Your Capital at Risk Part 2: Bucket Shop 4

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Part 1: Short Plus500
Part 2: Bucket Shop
Part 3: Customer Lifetime Value
Part 4: Companies House Inconsistencies
Part 5: Audit Opinions
Part 6: Unlicensed Activity
Part 7: Whois Plus500?
Part 8: Scalping
Part 9: Worldwide Web
Part 10: Competition
Part 11: Unanswered Questions
Part 12: Legal Consequences

Plus500 is a “bucket shop” that offers customers derivative interests without transacting on an exchange. Shockingly, that’s not illegal in Europe. This post is intended as background to explain how the model works.

Before delving into the company’s financials in detail, I must first confess my own initial naïveté regarding the company’s business model. Although it’s spelled out quite clearly in the Admission Document that Plus500 profits directly from customer trading positions, I found it hard to believe at first.

It is important to understand that Plus500 operates a form of legalized gambling, not a typical retail securities brokerage model that might be more familiar to American readers. When a customer purchases or sells a CFD through Plus500, Plus500 acts as the counterparty in a bilateral wager with the customer tied to the price of some underlying instrument. In other words, Plus500 is on the other side of the trade against its own customers. This is precisely the bucket shop model outlawed in the United States in the 1920s. When combined with high levels of leverage and no requirement to provide the same price that could be obtained on a recognized exchange, the potential for abuse should be readily apparent.

In its 2014 annual report, Plus500 claimed to be profitable on 349 trading days, up from 297 in 2013. This is startling not only because of its consistency. It is also remarkable because a typical trading year has only 252 trading days, depending on the timing of holidays and weekends. If Sunday nights are included (when interbank forex markets are open) there are still only 304 trading days. Evidently, Plus500 is also profitable on Saturdays when underlying securities markets are not even open! This is only possible because Plus500 trades against its customers without executing offsetting transactions on an exchange.

Plus500 reported $56.1, $115.1, and $228.9 million of turnover in 2012, 2013, and 2014, respectively. To provide some context for this revenue relative to the size of its business, consider a few point-in-time items from the balance sheet:

USD thousands at December 31 2012 2013 2014
Absolute value of customer positions (gross assets plus gross liabilities) 9,578 15,766 11,366
Segregated client funds 19,805 32,817 34,730

Plus500 filings state that the majority of positions are not held overnight, and investor relations informed me that customers make many small deposits over the course of the year and that the company may have gross exposure of $70-80 million at any given time. The company’s representative estimated that total deposit and withdrawal volume in 2013 was $300 million. Each of these figures, if true, is significantly higher than the point-in-time amounts shown on the year-end balance sheet.

However, given the size of its balance sheet and level of customer positions and equity, the reported turnover is still eye-popping. Dan McCrum wrote about this point already, but it is worth emphasizing. Plus500′s reported revenue in 2014 was 6.5 times the total amount of customer equity at year-end. If the $300 million estimate is correct, Plus500 captured for itself an astonishing 38% of the total amounts customers deposited to trade in 2013.

Despite this, according to company reports, customer losses have declined dramatically as a proportion of Plus500′s revenue, from 18% in 2011 to 1% in 2014. For Plus500 to generate the reported level of turnover from fees and spreads alone, the trading volumes on the platform must be staggering in relation to customer balances, implying very high average leverage on the platform. A January Numis note estimated trading volume at $160 billion in 2014 assuming a typical average round-trip spread of 20 bps. Their estimate of 150x average leverage is consistent with management estimates of total transaction numbers in the tens of millions and average notional transaction size in the tens of thousands. Plus500 would appear to have created a clever means by which customers lose money slowly, over many transactions, rather than all at once.

Given the typical intraday volatility of many of the products underlying Plus500′s CFDs, it is frankly rather surprising to me that with such high leverage and so much transaction volume that more customers don’t lose money due to margin violations. I question whether the notional volume on the platform is as high as estimated above or if the contribution from customer losses to revenue might be greater than the 1% claimed.

To the extent Plus500 has not hedged the notional exposure from a CFD position, which it generally does not do except on a portfolio level (more on this in part 10), then Plus500 recognizes the lost deposit amount as trading revenue when the position is closed.

Good for Plus500, if not for the customers.


On to Part 3: Customer Lifetime Value and the Bull Case –>

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4 thoughts on “Your Capital at Risk Part 2: Bucket Shop

  • Reply
    Assaf nathan

    seems like you did not read the annual report….

    The amount of segregated clients money is only the money that plus 500 holds. much more resides in other banks and does not appear on the balance sheet:

    this is one:
    The Group approach is to insure that there will be
    no material liquidity mismatches with regard to
    liquidity maturity profiles due to the very shortterm
    nature of its financial assets and liabilities.
    Liquidity risk can, however, arise as a result of
    the Group adopting what it considers to be best
    industry practice in placing some retail client
    funds in segregated client money accounts. A
    result of this policy is that short-term liquidity
    ‘gaps’ can potentially arise in periods of very high
    client activity or significant increases in global
    financial market levels.

    this is two:
    Segregated client money accounts hold statutory
    trust status restricting the Group’s ability to
    control the monies and accordingly such
    amounts are not reflected as company’s assets in
    the consolidated statements of financial position.

    how can you short if you did not read the financial statements?

    • Reply

      Plus500 takes customer deposits STRAIGHT AS REVENUE in the vast majority of cases.
      Cash/Cash Equivalent to Customer Segregated Accounts is 4:1 roughly – the exact opposite of what the industry standard is.
      It implies, and it is so confirmed in the annual report, that clients deposits are straight booked as revenue. Just read the corresponding paragraph in the annual report.
      This explains a lot, and it explains as well why all clients have greatest difficulties to access their funds when trying to withdraw what is considered their own money……. It’s a hassle for Plus500 because it forces them to constantly re-evaluate their accounts and correct already made entries in the books….. Any customer asking for his money is a pain to them……
      Seems YOU didn’t read carefully enough :)

    • Reply

      The segregated accounts outside the balance sheet are summed up on page 68 of the 2014 annual report, between USD 30m and 40m, almost unchanged. Just, it’s a question if these amounts are correct and if the accounts really are segregated to the industry’s standards. It seems like according issues are the main cause of currently blocked accounts – and not the anti-money laundering regulation.

  • Reply

    Plus500 claims that only 1% of the revenue consists of customer losses. That’s pure nonsense. Considering that Plus500 does not give any transaction to the market and that customers can’t really have many orders executed the way Plus500 manipulates them, I would suggest about 80% of the revenue consists of net customer losses (losses minus gains) as well as unfairly withheld withdrawals.