All Good in the Hood – A Robinhood Opportunity
The main thing I’m watching, right now, is Robinhood Markets Inc. (Nasdaq: HOOD), more specifically, how HOOD is trading in light of comments from SEC Chairman Gary Gensler claiming that the elimination of payment for order flow was “on the table.”
If the phrase payment for order flow (PFOF) is new to you, it won’t be for long.
PFOF is how discount brokerages such as Robinhood, Fidelity, Schwab, and TD Ameritrade can provide commission-free trading.
In a nutshell, the discount brokerages provide a customer-facing platform whereby you can place your trade orders and the back office of the brokerages handles the money vs. securities transaction.
But, none of these brokerages are trading shops, which means they’re not taking customer orders and matching them up with buyers and sellers, which is to say they’re not “market makers”.
To match buyers with sellers, all of the discount brokerages rely on wholesalers (which are third-party trading shops) to execute those orders on behalf of the discount brokerages’ front-facing customer operations. In return, the wholesalers pay the discount brokers for the order flow, and that’s how the discount brokers can offer free trading.
Which makes them insanely popular among retail traders. Even I’ve lauded brokerages like Robinhood for heralding a new era of trading, like in this piece from August of last year. But after the year of the retail trader took off back in January (remember the first GameStop short squeeze?), the SEC has decided to go after the so-called “inherent conflict of interest” between these wholesalers and the discount brokers.
The wholesalers, who ultimately make the market for your trade, see all the order flow, in advance to filling your trade, which means they have the ability to put on short-term trades, ahead of filling your order, that could benefit from the order flow there are about to fill.
Basically, the wholesalers are allowed to legally front-run your order. At least for now.
I’ll have a much more in-depth look at the practice of PFOF, its implications, what it means for your money, and how we can profit from it if there are any changes to the practice in your inboxes Thursday morning.
But that brings me back to Robinhood, which is being singled out by the SEC as the posterchild for PFOF, as well as the gamification of investing and trading.
If PFOF is curtailed in any meaningful way, it’s going to hit the top and bottom lines for all the retail brokerages who rely on PFOF to generate revenue to compensate for providing commission-free trading.
Management at Robinhood must have had a crystal ball because they’ve already indicated (in the company’s pre-IPO roadshow) they’re considering becoming their own market maker, thus cutting the wholesalers out of the equation, completely.
If Robinhood does become its own market maker, it would basically pay itself for order flow. That would immediately give Robinhood a huge leg-up on the other discount brokerages.
We’re still in very early innings regarding any meaningful changes to how PFOF operates, but that doesn’t mean people won’t be speculating and pontificating about it along the way. I think there’s going to be a lot of chatter about PFOF which will cause a lot of volatility in the discount brokerage space.
That might scare some people away, but I’m looking at it as an opportunity, specifically when it comes to Robinhood, who I think will ultimately be the winner if there are any significant changes to PFOF.
And that brings me to what I’m watching regarding HOOD.
The stock has support at $42.00. That’s where I want to be buying.
If shares of HOOD trade down to $42.00, I like buying the stock, outright.
Additionally, if the stock trades down to $42.00 over the next four weeks, I like buying-to-open a HOOD November 19, 2021 $43/$44 Call Spread for $0.40 or less. Go ahead and exit this spread for a 100% (or more) profit.
So that’s what I’m watching this week – and it’s big. Let me know if there is anything else bubbling up this week that you’d like me to talk about. Drop me a line at email@example.com. I look forward to hearing from you.