Some trading shops may have found solace in the sell-off hitting Wall Street.
Prompted by worsening fears over the novel coronavirus and its rapid spread, global markets suffered a freefall of sorts at the end of February. U.S. equities saw their worst week since the 2008 financial crisis, while European and Asian stocks did not perform much better. Trading activity surged, as a result, with 19.36 billion shares and a record $989.34 billion of notional value traded in the U.S. on Feb. 28.
Meanwhile, market makers have handled and executed the flood of investor orders while capturing a small profit in the process — making the recent spurt of frenzied trading activity a boom to their core businesses.
"Volatility helps drive profitability," said Shane Swanson, a senior market structure and technology analyst at Greenwich Associates who previously ran market-making firm Automated Trading Desk, in an interview. "A day or two of great earnings does not make your month, your quarter or your year. But it certainly helps."
The Cboe Volatility Index, which tracks implied volatility based on the S&P 500 and has been dubbed the market's fear gauge, has remained high in the downturn. After hitting its highest level since 2011 on Feb. 28, the index fell slightly on March 2 to 33.42. Stocks recovered some of their losses that same day, with the S&P 500 climbing 4.6%.
Using high-speed technologies within what are largely viewed as heavily streamlined corporate structures, market makers provide liquidity to the asset classes they work in so that a retail investor, for example, can seemingly buy 100 shares of a company's stock instantaneously, even if there are no offers to sell at that time. Market makers collect the usually small price difference when buying and selling those assets, but those numbers can add up when a company conducts millions of trades a day.
As middlemen, market makers like Virtu Financial Inc., GTS Securities LLC and Citadel Securities LLC "thrive on volume and volatility," said Jim Angel, a Georgetown University finance professor, in an interview.
For the past several years, the proprietary trading community, including market makers, has undergone a dramatic shift to compensate for the market's doldrums.
U.S. equity markets have been on a steady and largely uninterrupted rise outside of a few relatively brief volatility spurts such as Volmageddon, the fourth-quarter 2018 sell-off and now the coronavirus downturn. That has forced some proprietary trading companies to cut jobs and pursue M&A to diversify their asset mixes — or even exit the business entirely.
The recent return of volatility may provide some respite from those challenges. But it is unlikely to represent a long-term solution.
"If you don't have that global scale, if you're not truly a multi-asset class, you're very strategically limited in what you can do," Virtu CEO Doug Cifu said Feb. 11 during an earnings call. "Firms like Virtu are not only going to be the survivors, we're going to prosper because we've built this fixed-cost plant. We have always managed [the company] for times of a famine. And when there's times of feast, you see the outsized returns that we can generate."
Virtu is one of a handful of market-making firms in the world that is publicly traded.
As of March 2, the New York-based company's stock has risen 22.7% in 2020. Outside the U.S., Flow Traders NV, a Dutch market-making and trading company, has seen its stock recover in recent weeks after a steady decline in January and early February. Its shares have risen 10.5% since reaching a 52-week low Feb. 12.
Compass Point Research & Trading analyst Chris Allen called Virtu the "safest port in the storm" in a March 2 research report, writing that the company is poised to "reap the rewards" of an "exceptional" market backdrop.
Virtu released preliminary earnings results for 2020 through February on March 3, saying that it estimates its average adjusted net trading income fell to between $5.75 million and $6 million per day in the two-month period. The company posted average daily adjusted net trading income of $3.8 million in the first quarter of 2019.
It remains unclear whether this latest burst of volatility is over or not, though investors have relaxed some in the week of March 2, as central bankers around the world took precautions to curtail the economic impact of the new coronavirus' outbreak.
But the virus has also shown little signs of stopping in the near-term future, as data collected by Johns Hopkins University indicated that there are more than 90,000 confirmed cases and 3,000 deaths worldwide.
"Markets react to fear and pandemonium and greed. You can easily see fear and pandemonium increasing as this isn't controlled," TABB Group Founder and Research Chairman Larry Tabb said in an interview. "That will drive more volatility, which will drive more fear and greed and more buying and selling."
Greenwich Associates is owned by CRISIL. CRISIL and S&P Global Market Intelligence are owned by S&P Global Inc.