Money Stuff: The Fastest Options Are the Most Fun

Some of the work in the financial industry involves finding and fostering bad counterparties. If you are a stock market maker — you buy stock from customers who want to sell, and sell to customers who want to buy — and your customers are mostly huge sophisticated hedge funds, you will have a lot of unpleasant days. They are smart and large; when they buy stock from you, it will mostly go up and you will regret selling; when they sell stock to you, it will mostly go down and you will regret buying.

On the other hand, if you have customers who like a gamble and are always wrong, that’s great! When they sell stock to you, it will mostly go up, and you will make money. The obvious business model is:

1. Find more of those people.
2. Take them out to steak dinners, be nice to them, and generally make them feel like valued customers.
3. Proactively work to offer them trading opportunities that satisfy their urge to gamble, that give them more chances to be wrong, and that have a lot of profit built in for you.
4. Do as many trades as possible with them, though preferably not so many that you blow them up entirely. You want them to have enough fun that they keep coming back for more.

This business model is obvious in part because it is the actual well-known business model of a casino: nice dinners, fun games and lots of edge.

In finance, we talk a lot about “payment for order flow,” which is an important way that US equity market makers try to find bad counterparties: If you trade stock on the stock exchange, you run the risk of trading with sophisticated hedge funds, but if you trade exclusively with the customers of a retail brokerage, you know that all of your counterparties are retail traders. So market makers pay those brokerages to trade with their customers, and in fact there is evidence that the market makers discriminate even among retail customers: Some retail brokers’ customers are more sophisticated than others’, so market makers should pay more to trade with the unsophisticated ones. [1]

But you don’t have to just take your counterparties as you find them; you can work to encourage and develop bad ones. This is often a matter of product development: If you build a product that does nothing for sophisticated professionals but that is really good for noisy addicted gamblers, you will attract exactly the right sort of counterparty. This arguably explains much of crypto.

Anyway the the Wall Street Journal reports:

A popular, fast-paced trade has boosted the options market to record volumes in recent years. Now, Wall Street is looking to push it even further.

Zero-day-to-expiry options let investors bet on whether a particular stock-market index will rise or fall by the end of the day. They have drawn an enthusiastic following among amateur investors, even as skeptics call them a form of gambling. They are sometimes known by the hashtag #0dte.

So far, the #0dte boom has been limited to options tied to indexes such as the S&P 500 or Nasdaq-100. The next frontier could be options on stocks such as Tesla or Nvidia. …

Michael McCaskill, a 48-year-old day trader and volleyball-programs coordinator in Louisville, Ky., trades short-dated options in hopes of hitting the jackpot. He’s intrigued by the prospect of more-frequent expirations on single-stock options.

“The percentage gains are incredible,” said McCaskill, who has previously made profitable bets on GameStop, Netflix and PayPal. “It’s the short-dated options that give you that, whether it’s weekly or daily.”

I am sorry, I am sure he has lots of profitable trades and I don’t mean to be rude, but just, statistically speaking, for equity market makers, there are few more beautiful phrases in the English language than “day trader and volleyball-programs coordinator.” If you walk into the offices of Susquehanna International Group and say “hi I am a day trader and volleyball-programs coordinator from Louisville, Ky., and I love short-dated options but I wish they were shorter-dated, can you help,” they will treat you like a celebrity and give you anything you ask for. You are their muse.

As it happens, Susquehanna is salivating over single-stock 0dtes but Robinhood, less so:

In closed-door industry meetings, retail brokerages such as Robinhood Markets, Schwab, Tastytrade and Morgan Stanley’s E*Trade have advocated for a cautious approach, concerned they could face a customer backlash if investors’ options trades blow up, the people said. 

Other firms—including Susquehanna International Group, a huge options-market maker, and Nasdaq—have actively promoted bringing daily expirations to single-stock options, the people said. Both market makers and exchanges stand to benefit from the volumes that could come from further growth in the #0dte phenomenon.

The retail brokers basically make money if their customers are happy; the market makers basically make money by trading against them. There is an overlap in their interests, but it is not complete. If Robinhood gives its customers new ways to lose money faster, that’s probably bad for Robinhood in the long term, but it’s very good for whoever is on the other side of those trades.

The basic theory of “everything is securities fraud” is this. A US public company does a bad thing, or a bad thing happens to it. When the bad thing becomes public, the stock drops. Shareholders sue, saying “we didn’t know about the bad thing, so we bought the stock, and then it dropped, so that was fraud.”

