ResearchThe Weekly (5/10)

The Weekly (5/10)

May 15, 2024

Secrecy is the hallmark of the hedge fund industry.

In a world where markets are highly efficient, maintaining a competitive advantage is the number one asset and information is usually the currency.

So when quant power house Jane Street sued two former employees that had jumped ship to rival Millennium, some of the strategies for Wall Street’s best ideas were unveiled to the public. Seeing a glimpse of the inner workings of how and more importantly where these investing giants were allocating capital was a treat for the investment obsessed like us.

What’s interesting is that documents from the court case revealed that one of Jane Street’s biggest moneymakers isn't some exotic Wall Street derivative or AI thesis, rather the surprisingly unglamorous world of Indian stock options.

We're talking a cool $1 billion in profits last year for Jane Street alone.

This has investors scratching their heads and looking towards the burgeoning market in southeast Asia.

The country accounted for a staggering ~84% of all equity option contracts traded globally last year, up from a measly 15% a decade ago. The National Stock Exchange (NSE) is the epicenter of this frenzy, handling a whopping 93% of the volume.

Why the sudden surge? It likely goes hand-in-hand with India's booming stock market, which recently surpassed Hong Kong to become the world's fourth-largest. The benchmark Nifty 50 is flirting with all-time highs, and the number of retail investors in India has tripled since 2019 thanks to the rise of user-friendly apps.

What’s the investment of choice for these new entrants looking to take more risk? Given that shorting stocks (betting they'll go down) is a pain in India and crypto is under a regulatory microscope, investors, specifically retail investors, are turning to equity-index options.

In its simplest form, you pay a tiny premium for the right to buy a whole basket of stocks (an index) at a certain price by a certain time. Think of it as a lottery ticket for the stock market. If the market zooms past your strike price, you win big. Otherwise, you lose your premium, which is likened to the cost of playing.

Now, for the sophisticated players, this is a goldmine. Jane Street’s high frequency trading platform has been able to massively benefit from India’s low-cost, high-volume market. Using their information advantage they can out hustle a marketplace that’s still relatively inefficient.

It’s not just Jane Street benefitting either. Exchanges are making money on every trade, trading firms are raking in the fees, and the government is even getting its cut in taxes.

It’s not all good news though as retail investors looking to win big make up about 35% of option trades in India. Market regulators estimate that 90% of those traders lose money on derivatives so it appears that Jane Street’s profits could be coming at the expense of the every day investor.

But with institutional profits soaring, others are swarming.

Citadel, IMC, and others are beginning to build out their efforts in India. As markets become more crowded, they become more efficient. And as they become more efficient, the profits get squeezed towards zero.

Which brings us back to the ethos of information advantages in the investing industry.

The importance of secrecy we suppose is for good reason. The cat’s out of the bag and so are Jane Street’s incredible profits – like most market anomalies, this one will likely be competed away.

Markets are efficient and this is yet another example of that thesis proving true.

Have a great weekend,

– Your Titan team

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