Virtu (VIRT) stock hit the skids this week with the FX category declining by -43% sequentially with just flat year-over-year growth. This will not be good enough for a stock trading in-line with the exchange group with higher risk in its trading operations. We continue to see downside, with fair value up to 40% lower in the worst case scenario (we got a -10% correction in shares this week). Our latest research report is HERE.
Weekly Activity Wrap Up
U.S. cash equity volume continues to widen its lead with the largest year-over-year growth among the major product categories, now running higher by +19% thus far in the new 3rd quarter. U.S. equity options activity is also putting up high activity levels at +9% Y/Y growth. U.S. futures trading is currently in the midst of a summer lull at 17.0 million contracts daily, which is down -6% year-over-year. The important open interest tally continues to favor our Best Idea long view on CME Group (CME), with the big Chicago exchange's trading backlog up now +22% y/y (it was up +19% last week).
U.S. Cash Equity Detail
U.S. cash equity trading finished the week at 7.0 billion shares traded which is blending to a 6.8 billion daily average thus far for the 3rd quarter of 2015. This is +19% year-over-year growth for U.S. stock activity. The market share battle for volume is mixed, with the New York Stock Exchange/ICE standing pat at 24% market share but with NASDAQ's still sporting market share 200 bps lower than last year, a -6% decline.
U.S. Options Detail
U.S. options activity remains significantly higher, both quarter-over-quarter and year-over-year. 16.7 million contracts traded this week which is blending 3Q15 activity to 17.2 million contracts per day, up +14% quarter-over-quarter and +9% year-over-year. The market share battle amongst venues continues to be one of losses at both the NYSE/ICE and NASDAQ. NYSE has lost 400 basis points of share year-over-year settling at just 18% of options trading currently. NASDAQ has shed 300 basis points of share, good for a -14% loss from last year as ISE/Deutsche Boerse and BATS mop up volume and share.
U.S. Futures Detail
CME Group volume has been relatively low the last couple of weeks. In the most recent 5-day period ending August 8th, activity levels were 12.7 million contracts at the big futures exchange, blending 3Q15 volume to a 12.7 million average level, a -6% year-over-year decline. CME open interest, the most important beacon of forward activity, continues in strong fashion with 102.6 million contracts pending, good for +22% year-over-year growth, further improvement from the prior week's +19%.
Activity levels on the futures side at ICE hit 4.7 million contracts this week, with 3Q15 blending to a 4.3 million daily average. That is also a -6% year-over-year decline. ICE open interest this week tallied 71.7 million contracts, a -5% year-over-year contraction, worse than the prior week's -4% level.
Monthly Historical View
Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.
Sector Revenue Exposure
The exchange sector has broadly diversified its revenue exposure over 10 years as public entities with varying top line sensitivity to the enclosed trading volume data. The table below highlights how trading volumes will flow through the various operating models at NASDAQ, CME Group, ICE, and Virtu:
We recently presented our investment thesis on the Exchanges. To summarize,
- Long CME: Financially oriented CME Group (CME) is enjoying a long awaited boom in activity, as trader counts and open interest in Treasuries, Eurodollars, and FX products are swelling. The decade long concentration on trading energy and commodities is over and with steeply shaped forward curves and more profitable opportunities, financial products are seeing rapid adoption.
- Short ICE: We see collateral damage from the ongoing rapid price decline in energy and commodity markets. As a result, these important products at ICE will be less active than the Street expects, as commercial hedging and speculative energy trading dries up.
We think CME has $5 per share in earnings power in the out year and the stock will revisit near $140. As outlined in our presentation deck and replay below, a CME long position can also be paired with a short ICE position, with favorable fundamental exposures on each side of the trade.
Separately, recent IPO Virtu (VIRT) is being valued incorrectly by the market. Our main qualm is that the company takes intraday prop risk, but has no tangible equity capital to cover any potential trading losses. Shares of VIRT are currently on our Best Ideas list as a short with a fair value in the mid-teens (30-40% downside).
Hedgeye Exchange Black Book Replay HERE
Hedgeye Exchanges Black Book Materials HERE
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA