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Robinhood Research 8 months 6 days ago #33

  • dsamraj
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Description

Robinhood is a Silicon Valley tech startup company founded in 2013 by Stanford graduates Vladimir Tenev and Baiju Bhatt. [1] According to its’ website Robinhood is a commission free trading app that allows users to easily trade equity stocks, options, commodities such as gold, and cryptocurrency. [2]

Firm Name

The name for the app has an interesting backstory and is named after the character Robinhood who is found in tales and legends. [1] Robinhood was an outlaw who would steal money from those who were rich or who earned their money through false means and would give that money to the poor. [3]  In some sense the app has promoted itself as the app against Wall Street and for the “common man”.

Revenue Generation

As a potential investor, you might be wondering how exactly Robinhood generates revenue. After all, it was just mentioned that Robinhood was a trading app that charges no commission. It turns out that Robinhood generates most of its revenue in a manner that quite ironic to the name f the company. 70% of Robinhood’s revenue comes “payment to order flow.” [1]. In other words, Robinhood gets most of its revenue from selling customer data to Wall Street quant trading prop shops such as Citadel, Two Sigma, and SIG. These shops then test their algorithms on this data in order to turn a profit. Additionally, these firms pay Robinhood more money for data on more risky, volatile trades such as those on options compared to equities. [1] In fact, Robinhood is paid over triple for data regarding options compared to equities, and as a result markets its customers to trade options.

Market and Firm Growth

The market for online trading firms has grown rapidly in the past couple of quarters due to COVID. Many of those struggling financially are looking to the stock market to “make it rich” with an initial investment of government stimulus money [1]. Additionally, there are those who are genuinely bored and have decided to play the markets. Others who are interested in strategy games related to money no longer can enter casinos due to COVID and thus have turned to the markets [1].Robinhood has seen tremendous growth due to the market factors mentioned above as well as the unique qualities found its in platform. Robinhood’s trading volume rose 139% in Q2 2020 compared to Q1 2020. TD Ameritrade saw a 76% trading volume rise with E-Trade and Schwab seeing a 56% and 24% trading volume rise. [1] Robinhood is projected to hit $700M in revenue, a 250% increase from 2019. [1]

Competitors

Apart from the 3 traditional brokers mentioned above, Robinhood does have a some other competitors namely TradeStation, MooMoo, M1 Finance and others. [7]. That being said, Robinhood does currently lead its space.

Challenges Overview

While Robinhood is not struggling with competition, the firm faces several challenges from regulators and negative PR. One issue lies in the fact that inexperienced investors are allowe to trade options and other products. In a complaint filed by Massachusetts regulators a month ago, 68% of Robinhood option traders were alleged to have limited to no trading experience. [6]

Options Description

Options are complex products known as financial ‘derivatives’. In other words, the option itself is a piece of paper that has no value but is derived from an asset or stock tied to the option. [4]. The most popular types of options are call options which allow a buyer to buy a specific stock at a certain price by a certain date, while put options allow a seller to sell a specific stock at a certain price by a certain date. The option itself will cost a premium. [4] Pricing an option is even more complex than properly understanding the derivative. Even a simplified European option (which restricts redemption to the final date and has many other assumptions to simplify computations), requires the normal distribution function in the final answer. [5]. The derivation for the Black Scholes Model option pricing model [5] requires concepts from graduate level mathematics and physics such as Brownian motion and stochastic calculus.

Tragic Suicide

The controversy with Robinhood letting inexperienced investors perform option trades rose to new heights when Alex Kearns, a Chicago college student, took his own life after believing he had lost $730,000 in the market due to his equity and put option trades. In reality, he had misunderstood the metrics and actually had a net gain of $16,000 in his account. [8] The tragic event put Robinhood under increased scrutiny and negative PR with many demanding that Robinhood not be allowed to let inexperienced investors deal with complicated trades and topics.

SEC Fines

The scrutiny has only continued to grow. Recently Robinhood paid the SEC $65M in fines due to improper disclosure. Robinhood has hired two high profile regulators Anthony Cavallaro and Josh Drobnyk to help the firm with its legal challenges. [9]

Funding

Despite these challenges, Robinhood raised $660M in its latest funding round which was held during September 2020. Several venture capital firms were involved in the latest funding round including Andreessen Horowitz, Sequoia, Ribbit Capital, 9Yards Capital, and D1 Capital Partners. [10]. To date Robinhood has raised $2.2B [11] and is currently valued at $11.7B [9].

Conclusion

Robinhood is a disruptor of the traditional brokerage market and has seen both rapid growth and increasing interest from regulators. With both these sides to the Robinhood coin, it is an interesting firm to watch for 2021.

Articles for Further Reading (and in part used to create this post)

[1] (Forbes): www.forbes.com/sites/jeffkauflin/2020/08...hem/?sh=3362d7eb268d
[2] (Robinhood): robinhood.com/us/en/
[3] (BGRH): www.boldoutlaw.com/robbeg/robin-hood-beginners.html
[4] (Options): www.investopedia.com/terms/o/option.asp
[5] (BSM): www.investopedia.com/terms/o/option.asp
[6] (InvestmentNews): www.investmentnews.com/robinhood-accused...tts-regulator-200482

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Last edit: by dsamraj.

Robinhood Research 8 months 6 days ago #34

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