Cboe Global Markets, Inc. (CBOE) Earnings Call Transcript & Summary

Great. All right, everyone. Thanks for bearing with us. If any of you don't know me, I'm Ben Budish, I cover the U.S. brokers, asset managers and exchanges here at Barclays. For 1 of our last fire sides of the day, really delighted to have from CBOE, we've got Craig Donahue, CEO and Rob Hocking, Head of Derivatives; Jill Greevenou, CFO; and Prashant Bhatia, EVP, Head of Enterprise Strategy. So everyone, thanks so much for being here.

Thank you. .

All right. Let's jump into it. So Craig, you're almost 18 months into the CBO's strategy has shifted a bit over the past few years coming out of a period of heavy acquisitions to a more recent sharper focus on things like index options and data. So for you with some time in the seat now, can you talk a bit about your assessment of Cboe, how you think about the growth strategy where do you see the biggest opportunities?

Okay. Yes. Thank you. It's great to be here, and thank you for having us. I'm really pleased with how things have gone. I decided to come back to the industry and come to Cboe because I thought that, to some degree, it was a transformational type opportunity, which I really love and that has proven itself to be the case not only internally within Cboe, which is what I'll talk about, but then also just the external environment and the way that it's evolved very rapidly over the last 12 to 18 months, there's a lot going on, so I'm loving being here. We spent quite a bit of time early on in my tenure, really sorting through the whole portfolio of businesses at Cboe. Cboe had been as you mentioned, very acquisitive, had been trying to do a lot of things. And they had a certain strategy, and the strategy was really built around expanding their equities capabilities globally and the the idea was that they would layer on to that data and information analytics and then derivative products. But I think a lot of the entry points and a lot of things they tried to do were just too small scale to really contribute to growth and lots of obstacles to the achievement of that strategy. So we basically got a strategic realignment done. We exited a lot of the cash equities businesses that were quite marginal. We rationalized a bunch of other things. And that really allowed us to focus on the core. And I think doing that to me was obvious because we have great growth opportunities in the core. We've been achieving tremendous growth. But the organization was very fractured in its attention and its allocation of resources trying to do a lot of other things versus really paying attention to the core business and making sure that we're doing as well as we can in terms of both growth and profitability. So that went really, really well. We're well through that process. The other thing is that in the 5 years before I got there, Cboe had also grown dramatically in terms of the size of the organization. both through acquisition and through hiring, we've added like 900 people to the organization. So in tandem with the strategic realignment, we also went through an organizational rationalization, and that's been very positive for us as an organization because it really has caused us to be very focused on the core and then identifying new growth opportunities. So we're actually very excited about the shift in focus back to derivatives. I mean, obviously, got a great FX business. We've got a great data business. We've got a growing and very successful European equities business stable, but not growing U.S. equities business, but there's a lot more we can do in derivatives and including outside of equity derivatives per se, and that's within Rob's remit. For the moment, what we're really focused on are event and prediction markets that are oriented toward financial instruments, economic indicators, commodity prices much more so in our wheelhouse where we're starting is in securities-based event contracts. And Rob can talk about that, but we're bringing to market. We've already brought to market a binary yes-no contract based on the S&P 500, and now we'll be bringing to market soon after regulatory approval, KPI contracts. And that's a huge market opportunity for us, we think, in terms of the total addressable market. And then in tandem with that, as we're thinking about product innovation, especially in the derivatives markets is expanding our clearing capabilities. We have a clearing house in Europe, a clearing house in the U.S. And that's a great way for us to be able to control our ability to innovate and our ability to bring products to market and also the ability to provide value clients in terms of cross margining benefits and reducing capital and margin requirements in new products that we develop. So very excited about that.

Great. A lot to dig in there. But maybe just 1 of the sort of high-level question, maybe with 1 specific 1 in there. Just thinking about the macro environment, give us a bit of your assessment of how customers are behaving, thinking about retail institutional, how they're using the CBO product suite. I'm particularly curious on the retail side, given the lifting of the pattern day trading restrictions a few months ago. It looks like there's some early signs that we're seeing a pickup in activity. So curious if you could weave that in as well in terms of what you're seeing on the ground?

