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In October 2020, the Wall Street Journal published a fascinating piece about the popular social media platform TikTok that caught my attention. At the time TikTok’s global future was uncertain as the US & China sparred over the app’s ownership and data sharing agreements with the Chinese government. Amid a flurry of headlines, the WSJ took time to highlight an unlikely winner of TikTok’s recent exponential growth streak - Susquehanna, a low-key, under the radar trading firm based in Pennsylvania. In 2012, Susquehanna bought a 15% stake in TikTok’s owner ByteDance, and held on to its investment as the app launched & spread in America. As of 2021 that stake is worth north of $30 billion.
Questions flooded in as I read and re-read the article. What the heck is a Wall Street trading firm doing with such a big stake in TikTok? Who the heck is Susquehanna? How did they get so rich with so little media coverage?
So I did some digging.
Bala Cynwyd High Rollers
The idea that became Susquehanna was formed in the mid 1970s at SUNY Binghamton, a New York college near the Pennsylvania border. Six classmates - Jeffrey Yass, Steve Bloom, Eric Brooks, Arthur Dantchik, Andrew Frost and Joel Greenberg - became friends through their shared skill & interest in poker and horse racing. The group wouldn’t just skip class to gamble - being mostly science & math majors, they took an obsessive, analytical approach to the game. The six students used advanced game theory & statistics to find a consistent edge, and used that edge to make millions of dollars at the betting table. After college the group spent a year in Las Vegas, winning enough at the casinos to cover their bills and more.
It was around this time that Yass gave serious thought to the idea that the group’s success could expand beyond the poker table. A new market was forming on Wall Street with vast potential for gamblers like them - options. In 1973 the CBOE launched the first US exchange-listed options contract, opening up a complex new trading frontier. Markets were still figuring out how to properly value & trade these instruments, and even the industry’s top firms hadn’t mastered them quite yet.
Yass saw a direct overlap between options and poker, and for good reason. In its simplest form, both pursuits are about probability & risk management. In poker and in options trading, the player who can quickly form a range of potential future outcomes & accurately value exposure to those outcomes will win.
For example, suppose I let you choose between two sets of potential payoffs:
A 10% chance to win $1,000,000
A 25% chance to win $500,000
With this level of information you would correctly claim the choice with the better expected value is #2 ($500,000 * 25% = $125,000 is greater than $1,000,000 * 10% = $100,000).
Now suppose I put a price on these odds:
Pay $50,000 for a 10% chance to win $1,000,000
Pay $130,000 for a 25% chance to win $500,000
Now that I’ve introduced price as a new variable, your choice should change to #1 ($100,000 expected value for only $50,000 is way better than a $125,000 expected value for $130,000).
Simple examples like this help explain what poker players & option traders do on a daily basis - they take inputs from their respective environments to process the relationship between expected outcomes, risk, reward and price, betting when the odds are in their favor and waiting on the sidelines when they don’t have an advantage.
Around the time of CBOE’s launch, another innovation made headlines in the options market. Fischer Black & Myron Scholes, two researchers at the University of Chicago, discovered a mathematical formula to express the risk/reward/price relationship that could be used to price options. At the heart of the Black-Scholes equation was the idea that a basket of securities called the “replicating portfolio” could be created with the same payoffs as an options contract. Using the Black-Scholes formula allowed traders to buy or sell an option, create a replicating portfolio using a combination of stocks, interest rates & time, and arbitrage between the two for profit. Black-Scholes was an utter game changer that gave legitimacy to the options market and allowed sophisticated firms to build trading strategies that nearly guaranteed consistent profits.
After his stint in Vegas, Yass went to NYU for business school where he began experimenting with options trading in addition to poker & horse racing. His foray into options proved so successful that Yass wouldn’t end up finishing school. Israel Englander, a successful hedge fund manager & NYU alumnus, sponsored Yass for a seat on the Philadelphia Stock Exchange after seeing his early success as a grad student. Yass honed his options trading experience as a floor trader on PHLX, and slowly brought his old poker friends back to Philly to trade with him. By 1987, the group had officially started a trading firm named after the Susquehanna River in Pennsylvania, and the outfit officially began their decades long takeover of the options market.
Susquehanna quickly found a chance to prove their trading prowess. Only a few months after launching their firm, Black Monday hit in the US sending stocks down -20% in a single day. During a year where most professional traders were either licking their wounds or going bust, Susquehanna ended the year up $30 million, rivaling firms more than 100x their size. Their expertise in index options, a new & at the time controversial product thought to be a cause of the crash, helped them thrive.
As the options market grew in size & stature with the advent of electronic trading, so too did Susquehanna. By the 2000s, 20% of the entire US options market ran through Susquehanna’s operation, a close second only to Citadel Securities.
Think about this for a moment. Everyone knows who Citadel Securities is - and I mean everyone. It’s hard to miss a headline about CEO Ken Griffin buying not one, but several of the most expensive houses in the world. Or a barrage of stories about how Citadel Securities pays Robinhood hundreds of millions for retail order flow, getting Griffin hauled before Congress amid the GameStop blowup. Or news of former SEC, CFTC and other regulatory heads taking jobs with the firm to help its government relationships.
Other than the occasional one-off mention in financial circles, do we ever hear about the exploits of Susquehanna or its leadership? Was Jeff Yass hauled before Congress to talk about his firm’s part in today’s chaotic markets? It really is quite impressive how a firm so successful & integral to the financial system stays so far out of the spotlight. A former trader there puts it plainly: “If you have to choose between fame and fortune, choose fortune.”
