Interactive Brokers CEO Thomas Peterffy on Bitcoin

Just reading the Interactive Brokers Q3-2017 conference call, we have the following amusing dialog between an analyst and CEO Thomas Peterffy:

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Mac Sykes
Understood. And when I think of IBG, I think of technology innovation, a broad suite of global product vehicles and as you mentioned, sophisticated traders. And love it or hate it at this point, Bitcoin’s market cap is now about 1/3 of JPMorgan’s. So 2 questions on this. Have you considered accessing this marketplace? And number two, have you heard client feedback asking for this kind of access?

Thomas Peterffy
The answer is yes to both, and the result is that we’re not going to do it.

Mac Sykes
Got it. What would make you just change your mind?

Thomas Peterffy
If the United States of America said, you know, besides dollars, we also have Bitcoins, and you can pay your taxes in Bitcoins, we would be the first one to go and do it.

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Ouch. Interactive Brokers is a brilliant, brilliantly run company, but the public entity is a company that only owns 17.4% of the actual operation. It is primarily for this reason and valuation that I am not an investor, but it is up nearly 50% over the past half year and strategically I think they are hitting every correct button in their business execution.

Overall market thoughts – volatility – fossil fuels

This is another rambling post with no coherency. The quarterly reports from companies are flowing in and I am reading them – but there are few companies that are below my price range where I start to care about them in detail. As such, my research pipeline at this point is in the exploratory mode rather than doing detailed due diligence.

It is in the middle of summer and I am not expecting much in the way of volatility – it is truly a summer where major portfolio decision-makers have decided to take away from the trigger switches.

Accordingly I have been sitting and watching with respect to my own portfolio while I do my casual research. Probably my biggest error of omission was watching the solar market rise over the past six months – I’d written them off, along with almost everybody else, as languishing when the price of fossil fuel energy dropped. A lost opportunity there – there was one company in particular which I earmarked, financial metrics looked great, but didn’t even pull the trigger, primarily due to insider selling. If I executed correctly on it, I would have been looking at a double now. Oh well.

An equity chart that caught my attention was the high expectations of investors of Canaccord pulling a great quarter, which came nowhere to fruition:

This is very obviously the chart of expectations crushed after a quarterly report – a regression to the recent mean would suggest a $4.50-ish stock price. I also notice their domestic competitor, GMP, being crushed after their quarterly report.

I also notice most liquid fossil fuel companies are getting hit badly and are close to multi-year lows. In the USA, most of the companies receiving boosts are the ones that have had been relieved of their debt burdens through the Chapter 11 process (LNGG is a great example of this). I still don’t think equity holders of fossil fuel extraction companies are going to be too happy over the next 12 months.

I also took notice with Interactive Brokers, and Virtu’s commentaries with respect to Q2-2017 as being one of the lowest volatility environments possible – they are two types of businesses that generate revenues as a function of trading volumes. Volatility correlates negatively with an increase with the broad markets – I am looking for defensive-type companies that will do okay in an environment like present, but will really do well when volatility increases.

Interactive Brokers is a classic example of a great company (they are the best at what they do by a hundred miles over everybody else), but one who’s stock I am not interested in buying at current prices.

Mostly everything in the Canadian REIT sector seems to be over-valued. An interesting trend is that the downfall of retail is somewhat being projected by RioCAN’s chart – trading below book value, it might seem to be an interesting value, but are they able to keep up occupancy and lease rates to businesses that have to compete against Amazon? The residential darling of the market is Canadian Apartment Properties (CAR.UN) but they are most definitely not trading at a price that would suggest a future performance beyond a high single digit percentage point and this is under the assumption that their real estate portfolio asset value remains steady. Trading in the entire REIT sector seems to be entirely yield-focussed which is never a good basis to invest, but it is a good basis to evaluate other investors’ expectations on these entities.

Gold has also been up and down like a yo-yo and might be an interesting bet against dysfunctional monetary policy. Unfortunately my ability to analyze most gold mining firms is generally not that fine tuned.

The liquidity of my overall portfolio is very high (nearly a quarter of the portfolio is collecting dust at a short duration 1.5%), but right now I don’t see much investment opportunity that would suggest avenues for outperformance. I could shove the money into some sub-par debenture (e.g. TPH.DB.F which buys you a 7% coupon until March 31, 2018 maturity) but do I really want to lock my capital into something that is questionable? It is the literal metaphor of picking up pennies in front of a steamroller. My policy is that if I have to force my money to work, chances are the investment decision’s risk/reward is worse than if I just held it in cash and waited for some sort of crisis to hit. I generally define “crisis” as something that will take the VIX above 30%, but it has been awhile since we last saw it:

It is pretty ironic how the election of Donald Trump was foreseen by most pundits to be the end of the world and higher volatility times, but so far the opposite has turned out to fruition. Will it continue? Who knows.

I see a lot of people making the mistake of impatience, and also the mistake of assuming that the index ETFs that they are investing into (Canadian Couch Potato, etc.) will leave them safe through masked diversification – works great as long as there are net capital inflows, but what happens if there is a correlated bust among these products? Will retail continue their conviction when they see a 10% drop in prices, or will they grit their teeth and add to their positions?

I continue to wait. It might be a very boring rest of the year with very limited writing. If you think you’re in a similar predicament, I’d love to hear your comments below.

