In one sentence: Answering a listener about Robinhood and zero-commission brokers, Phil and Danielle explain why "free" trading is paid for through the spread and sold order flow, why Robinhood limited GameStop buying, and how to test your own broker's fills.
Key ideas
- Why derivatives got out of hand. Options began as useful hedges (a baker locking a wheat price, warrants as a sweetener). The trouble starts when contracts are resold and stacked into contracts on contracts. Phil recalls Buffett calling these a financial nuclear bomb, and links it to 2008 and to GameStop. [04:00–10:00]
- Robinhood's collateral crunch. As Phil describes it, the clearinghouse required it to post billions in collateral, and it raised money overnight. Phil and Danielle say the lack of commission was not the cause, since the requirement was set by the exposure. [10:00–12:00, 17:00–18:30]
- There is no free trade. Phil says the broker earns on the spread between bid and ask, and by selling retail order flow to large funds, which can give retail clients a slightly worse price. This is legal. Wide spreads show up in illiquid stocks and options. [12:00–15:00]
- The conflict. One fund that took order flow also became an investor in Robinhood's rescue and had been short GameStop. That is why many saw cronyism, though the hosts say the broker had no choice. [15:00–17:30]
- Interactive Brokers. Phil prefers it for routing orders to the best venue, and its chairman explained the same forced restrictions. He says he has no financial interest. [18:00–21:00, 28:00–31:00]
- Other brokers. Danielle has heard good things about Schwab and about Fidelity, which she says didn't shut down GameStop buying. They tell listeners to choose their own. [31:00–32:00]
- Know how a company makes money from you. Danielle applies this to brokers and also to tech companies and data. [26:00–27:30]
- Test your broker. Two people place the same order at the same moment on different brokers, then compare fill price and speed. [27:30–33:00]
- Pennies matter in options. For a long-term stock buyer, a two-cent difference on a $50 share barely matters. For options, one cent can change whether a trade is worth doing. [33:00–34:30]
How it maps to RuleOne
- RuleOne doesn't place trades. The execution step is outside the site, so the broker choice stays with you. Use the buy price from the stock page and a limit order.
- Wide spreads are a reason to avoid thinly traded options and small illiquid stocks.
Buffett, Munger and Graham links
- Buffett's 2002 Berkshire letter on derivatives as "weapons of mass destruction". Check the year before citing.
- Munger and Buffett's repeated advice to keep trading costs and turnover low.
Words to know
- Bid/ask spread: the gap between the highest price a buyer offers and the lowest a seller asks.
- Payment for order flow: a broker being paid to send client orders to a trading firm.
- Fill: the price at which your order is executed.
Try this
With a friend, buy one share of the same liquid stock at the same moment from two brokers and compare the fill prices.
Check yourself
- How does a zero-commission broker make money?
Answer
Through the spread and by selling order flow, among other things. - Did zero commission cause Robinhood's collateral problem?
Answer
The hosts say no. The requirement came from the size of the positions being cleared. - When do small price differences matter most?
Answer
In options and frequent trading, less for a long-term stock buyer.
Short quotes
"There's no such thing as a free trade. Those don't exist." (Phil, ~12:00, auto-transcribed)