Many elements of the January 2021 meme stock frenzy are already well known and timeworn – the wild, correlated rally in a family of around 100 stocks; the lurid conspiracies that sprouted after clearing houses hiked margin requirements and retail brokers shut down trading in some companies. And the Congressional hearings that followed, with Ken Griffin one of the key witnesses – his hedge fund had bailed out a short-seller; and his market-making firm, Citadel Securities, is the biggest provider of retail liquidity.
One story that hasn’t been told is what happened within Citadel Securities during this period.
“Elements of this were unique,” says Joe Corcoran, the firm’s New York-based head of markets. “The January surge, while quite significant in both size and scope, was largely consistent with – and predicted by – behaviours we had previously observed. But there was a specific subset of names with unique behaviours and correlations that were not well explained by historical analysis, current data or predictions. So, that was challenging at first.”
Like all big electronic market-makers, Citadel’s business depends on its ability to price its trades accurately, and at speed – and that in turn requires a deep understanding of their behaviour and the correlations between them. The behaviour of any given stock, or group of stocks, will change in different market conditions, so the firm’s various risk-based market-making strategies are augmented by a library of specific adjustments that trigger when the market is gripped by a particular mood or affected by particular forces. One example is a factor that comes to the fore when investors are worrying about a China-US trade war, says Corcoran.
As the frenzy took hold in January last year, Citadel started looking for a “meme factor” – a way to recognise a stock that had fallen within the orbit of the market’s retail army. As the first hours and days of the frenzy played out, quants and engineers at Citadel Securities took the new data that was flooding in and looked for precedents they could learn from.
Unlike a normal risk factor, which may be fairly stable from day to day, Corcoran says the meme-related activity was highly variable – manifesting as sudden, dramatic changes in behaviour – which lent itself to an event-based approach.
“We realised these abrupt changes in trading cadence had similar characteristics to events in the biotech space or other stocks that are driven by episodic catalysts. This resulted in price-gaps and truncated moves, sometimes intraday, which were not as well explained by historically relevant factors.”
He adds: “Using this analog we decomposed the episodes into distinct phases – specifically, ignition, acceleration, plateau and descent. Each phase fits with distinct data and behaviour consistent with that phase, or with expected transition into the next phase. This is the type of work we deliver every day, but I was still impressed by the speed with which the team identified, analysed, solved and deployed this particular adaptation. It meant we were able to quickly provide more liquidity – we became much more confident in our understanding of the move, where we were in the move and the risk we would have going forward.”
There was no ‘eureka’ moment, adds chief operating officer Matt Culek – instead, a series of tests and incremental changes were made over a period of days.
“It’s not really binary – it’s not like you do a bunch of work and then say ‘OK, now I understand it.’ It’s incremental. You make an adjustment, you see how it works, and then you update as you have new insights or see new things. But I think that iterative cycle converged pretty quickly to a point where we were comfortable providing liquidity and maintaining our standard business model,” says Culek.
While grappling with stocks that were behaving in strange and unique ways, Citadel also had to ensure it could cope with volume surges, as one rival or another stepped back from the market or was overwhelmed.
During this period, the firm had frequent calls from retail brokers, says Culek: “They’d get in touch to warn us: ‘Hey, market-maker X is down, you’re going to be getting an increased amount of flow.’”
How many liquidity providers were affected? “I think everybody – except us – had issues at one point in time during that period,” says Culek.
This account is corroborated by a senior source at one large trading venue.
To limit the pressure on its systems – and its tech and ops teams – Citadel minimised the amount of non-essential technology changes it made.
On January 27, the frenzy hit its keenest pitch and GameStop – poster child of the meme rally – reached its peak closing value of $347.51, having gained more than 1,600% in the space of just 12 trading days. During its meteoric ascent, around 100 million GameStop shares were trading every day – a roughly 1,400% increase on its 2020 ADV.
That day saw Citadel Securities execute a total of 7.4 billion shares on behalf of retail investors – the firm’s all-time high. As a yardstick, the ADV for the entire US equity market was just over 7 billion in 2019, before the pandemic hit, according to the Securities Industry and Financial Markets Association – that figure rose to 11.4 billion in 2021.
“This series of events that occurred – I can understand why that generated a lot of interest,” Culek says. “The scale we’ve achieved has made us an important part of the market.”
But he dismisses the firm’s online critics: “How some of the more crazy conspiracies came about, I mean, who knows – that’s a different academic area of study than I would consider myself an expert in. We’re very proud that we were able to be there for our clients when it mattered the most – when it was really challenging, when we saw volume and volatility levels no one had seen before in the retail space, and we’ve heard directly from our clients how grateful and thankful they are that we were there.”