This is a general enough pattern that I often write that any bad thing that a public company does is also securities fraud. But this is not strictly true, and there are at least two cases that do not fit this pattern:

1. Technically, the fraud lawsuit requires some sort of misrepresentation. It is generally very easy to find this sort of misrepresentation — the company’s public filings say “we have a code of ethics,” the company’s chief executive officer does something bad, the lawsuit says “you disclosed you had a code of ethics, which made us think the CEO wouldn’t do something bad” — but there could be exceptions. If a public company’s disclosures included a prominent risk factor saying “our CEO does mixed martial arts and if he gets punched in the face that will be bad for our business,” and then the CEO gets punched in the face, and the company puts out a press release 15 seconds later saying “he got punched in the face really hard and that’s bad,” and the stock drops, then it’s hard — not impossible, but hard — for shareholders to argue that they were deceived. If the disclosure is really good, even if a bad thing happens and the stock drops, that is probably not securities fraud.
2. Conversely, if the disclosure is bad, and then it is corrected, and the stock doesn’t drop, then nobody is going to sue. If the company has a risk factor saying “our CEO does mixed martial arts,” and then it puts out a press release saying “actually we just pretended he does mixed martial arts to make him seem cool, he doesn’t really, really he enjoys crocheting,” and the stock goes up, then who is going to sue? 

I suppose the answer to that last question is “the SEC”? If a public company says something in its public disclosures, and that thing is wrong, but not in a way that is material to investors — it doesn’t affect the stock price — that is still potentially a violation of the rules, and the US Securities and Exchange Commission could still get involved.

Sometimes it obviously will: If the company is just making up its financial results, the SEC will punish it, even if it turns out that investors don’t care about the financial results. [2] Other times it obviously won’t: If there’s a typo in the middle name of a director in the proxy statement, the SEC won’t care; its job is to protect investors from material misrepresentations, not to fact-check every line of the disclosure.

But there’s a middle category of things that the SEC thinks investors should care about, even if they don’t. The SEC mandates disclosure about conflict minerals, for instance, and it is possible that that rule is more about the US government’s political concerns than it is about investors’ financial concerns. If a company’s conflict minerals disclosure says “we make sure that none of our materials were mined in an unethical way,” and it is lying, its shareholders might not care, but the SEC probably will.

Or we have talked about the SEC’s efforts to require climate-related disclosures. Broadly speaking those disclosures are probably of interest to investors, but it’s not clear that all of them will be financially material. If a company says “we use only clean energy to run our computers,” and in fact it uses dirty energy, and the truth comes out, the stock might not drop. But the SEC will be concerned, not purely because of its mandate to protect investors, but because it cares about climate disclosure. It cares enough to propose the new rules. A company that flouts those rules will annoy the SEC, even if investors don’t care.

Today the SEC fined Keurig Dr Pepper Inc. $1.5 million for making hard-to-recycle coffee pods:

The Securities and Exchange Commission today charged Keurig Dr Pepper Inc. with making inaccurate statements regarding the recyclability of its K-Cup single use beverage pods. To settle the SEC’s charges, Keurig agreed to pay a $1.5 million civil penalty.

According to the SEC’s order, in annual reports for fiscal years 2019 and 2020, Keurig stated that its testing with recycling facilities “validate[d] that [K-Cup pods] can be effectively recycled.” But Keurig did not disclose that two of the largest recycling companies in the United States had expressed significant concerns to Keurig regarding the commercial feasibility of curbside recycling of K-Cup pods at that time and indicated that they did not presently intend to accept them for recycling. In fiscal year 2019, sales of K-Cup pods comprised a significant percentage of net sales of Keurig’s coffee systems business segment, and research earlier conducted by a Keurig subsidiary indicated that environmental concerns were a significant factor that certain consumers considered, among others, when deciding whether to purchase a Keurig brewing system.

“Public companies must ensure that the reports they file with the SEC are complete and accurate,” said John T. Dugan, Associate Director of the Boston Regional Office. “When a company speaks to an issue in its annual report, they are required to provide information necessary for investors to get the full picture on that issue so that investors can make educated investment decisions.”

There is no suggestion that this was material to any investor’s financial decisions, or even that the stock dropped. (There was a consumer class action that reached a $10 million settlement in 2022, so this really did cost the company some money, though the SEC doesn’t mention it.) It’s not even technically an “everything is securities fraud” case: Keurig is charged, not with fraud, but with violating the rule requiring it to file annual reports. [3]

But it is close enough. If you are a public company, and you say stuff about your environmental record, and it’s wrong, investors might not care. But in the US, the SEC is the all-purpose meta-regulator, and it cares a lot about public companies’ environmental records. So if a company makes claims about recycling that are wrong, the securities regulator will get involved.

The point of dual-class stock is to prevent shareholder activism. If you run a company, and you own 10% of the economic value of the stock but 60% of the votes, you can kind of do what you want. And if a big activist hedge fund buys some stock and starts agitating for change, you can just say no. “Replace the chief executive officer, give me three board seats, do a stock buyback and consider strategic alternatives,” the activist will say, and you’ll say no. What can the activist do? Run a proxy contest to replace the board? You have 60% of the votes; you’ll win. Mount a hostile takeover offer? You have 60% of the votes, you can block it. 