KCG Holdings: Bought out

KCG Holdings (NYSE: KCG) looks like it will finally be bought out by Virtu (Nasdaq: VIRT) for US$20/share, cash. They also announced their first quarter results, and according to my scorecard they did better than expected – while their bottom-line net income was slightly negative, they were significantly better on trading revenues than I was expecting. I was expecting a very lacklustre quarter due to incredibly low market volatility in the quarter. Interactive Brokers (Nasdaq: IBKR) is a regular conference call I read and they can attest to the impact of low market volatility on trading.

My investment history with KCG is quite fascinating. I did not disclose things here until October 2016, but I have been trading the stock at various times since 2013, which resulted in material performance gains, especially in 2013 (I took a fairly heavy call option position at the second half of the year). It has exhibited a narrow price range since its merger with GetCo after their August 2012 trading blow-up. The company has generally been off the radar of most investors as it received little analyst coverage and was treated like toxic trash.

Virtu has a plan to raise $1.65 billion in debt financing for the merger and also has sold $750 million in equity at $15.60/share, which should make the buyers happy considering they are now trading at $16.40/share – the market believes this will be quite valuable for Virtu. KCG’s existing 25% shareholder has consented to the agreement, which makes it very unlikely that the deal will not pass through KCG shareholder approval. Given the highly strategic nature of the acquisition, I also doubt there will be other competitors for KCG. Thus, this merger looks like a done deal.

Current trading is at US$19.75. The expected closing is in the third quarter of 2017. As the current spread between market and US$20.00 is around 127 basis points, this would imply a merger arbitrage spread of about 3.8% annualized, so I am in no rush to sell as I have nothing else to deploy my capital into.

The only other issue of concern is KCG’s senior secured debt, maturing on March 15, 2020. According to the fine print, the notes can presently be called off at 103.438 cents on the dollar and there is a required offer for 101 cents on the dollar due to the change of control (which would be redundant since the notes are trading over this in the marketplace). I would suspect Virtu would be eager to get these notes off the books as quickly as possible as they contain covenants that would otherwise restrict the KCG entity. I’ll hold onto these as long as possible but do not think they will survive much longer.

Interactive Brokers / Options / Probabilities

Interactive Brokers (Nasdaq: IBKR) is the best brokerage out there that is available to the retail level. They give me a degree of comfort that simply doesn’t exist in any other brokerage firm that I have dealt with. One of the reasons for their superiority is their founder, Thomas Peterffy, continues to push the innovation curve in such a manner that makes the firm cutting-edge.

The company is publicly traded and has been on an unsual uptrend over the past few months:

ibkr

The only reason why I have never put money in them is because the publicly traded entity is essentially a minority slice (12.4%) of the “true” asset and this creates all sorts of perversions of incentives that are not necessarily in shareholders’ best interests. It is a classic case of the underlying business being fantastic but the stock not necessarily being a good investment.

Anyhow, they have a tool that is relatively easy to utilize that highlights potential option strategies given the differences between the market’s implicit probability distribution and your own personal expectation of outcomes. Although I do not trade options very often (indeed, it is very rare that I do so simply because trading options is quite costly in terms of spread), this tool and this explanation is quite intuitive. If you do not understand how options are priced, this is a pretty good tutorial that avoids math.

Clearly understanding the math helps and I would highly recommend people learn some option pricing theory before considering trading them. Putting it mildly, options are a fantastic way of losing money if you don’t know exactly what you are doing. Options also appeal to gambler-types that love seeing huge rewards in total disproportion to the amount risked.

Interactive Brokers increasing margin thresholds

Interactive Brokers is the best accessible brokerage with respect to margin. They are also exceedingly inexpensive (for Canadian currency, their rates are currently 2.5% between $0 and $100k, 2.0% for $100k-$1M, and 1.5% above that). I have not employed margin for quite some time, but others can borrow money at low rates. Considering the prevailing interest rates, others see it suitable to leverage by borrowing very cheap money and investing it into income-yielding securities, while skimming the few percentage points. That said, the securities that are now available to leverage from now has a market cap limitation of US$250M or above, as they announced today:

As a result of recent market volatility, please be advised that IB is increasing the margin rates on low capitalization stocks (currently defined as companies with less than $250 million in market capitalization). The margin increases will occur in three steps beginning on Wednesday, September 21, 2011 and ending on Friday, September 23, 2011. The margin rates will increase to 50%, 75% and 100% at the open of business on 9/21/2011, 9/22/2011 and 9/23/2011, respectively.

The current list of stocks which are subject to this margin increase is subject to change. The current list can be found on the following page:

http://ibkb.interactivebrokers.com/node/1788

Upon implementation, any of the incremental margin increases may result in a margin deficit in the account. A margin deficit implies that an account becomes subject to automated liquidation. Please carefully review the current positions within your account and adjust the portfolio accordingly.

I suspect the brokerage firm has done some risk analysis on customer profile accounts and has determined that the concentration within these low capitalization stocks has reached a point where they could not spontaneously liquidate the securities at an acceptable price in the event the stock market crashes. In such an event, the brokerage would be left to cover the remaining shortfall in the customer’s account (as presumably the customer will not be cutting a cheque back to cover such a deficit).

Interactive Brokers (Nasdaq: IBKR) is a very well-run operation and they probably did not make this decision lightly as it will be costing them some money.