Citadel has also been compensated for being there. Culek cites recent reports that claimed the firm made $6.7 billion in net trading revenues during 2020, adding that this figure was “more than double the previous high we’d seen in 2018. What we can say publicly at this point is that 2021 was another record year for the firm.”
One of the questions for the US equity market is whether retail participation will continue at pandemic levels. So far, evidence is mixed. During the meme stock frenzy, retail trades made up as much as a quarter of all volume, Culek says – but as the year rumbled on, retail’s share slid back to the upper-teen percentages. In the options market, however, retail participation boomed and has remained robust.
Citadel Securities has been using its dominant position in retail equity options to build an institutional business over the past couple of years. That includes popular weekly and monthly research reports, in which Citadel’s retail flows are digested and analysed for the institutional audience – another sign of how the market’s traditional order has been upended.
“Retail’s aggressive move into the options world has resulted in some changes that most institutions are just not used to. For instance, you’d normally find that calls have a considerably lower implied volatility than puts – but you didn’t see that during last January’s moves. There was significant buying of upside calls, which changed the entire skew profile of the market. Retail has become quite an impactful force,” says Corcoran.
Retail’s aggressive move into the options world has resulted in some changes that most institutions are just not used toJoe Corcoran, Citadel Securities
After hiring David Silber and Jason Roelke from Deutsche Bank to lead the charge in 2019, Citadel has grown the institutional options team to eight, while adding more than 250 clients. Since the end of 2020, client volumes have jumped 90%.
Culek claims the firm is now a top 10 institutional market-maker for listed options. “We’ve had good early success, but we can go a lot further. Our ambition in 2022 is to become a top five dealer in this space,” he adds.
The logic makes sense – Citadel’s big retail base might generate axes that institutions want to trade against, and a growing institutional business could give the market-maker a more diverse book of risk. But are there any conflicts here?
“There’s no communication between the institutional business and the retail business – client information, open orders, anything like that,” Culek says.
Ready to join the club?
The US Treasury market is another place where Citadel aims to build on an existing strength. For years, the firm has flagged its interest in becoming a primary dealer in the US – now, it is getting ready to apply, though still coy on the timing.
“We do, at this point, expect this to be something we will do,” says Culek.
He adds that a consulting firm has been engaged to compare Citadel’s capabilities against the eight eligibility criteria specified by the Federal Reserve Bank of New York. The Fed requires non-bank primary dealers to have net regulatory capital of $50 million, for example – lowered from $150 million in 2016 to open the door to a wider group of firms – and to be a participant in the market’s government bond clearing service. Some of the necessary investments identified by the consulting firm have already been made, Culek says.
He declines to give any clues on when Citadel might apply to join the 24-member club, but is more open about the attractions of the role – including having more influence in ongoing discussions about how to reform the world’s biggest government bond market.
“One of the things that is really important to us – and one of the benefits of being a primary dealer – is having a larger seat at the table on market structure reform and market structure changes,” says Culek.
An oft-touted – but slow-burning – revenue stream for larger market-makers is the white-labelling of liquidity to other dealers. This is typically presented as a way for domestic and regional banks to provide their local clients with access to international markets. Citadel Securities has spoken about its first steps into this business before, referring to the arrangements as liquidity “partnerships”.
One of the things that is really important to us… is having a larger seat at the table on market structure reform and market structure changesMatt Culek, Citadel Securities
In 2021, there were more of these deals, but in some cases with a new emphasis – larger dealers opting for private, bilateral liquidity streams in place of public, multilateral venues where information leakage is a threat.
“Given the nature of these partnerships, I can’t really get into much of the detail, but it’s a growing trend for larger financial institutions to make decisions on how they’re going to invest in their operation: what makes sense, what doesn’t. It’s an active dialogue and it has accelerated over the past year,” says Corcoran.
Finally, a watch-this-space topic: Citadel had been portrayed as a sceptic on crypto-currencies, until it sold a $1.15 billion stake to Sequioa Capital and Paradigm last month. The latter is a venture capitalist focused on crypto and opportunities in online decentralisation.
That’s not a coincidence, Culek admits: “We’re getting their views on how we should think about the opportunities in this space – what type of business and what type of strategies make sense for us, given the firm we are and the views we have on regulatory clarity and market structure.”
Citadel’s perceived snubbing of crypto was based on comments made by Griffin in 2018, and subsequently, he questioned the value of the market. But last year, he also said Citadel Securities would trade digital currencies if the regulatory picture was clear.
Culek echoes that stance. He calls for “more clarity” on how the market will be regulated – the firm’s principal concern – and adds that Citadel also has “some operational questions” about crypto. But the firm isn’t just sitting on its hands in the meantime, he adds. As well as the ongoing conversations with Paradigm, he says “we are actively exploring and working on various initiatives in the crypto-related space. Things are happening, work is being done internally – but nothing’s been finalised yet, so we’re not saying much publicly.”
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