Still hope springs eternal:

Activist investor Starboard Value said News Corp should eliminate its dual-class share structure, saying it gives too much influence to the family of Rupert Murdoch.

The dual-class structure isn’t in the best interest of shareholders and doesn’t reflect best-in-class corporate-governance practices, Starboard, which has a stake in The Wall Street Journal parent, said in a letter to shareholders. …

Starboard said it believes there is a path to achieve majority support for its proposal and send a message to the media company’s board. “If the board refuses to listen, we can then take further action,” it added.

Here is the letter. I suppose there are two points here:

1. Public companies are susceptible to pressures other than shareholder votes. If Starboard makes a very persuasive case to eliminate the dual-class stock, maybe Murdoch will read it and say “huh yeah let’s do it.” (Because, to be clear, the very persuasive case would be something like “this company will be worth more without dual-class stock,” which would be good for Murdoch too. [4] ) Or maybe News Corp.’s outside shareholders and independent directors will read it and be persuaded, and will push Murdoch to do it, and he’ll find it annoying and embarrassing to say no. Even though he can’t be outvoted, he can be pressured into doing what Starboard wants.
2. Actually he can be outvoted! The Murdoch family controls about 40.5% of the voting stock, so if every other voting shareholder voted with Starboard then it would win the vote. In general people assume that a 40% voting bloc is functionally equivalent to controlling the company — not everyone votes, etc. — but maybe sometimes it isn’t. Starboard is proposing a non-binding advisory vote, so even if it wins News Corp. won’t have to get rid of the dual-class structure. But winning a non-binding vote would send the message that, if News Corp. doesn’t get rid of the dual-class structure, the next step will be Starboard mounting a proxy fight to take over the board — and if it can win the non-binding vote then it can also win the proxy fight.

At this point my model of the US Securities and Exchange Commission is that it is mostly looking for stable recurring revenue streams. This is a weird model! You could have a model of the SEC that is like “when people do fraud, the SEC fines them,” but that is a lumpy and uncertain revenue stream. (What if no one does fraud, or the SEC doesn’t catch them?) Or you could have a model like “the SEC tries to keep people from doing fraud in the first place, and every time it fines someone for a successful fraud that is a bad outcome,” but where’s the money in that?

But instead two of the SEC’s marquee enforcement initiatives these days are:

1. If a financial services firm has employees who have texted about work on their personal cell phones, the SEC fines the firm millions of dollars. Because this is every firm, the SEC can reliably keep extracting these fines.
2. If a company has ever asked an employee or customer to enter into a nondisclosure agreement, the SEC fines it for violating the whistleblower protection rules. This also appears to be every company — not just financial services companies, either! — so it is a very reliable source of revenue.

The nondisclosure-agreement stuff tends to generate smaller fines than the cell phone stuff, or actual fraud, so it is steady but boring work. Still it seems to be ramping up. Here’s a case from last week against Nationwide Planning Associates Inc.:

According to the SEC’s order, from May 2021 through February 2024, Nationwide, NPA, and Blue Point collectively asked 11 retail clients to sign confidentiality agreements in connection with payments made by the entities to the clients’ investment accounts. The payments were intended to compensate the clients for losses caused by the firms’ alleged breaches of federal or state securities laws. The order finds that the agreements contained provisions that impeded clients from reporting potential securities law violations to the SEC by permitting communications only where the SEC first initiated an inquiry. As described in the order, some of the agreements further required the clients to represent that they had not reported the underlying dispute to the SEC or to another securities regulator and would forever refrain from such reporting.

Not allowed to do that! We have talked about this a few times before. There is an SEC whistleblower protection rule that makes it illegal to “impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement,” and the SEC interprets that rule to mean that it is illegal to have a confidentiality agreement — if you are a public company or a securities firm — unless it says “but of course you’re allowed to report possible securities law violations to the SEC, that’s not prohibited by this agreement.” (And you have to write the language exactly right.) If you settle a customer complaint by paying the customer money in exchange for a confidentiality agreement, that is just going to cost you more money, when the SEC finds out about it. And the SEC will find out, because somebody — the customer, or one of your employees — can probably get a whistleblower reward for reporting it to the SEC.

Meanwhile here’s a collection of cases from yesterday against a random grab bag of companies, most of them not in the financial industry:

The Securities and Exchange Commission today announced settled charges against seven public companies for using employment, separation, and other agreements that violated rules prohibiting actions to impede whistleblowers from reporting potential misconduct to the SEC. To settle the SEC’s charges, the companies agreed to pay more than $3 million combined in civil penalties.