Sure. So I think Cboe exists kind of on what I would call the higher end of retail, and I'd like to sort of describe it that way because I think there's a lot that's happening in retail right now, and then there's sort of the gaming platforms and there's the sports betting and all that kind of stuff. I think where we are is -- and I just want to take a second to step back and remind everybody that we've been capitalizing on this trend toward retail for 6 or 7 years, wholly unrelated to event and prediction markets and all the things that we see happening today with offshore perpetuals and all that kind of stuff. And that was really with the advent of 0 DTE trading. And so when we look at -- and this is another distinction that I just want to highlight is we have lots of people taking ownership of their own financial future. We have lots of people who are increasingly sophisticated and actually do understand options, including a lot of the retail broker dealers have done a great job, not only with education as do we, but in the development of tools that make it much more intuitive and easy for them to learn how to trade options, having shorter duration 1-day expiring contracts, I think, also was very additive to that. So we see really strong long-term secular growth trends that we're capitalizing on the increasing importance of the U.S. equity market and the S&P 500, the shift from mutual funds to defined outcome ETFs, which has been extraordinary and embedded in all those are options that come into our market secondary effect there. And then just this overall trend toward increased sophistication. It's still at a very nascent level we think, in terms of where it can go over time and Rob can talk a bit about that. But the pattern day trader rules has had a positive effect as well. We had a fairly arbitrary limitation on the amount of trading that you could do on options, depending on your net account value that's been lifted. And as Rob can describe, there's been a step function increase in volume that we're seeing coming the retail -- the larger retail broker-dealers that have already implemented that. So -- but overall, I would say, incredibly positive. And I think the last thing that I'll just say, so I don't keep talking is that when we look at the use cases, we see people doing fairly sophisticated trading activity in our products. So -- and I just want to highlight that because I think people worry about the sustainability of it, especially when they're thinking about sports betting and gaming and event and prediction contracts that are oriented toward other things that may not be sustainable. In our case, when we're looking at what they're doing, a lot of what they're doing is what larger institutional users in our markets are doing.

Right. You got to answer my next question was -- it's all good along those definitely a perception that retail is more at the lower end. But are there any -- I'm curious if there are any specific KPIs or stats you have the percentage of trades that are single leg call, single egg put versus more sophisticated strategies? Any way to sort of measure that?

I think the great thing is, overall, I would actually take a step back, it's the balance we're seeing overall across the platform. If you look at 0 DTE, it ranges around, call it, 60, just high -- or low 60s as a percentage of SPX trading -- when you look at the breakdown between retail and institutional, once again, it hovers between, call it, 55% to 60% retail, the balance institutional Obviously, that led to in the Q2 record SPX volumes around 5 million contracts, $3.1 million of that was 0 DTE. But I think it's also important to then show is options expiries in the 30- to 60-day bucket, we're up, call it, 14%, 15%. If you were to look at options and expiries of 90-plus days, those were up 28%. If you look at electronic access, up 163%, if you look at open outcry access up over 20%. So you look at short term, long term, both retail, institutional, both electronic, open outcry, both up -- it just speaks to the stability of the platform, and it speaks to the kind of the diversity of how all the market participants are coming in and using the product and it's leading to just a massive liquidity pool that then builds on that. Now we have international demand wanting to come in, people in regions like Korea, Thailand, all wanting access to that liquidity. And I think -- as that comes in, you all have heard the statement liquidity begets liquidity, we just can continue to grow. And then we use that as a foundation to now lean into things like we've already talked about, KPI contracts. Things that now are kind of offshoots of that liquidity, valuation components of single name companies that lead to stock price valuation, stock price leads to the sectors, option-based ETFs, those lead to the indices and you kind of wrap it all together into a very long-term sustainable business.

Maybe following up there because you mentioned, I think, some of the international interest. And I know on earnings calls for some time, you called out APAC and I think more recently, Europe is being mentioned. Just maybe if you can give us an update what you're seeing there, what sort of inning are we in terms of adoption of the suite, retail engagement -- and to what degree does demand overseas coming from retail brokers versus institutions?

I think we've had a heavy focus in the APAC region on the retail side, on the retail broker side. I still think demand continues to grow for the liquidity pools, like I mentioned, some of the barriers to entry are just from a regulatory standpoint in some of those regions, some of the cultures options are still viewed as a risky tool. So we're kind of working through that. So I think early days, I would say, a penetration and options usage there. When I think more on the institutional side, I think more of, call it, the Middle East region. You look at a lot of the sovereign wealth funds in the Middle East the Adia, the Ateca. They all have 30%, 35% exposure to the S&P 500 in their portfolios, but yet are very underrated in the options market. And we see that as a huge kind of growth area on the institutional side, once again, as we build off of those, we just kind of continue to expand where we see that demand.

Great. You mentioned also a little bit the short-dated SPX complex. So maybe a question there. I think most recently, it's around 63% of total SPX trading volume, and it's, I think, up pretty meaningfully over the last several years. So I guess for the shorter dated contracts, maybe how would you describe the use cases? And sort of given Xero's importance in driving growth over the last 4 to 5 years, how high do you think this can go? And what does this sort of mean for like the longer-term growth outgo?

