Just a couple of months ago we’ve been making fun of Timber Hill. A few Norwegian retail investors fooled the sophisticated automatic trading software and made a few bucks along the way. Both vikings, Svend Egil Larsen and Peder Veiby, were sentenced to suspended jail terms last October. Story isn’t over yet, as they will appeal to the verdict. This fairy tale from the polar circle is a funny anecdote, but more serious was the complaint from Timber Hill’s parent company Interactive Brokers that market making wasn’t worth the risk anymore. Fast trading algoritms shot their quotes from the market beating them on the delta.
Only a few months later things have changed. Timber Hill’s profits soared in Q1 from $6 million to $135 million. That’s a great comeback for the famous worldwide electronic trading system. Discussing the results, chairman Thomas Peterffy has identified three sources for the improved results:
The average effective spread in the first quarter was about 30% wider than a year ago and 9% wider than in the fourth quarter. This is a positive trend that helped fuel our trading gains during the quarter. Also a positive, the ratio of actual to implied volatility has risen from the historically low levels we witnessed at the end of the last year. In the first quarter this ratio increased to 70% from 61% in the prior quarter and stayed on par with the year ago quarter.
However, the average implied volatility level remained surprisingly low despite a chaotic first quarter with the eruption of protest in the Middle East, the disaster in Japan and a shaky West recovery threatened by rising oil prices and stubbornly high unemployment rates. The mix actually fell about 8% from the year ago quarter and 4% from the prior quarter.
Basically, the bid-ask spreads has widened, the trading volume and the realized volatility have increased. Petterffy also notes the low implied volatility in the current option prices. Volatility is sinking, while the world seems to be on fire and a new European debt and/or banking crisis isn’t unthinkable. Greece will have to restructure their debt sooner or later, and with the Landesbanken at stake political mess is guaranteed. Anyway, with a $ 135m profit one thing is clear for all other market makers ; we’re back in the happy days again.