The 'ultimate play' on volatility on Wall Street is set for a rough quarter

We won’t know exactly how Virtu Financial fared during the third quarter until November 7, when the high-frequency trader unveils its earnings, but one UBS analyst is betting things won’t look good.

Times are tough for high-speed traders, which do better when during more volatile market conditions. The firm posted weak earnings for the second quarter, which came in below Wall Street’s estimates. Alex Kramm, an analyst at UBS, said the third quarter will be even worse.

The bank slashed its expectations for the firm’s Q3 earnings per share by nearly 80% to $US.04 from $US.19. The firm delivered $US.13 per share to investors in the second quarter of 2017.

“We view VIRT as the ultimate play on our belief that trading volumes remain cyclically depressed and are poised to increase as the debate around global interest rates plays out and geopolitical uncertainty continues,” UBS said.

Virtu acquired KCG, another high-frequency trading firm, earlier this year. Low volatility and rising technology costs have forced a number of HFTs to merge or close up shop. UBS thinks the acquisition will weigh on Q3 EPS.

“While VIRT announced that it had already taken actions to achieve half of the expected run rate synergies of $US250mm exiting the 3Q, we believe that those actions will weigh heavily in the near-term, resulting in a messy quarter,” Kramm said.

As liquidity providers, HFTs are scanning the markets for opportunities in which buyers and sellers aren’t matched up. But when volatility is too low, like it has been for the past four months, those opportunities are hard to come by because there are fewer price swings. Cifu addressed this low volatility environment during the firm’s last earnings call on August 10.

“We remain confident that the core results are a consequence of the terrible environment for a market-maker,” Cifu said. “While we are not happy with the results, we are proactively managing our business to grow and to continue to earn an acceptable return in this environment.”

Markets haven’t gotten more active since Q2. Average equities volatility were down 17% compared to Q3 of 2016 and volatility for commodities were down 27%, according to UBS. There were some bright spots, however. FX volatility was up 2% over quarter 2 of 2017.

UBS has not changed its $US18 price target for Virtu, a stock for which the bank has a buy rating. It is looking to the fourth quarter to see where the company stands when Virtu and KCG are fully integrated.

“We believe this demonstrates the potential of the combined firm as costs are removed and the company delevers,” Kramm wrote. “As such, we believe the dividend will remain secure, and there could still be upside in a more normalized environment.”

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