Yes, great question. Once again, I'll come back to the balance. So what I'd like to see in the DTE case is the balance of risk. 95% roughly of the contracts traded or defined risk. So either buying an outright option collar put, buying a spread, selling a spread, everything where you know your risk going in, which is great for us to see. It means that sustainability is there because you're never going to have that blow up moment where somebody just has unexposed risk. So I think you'll continue to see the percentages fluctuate over time based on the environment, retail tends to be much more active in calm environments as you would expect. Volatility upticks, you get more market uncertainty, that's when the institutions start to trade a little bit more and you see that percentage of maybe retail dip institutions increase, but once again, it's still very balanced. Where you're seeing a lot of the strategies come in. Once again, I think yield generation has been a very common one, whether you're overwriting calls on a long-only portfolio or you're using call spread, put spread overlays and writing those on the sell side to capture that option premium. I think those have been very, very common and continue to grow. And then also, to be honest with you, and this is kind of a side shoot to the answer, we've seen options grow from more professional institutional side that are now using them to embed into ETFs that are offering option-based ETFs to the retail side. So if you're a retail client that don't trust yourself in trading the options directly but want the performance of options in your portfolio, these ETF products have been great. We've gone from probably about 2019 around $5 billion AUM tied to these option-based ETFs to about $300 billion currently. And I know BlackRock just came out with a research report saying they anticipate that to be around $650 billion as early as 2030. So you see options usage continue to grow on multiple, I would say, avenues, which is just super encouraging.

Right Well, maybe in there, talk a bit about the strategy, what type of traders these contracts meant to appeal to? And what does the initial uptake look like?

Yes. I think who we're trying to appeal to are non-option traders today. We launched binary contracts back in 2008, and they weren't successful. We ended up delisting them mainly because we were offering a binary product to an existing options trader. Once you're trading a pure option, the binary yes, no, 0 to 1 element isn't really what you're looking at . We went live about 1.5 weeks ago, -- the difference in those platforms now, though, is like that was kind of a gateway product to us getting out KPI contracts, which will be structured very similarly in that yes, no format. With the IBKRs and the Schwab platform currently, they're not in that -- they're not being offered in the graphical user interface version of the yes/no kind of gamification platform view that you see something like on also poly market. That is something they're still developing and will roll out later this year. So early uptake of this contract, I would say, is there, but it's slow because you're still kind of, in my opinion, working with that same user base that knows options today. What we're really excited about is the rollout of the KPI contract, mainly because now you're going to use this, yes, no vehicle to give a valuation component that doesn't exist today. We do broad-based very well with SPX. I've talked about the defined outcome in the ETF space that's kind of that sector level or slightly smaller than broad-based. We do single stocks well with our multi-list contracts. Now we're going to take that a step lower and we're going to start to get into the individual metrics that drive the valuation of those stocks themselves, which is super exciting because I think -- it will entice retail to start. I think you'll see the rollout work very similar to 0 DTE where kind of that 80%, 85% of retail to start, but then I think you'll see institutions come in when the data sets become available when they can go to their risk managers and get approval to introduce some of these new products to their portfolios. But you're going to be able to trade these individual metrics that impact individual stock performance. And I'll close with -- I've been using this example a lot, but I think it's a great example, Home Depot last quarter. They beat on every KPI metric and yet on future guidance, their stock price was down immediately after. So if you were trying to have a trade on that was to represent the beat on all these individual performance metrics and you own the stock, thinking that was going to show up in that performance, you would have been dead wrong and it actually would have worked against you. Now having these components, you can have backward-looking metrics where I can look at Tesla car deliveries, I can look at Navidea data revenue sales, and I can actually have components in the valuation chain able to trade that. And then I can also look at future guidance and maybe use the stock price or something along those lines to make those trades, which I think is a super interesting kind of forward-looking way to evolve this industry.

Maybe just on the regulatory side. So you're in a -- you had an application with the SEC. Can you talk a bit about that process, what the conversations have been like? I think there was a bit of confusion because the SEC extended the potential deadline to maybe help us understand what all that means.

Yes, I can take that. I mean I think, first of all, we think the SEC has been great to deal with all this stuff. They're very interested in these products. And we've had, I think, a really good back and forth with them. So right now, while they've extended the time frame, we have 2 things that are predicates for us to go to market. One is the approval of the contracts themselves. And the second is the approval of our application to be a temporarily registered securities clearing agency that 1 had a slightly longer time frame anyway. So the extension of the common period doesn't really affect us in that way because we need them both. But our expectation based on our interactions with the commission and the commission staff is that we would hope to see regulatory approval well within that extended timeline, so -- but it's been very positive. The commission has been moving very quickly on both in terms of our interactions, raising questions. We've been able to answer them -- and so we're very positive on that.

Great. Maybe just 1 last question on the single stock KPIs. So any color on the early reads with buy-side firms and market makers. You mentioned I think you expect a lot of like retail uptick, but from our conversations, there seems to be a lot of interest, especially like the liquidity is there, and you can get good execution. So what's the appetite for those types of customers or product structured this way? And maybe as you think about like early liquidity, how do you ensure market maker participation and get liquidity off the ground?