Many of these seem to have involved employment agreements where the employees had to waive their right to get any whistleblower rewards from the government, and I have to say I sympathize with the employers there? Like imagine that you are a good, upstanding, but large company. One of your employees discovers that another employee is doing something bad. The good employee has two choices:

1. Immediately try to stop the bad behavior and report it to compliance, so that the company can quickly eliminate bad behavior and continue to be good and upstanding.
2. Say “ehh let’s see where this goes,” watch the bad behavior fester for a while, and then, when it’s bad enough, report it to the SEC to extract a big fine. And then take a cut of that fine as a whistleblower award.

The first choice is better for the company, and probably for the world, so the company wants to encourage it. The second choice is more remunerative for the employee, and for the SEC.

Tether’s USDT stablecoin is an obviously desirable product: It’s a US dollar bank account that is not subject to US banking regulation. Lots of people want US dollar bank accounts, to move money internationally or to pay for things. Many people cannot get US dollar bank accounts, though. Sometimes this is because they do not live in the US and lack convenient access to the US banking system, and sometimes it is because they are terrorists:

A giant unregulated currency is undermining America’s fight against arms dealers, sanctions busters and scammers. Almost as much money flowed through its network last year as through Visa cards. And it has recently minted more profit than BlackRock, with a tiny fraction of the workforce.

Its name: tether. The cryptocurrency has grown into an important cog in the global financial system, with as much as $190 billion changing hands daily. ...

Wherever the U.S. government has restricted access to the dollar financial system—Iran, Venezuela, Russia—tether thrives as a sort of incognito dollar used to move money across borders.

Russian oligarchs and weapons dealers shuttle tether abroad to buy property and pay suppliers for sanctioned goods. Venezuela’s sanctioned state oil firm takes payment in tether for cargoes. Drug cartels, fraud rings and terrorist groups such as Hamas use it to launder income.

Yet in dysfunctional economies such as Argentina and Turkey, beset by hyperinflation and a shortage of hard currency, tether is also a lifeline for people who use it for quotidian payments and as a way to protect their savings.

Tether is arguably the first successful real-world product to emerge from the cryptocurrency revolution that began over a decade ago. 

That seems right. The central promise of crypto is arguably “code is law,” a new financial system freed from legacy regulation, and the first successful real-world crypto product is essentially a way around US regulation. You might like that! You might argue that the US abuses the power of the dollar to cut off people it doesn’t like — including ordinary Russians and Venezuelans — from convenient access to the global financial system. Or you might dislike it! You might argue that a lot of people who are sanctioned by the US really should be cut off from the global financial system. But Tether really has succeeded in setting itself up as a US-dollar-based alternative to the US dollar system. 

A plausible simple model of Elon Musk is:

• You can predict he will create a lot of value for investors, but
• You can’t predict which investors.

If you buy Tesla Inc. stock and Tesla builds cutting-edge fully self-driving cars, that’s probably good, unless Tesla just decides to allocate the revenue for those cars to xAI, Musk’s entirely separate private artificial intelligence company. If you invest in SpaceX, Musk’s private space company, and it makes a lot of money by sending good rockets into space, that’s probably good for you, but it gets riskier if SpaceX lends its profits to Musk so he can buy Twitter. There is a large loosely organized conglomerate of Elon Musk companies with different shareholders, and Musk keeps getting new ideas, and he will probably implement those ideas at the (existing or new) company that will be best for him, and if you’re a shareholder of one company there’s no guarantee that you’ll continue to get his best ideas.

As an investor, if you believe this model, I suppose the best you can do is:

1. Invest a lot of money with Musk,
2. Spread it out among all of his businesses,
3. Stay as close to him as possible so that, if he starts a new business, you’ll get to invest in that one too.

Here’s a Wall Street Journal story about John Hering, a Musk-friendly venture capitalist:

To win Musk’s attention, and ensure access to funding rounds of his startups, Hering and Alexander Tamas, a German tech financier, have essentially committed their venture firm, Vy Capital, to serving the world’s richest man.

Such venture giants as Valor Equity Partners and Sequoia Capital also have invested large sums, but none are as far out on a limb as Vy Capital. More than half of its $8 billion in reported assets is parked in Musk’s startups.

Hering, 41 years old, donates most of his working hours to aiding Musk startups and holds company ID badges to grant him entry.

Also, though, this is the sort of investor that Musk should want. An investor who invests across Musk’s empire won’t care much about corporate formalities or complain if Musk does shift resources from one company to another, and if any Musk companies need capital that investor will provide it without asking too many questions. He goes wherever Musk needs him, and brings money.

This is why I like the idea of the Musk Mars Conglomerate in which all of Musk’s random ideas are owned by a single corporation, but I suppose that has downsides. I mentioned a big one yesterday: It is good to pay the employees of each business in that business’s own separate stock, to motivate them to build rockets or cars or AI or brain implants or tunnels or whatever their particular business does. But “half a dozen separate companies, all with pretty much the same shareholders” might be the best available compromise.

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