E-brokers and banks finally have something to cheer about: Volatility boosts trading

  • The S&P saw average intraday volatility of 1.38 percent in the first quarter, more than three times that of the fourth quarter and the highest level since the first quarter of 2016.
  • After languishing around 10, the Cboe volatility index exploded to 50 in early February.
  • Net revenue will likely be at record levels. And the volatility looks like it is continuing.
Pedestrians pass in front of an E-Trade location in New York.
Scott Mlyn | CNBC
Pedestrians pass in front of an E-Trade location in New York.

The trading community, which has bitterly complained for years about low trading volumes and low volatility, finally has something to cheer about: volatility.

Stock market volatility is expected to be a big help to the trading operations of the money center banks, which began reporting earnings Friday morning. It will be a big help to the e-brokers, and to stock exchanges as well.

Schwab reports quarterly earnings Monday, the first retail broker to do so. Most of these firms are sitting on double-digit stock price increases this year, at a time when the S&P 500 is flat.

E-broker stocks soar

Interactive Brokers: up 22 percent

TD Ameritrade (Scottrade): up 19 percent

ETrade: up 18 percent

Schwab: up 2 percent

Source: CNBC

Another beneficiary of market chaos: Market maker and high-frequency trading shop Virtu Financial, whose shares are up nearly 100 percent this year.

You'll notice Schwab is underperforming, up only 2 percent on the year. That's because only about 7 percent of its revenue comes from trading. For ETrade, it's 17 percent, and for Ameritrade, it's 27 percent.

The primary factor driving this surge is volatility. The S&P saw average intraday volatility of 1.38 percent in the first quarter, more than three times that of the fourth quarter and the highest level since the first quarter of 2016.

And after languishing around 10, the Cboe volatility index exploded to 50 in early February, initially on wage inflation concerns. It was the highest level for the "fear index" since August 2015, when the Chinese suddenly devalued the yuan and set off a firestorm of trading activity.

This led to a small explosion in trading activity. Overall equity volumes were up about 20 percent in the first quarter over the fourth quarter, but retail trading was even stronger. Daily average revenue trades, the primary metric for trading activity, were up nearly 45 percent year over year, according to estimates by Rich Repetto at Sandler O'Neill.

Another contributor has been the very strong retail interest in trading bitcoin and cannabis-related companies. I know, it sounds crazy, given that there are hardly any bitcoin-related or cannabis company stocks, but Repetto noted that Ameritrade and ETrade in their January earnings calls said 9 percent to 10 percent of trades were coming from these areas.

Given the small size of the trading population of those two groups, it is a testimony to the bitcoin and pot cultural phenomenon that swelled up recently. Bitcoin's price has since pulled way back, so that trend might not have continued into March.

Higher interest rates are another important factor. Most e-brokers have banks whose profitability improves as rates go up. In the case of Schwab, interest revenue accounts for about half of total revenue. It counts for even more at ETrade.

Bottom line: Net revenue will likely be at record levels. And the volatility looks like it is continuing.

But volatility may not always translate into higher trading activity. February's strong activity may be an anomaly. March retail trading activity is likely down 15 percent to 20 percent from February, Repetto said.

Price competition among the e-brokers is intense. The industry cut trading commissions last year, though there have been no further cuts this year. Another big player is about to enter the space: J.P. Morgan is expected to roll out an online brokerage offering this summer. The big banks have had a hard time competing against retail-focused e-brokers in the past, but an increasing focus on automation may level the playing field.

There could be a consolidation push as a result of the competition. Repetto, in particular, pointed to ETrade.

"ETrade's management has a mandate to achieve certain growth objections by the end of the third quarter, so there is speculation they could be a potential consolidation target, depending on whether they achieve their objectives or not," he said.