Since the early 2000s, Susquehanna’s unique expertise in options has given it an edge in an even larger & more integral part of the financial system: ETFs. Just like an option, an ETF relies on the idea of a “replicating portfolio” to price itself. An ETF is quite literally a basket of securities that track a benchmark - the price of an ETF should directly match the price of its underlying basket. Susquehanna specializes in trading ETFs that are difficult to price, like illiquid fixed income or international products, particularly in Europe. The firm’s metrics speak for themselves:
With two major money making operations now stood up in options & ETFs, Susquehanna followed other upper echelon trading firms and began diversifying its investments. In 2006 Susquehanna founded its own venture capital firm focused on startups across the US, Israel and China. Noteworthy portfolio companies today include Credit Karma, eToro and Pyoneer, each worth billions in market value and some undergoing public listings in 2021. In a way, Susquehanna isn’t straying very far from its core strength when it comes to venture capital - like options, startups provide a convex risk/reward opportunity with limited downside but truly massive upside.
No company better explains this theory at work than ByteDance, formed in 2012 with Susquehanna as an early backer. A $5 million investment in ByteDance’s founding year bought 15% of the company and a board seat. As TikTok grew in Asia and was launched in the US in 2017, returns started to build. By the end of 2020, TikTok had become the #1 most downloaded app in the US with over 800 million monthly active users - more than Twitter, LinkedIn, Pinterest, Snapchat or Reddit. That 15% investment is now valued at over $30 billion, rivaling the value of Susquehanna itself. To put this incredible ownership stake into perspective, Susquehanna owns about as much of TikTok as Mark Zuckerberg currently owns of Facebook. Talk about an attractive risk reward opportunity for a $5 million lottery ticket.
Where are the original Susquehanna Six founders now? Steve Bloom left the firm in 1993 to manage his sizable fortune as a family office. Eric Brooks went on to win the 2008 World Series of Poker in Seven Card Stud, and runs a non-profit focused on decision making education among children. Arthur Dantchik still works at Susquehanna as a Managing Director, serving on the board of ByteDance on Susquehanna’s behalf. Andrew Frost still helps manage Susquehanna’s sprawling venture capital business in Asia. Joel Greenberg is an active political donor, supporting multiple Mayor & Governor campaigns in the past and the founder of a super PAC.
Last but certainly not least, Jeff Yass continues to lead Susquehanna to this day with the largest ownership stake in the company & a rumored fortune north of $12 billion. His betting prowess & entrepreneurial spirit has taken him from poker games in his college dorm room to the flashy Vegas casino tables, to the crowded Philadelphia options pits and ultimately the top of Wall Street’s food chain. While not a fixture of Congressional hearings or the spotlight of the news media, Susquehanna is one of the largest and most successful Wall Street trading firms in operation with a massive impact on today’s market infrastructure. Just because they’re good at avoiding press coverage & keep strategies close to the chest doesn’t mean they don’t deserve attention.
If you have to choose between fame and fortune, choose fortune.
Ahead of its public listing on April 14, Coinbase reported Q1 2021 earnings that confirmed how Bitcoin’s incredible recent run has impacted crypto exchanges. Coinbase made $1.8 billion in the year’s first quarter alone, 50% more than it made in all of 2020. 6.1 million monthly transacting users on Coinbase’s platform helped trading revenue surge along with Bitcoin’s nearly +100% rise YTD. In terms of annual guidance, Coinbase gave a wide range of potential outcomes with the caveat that like everyone else, it can’t predict future volatility & trading volumes. Coinbase expects monthly transacting users to be anywhere from 4 to 7 million in 2021, with transaction revenue closely following active user trends & crypto interest as a whole.
Exchanges put out a new wave of volume reports this week as March and Q1 came to a close. While comparisons will look strange vs. Q1 2020 marking the height of COVID volatility, trading volumes are so far trending quite well for exchanges across major product groups. ICE & CME are enjoying improvement in their interest rate & energy volumes as traders begin to prepare for a reflationary environment. CBOE VIX futures open interest is recovering after the index dropped below 20 and has stayed near this level for most of March. Marketaxess & Tradeweb saw growth in volumes & electronic market share year over year even after COVID lockdowns boosted adoption.
Virtu Financial CEO Doug Cifu was interviewed on the Odd Lots podcast recently talking about his firm, the market-making landscape & equity market structure as a whole. Cifu did a good job breaking down the business in simple terms & sharing a bit about how the company was started & his future plans. You can find this episode here.
Chart of the Week
For those of you reading this newsletter who are not on Twitter, you’re truly missing out on some incredibly detailed finance & market structure content shared willingly for free by others. For example, Stretching Spreads (@FadingRallies) published an interesting set of charts showing how fragile underlying market liquidity has become since Volmageddon in 2018 and the COVID crash of 2020. The below chart tracks three main metrics:
Equity Market Liquidity (the white line) showing the aggregate level of order book depth over time. Low order book depth means the market is less able to absorb large trades without moving prices significantly either up or down.
E-Mini S&P Futures Market Depth (the green line) showing largely the same dynamic as #1, but this time for CME’s flagship equity index futures product. If S&P 500 futures liquidity is low it means large trades can spill over into the underlying stock market with greater speed & impact.
SPY+Top ETFs Bid-Ask Spread (the pink line) showing the cost of trading even the biggest ETFs is higher today than pre-2018, with big spikes seen when volatility picks up.
What does this all mean? While markets may be quieting down in recent weeks, all may not be as it seems beneath the surface. If order book depth doesn’t improve from levels we saw in March, it may not take much to bring markets back to the kind of chaos we’ve become accustomed to over the last year & a half.
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Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this newsletter, I am long ICE, CME, TW, NDAQ and VIRT. I am also long Bitcoin & Ethereum.