earnings were approximately 67%, 64% and 63% derived from options, respectively.
For reference, 13% of 13 million equals 1.69 million. This is the number of Robinhood users that we estimate to have traded options. The number of multileg options is 260,000 much smaller users.