Spirited VIX Volume Spurs Cboe Growth

Cboe Global Markets, Inc. (CBOE -0.98%) reported expansive earnings growth in its first-quarter 2018 report, issued on May 3. In addition to revenue tacked on from its acquisition of Bats Global Markets in March 2017, Cboe enjoyed increased volume in trading of the company's proprietary VIX (Cboe Volatility Index) futures and options.

However, as of late, investors have grappled with misgivings around the company's volatility-based products. We'll discuss those concerns below, after reviewing headline numbers and important details from the quarter.

Cboe Global Markets: The raw numbers

Data source: Cboe Global Markets, Inc. *Difference too large for meaningful comparison; see below for special items affecting net income and earnings per share.

What happened with Cboe Global Markets this quarter?

• The bulk of Cboe's top-line advance was due to $131.2 million in net revenue acquired from the Bats transaction last year.

• However, organic revenue surged 28% -- as net revenue excluding Bats' contribution jumped by $43.1 million, to $197.3 million.

• Cboe posted revenue growth in each of the company's five segments: options, U.S. equities, futures, European equities, and global FX (foreign exchange). For ease of comparison to the prior-year quarter, the individual segment results below will be discussed on an adjusted basis, as if operations of Cboe and Bats were combined in the first quarter of 2017.

• Options net revenue advanced 24% to $167.1 million on higher net transaction fees. According to Cboe, 84% of options net revenue was attributable to the company's proprietary index options. The average daily volume (ADV) of SPX (the S&P 500 Index) options increased 39% year over year, while VIX options ADV jumped 62%. A higher-volatility environment in equity markets in comparison to the last couple of years is elevating trading levels of VIX products in 2018.

• U.S. equities net revenue grew 10% to $79.7 million, which management attributed to higher transaction fees and market-data fees.

• The futures business was buoyed by heavy activity in VIX futures trading. ADV in VIX futures improved by 41% to 360,500 contracts -- a quarterly record. The segment's top line of $42.3 million represented expansion of 47%.

• European equities net revenue grew 18% after adjusting for foreign currency effects. Cboe cited higher transaction fees for the performance, as well as increased non-transaction fees from implementation of MiFID (Markets in Financial Instruments Directive) II, a set of European regulations which extends the transparency and structured-markets goals of the original MiFID implementation.

• Global FX boasted a 44% increase in ADV during the quarter, pushing net revenue up 35% to $14.6 million.

• The company scaled its $65 million target of projected annual synergies related to the Bats merger to $85 million, and noted that it expects to realize this goal in 2020, a year ahead of schedule.

• In April, Cboe began disseminating the "Cboe One-Year Volatility Index," which measures estimated volatility over a one-year period, as opposed to the VIX, which gauges estimated volatility 30 days forward. As you might guess, the organization is exploring futures contracts based on its new index, subject to regulatory approval.

• After adjusting for acquisition expenses, and the amortization of intangibles which hit Cboe's books via the Bats purchase, operating margin rose roughly 6.5 percentage points against the first quarter of 2017, to 66.5%. The difference was primarily driven by Cboe's heady organic revenue growth.

Image source: Getty Images.

What management had to say

For all the positive trading volume, uncertainty hangs over Cboe's stock price due to allegations that VIX trading settlements are subject to manipulation, as asserted in an academic paper published in May 2017.

On May 3, 2018, the same day first-quarter earnings were released, Bloomberg News reported that both the Securities Exchange Commission and the Commodity Futures Trading Commission have opened investigations into the monthly auctions which determine the price of the VIX.

Shareholders were already unsettled by atypical settlement activity that occurred during the April 18 VIX auction, so the news on May 3 pushed Cboe stock into the red. Though it opened higher on the strong earnings report, Cboe stock closed down nearly 3% by the end of the trading session.

There are a few things investors should understand about the VIX controversy. First, according to Bloomberg, both regulatory investigations are preliminary -- Cboe itself isn't being investigated at this point, nor is it accused of any wrongdoing.

Second, Cboe has consistently and vehemently maintained that it's confident in its auction process, as well as the controls it has in place to prevent manipulation. Cboe issued a letter to customers and the investment community at large on April 24; it addressed both the April 18 event and concerns about VIX auction settlements in general. The April 24 letter attributed an unusual disparity between trading prices and settlement prices in the April 18 auction to a lack of liquidity.

During the company's May 3 earnings call, president and chief operating officer Chris Concannon underscored Cboe's commitment to transparency, and characterized the unusual April 18 auction as a temporary issue which the company could fix by working with market participants: "[W]e wanted to be clear that we were disappointed with the 18th, and we saw it as a liquidity challenge and nothing more. And we're out now trying to enhance that liquidity, as I spelled out earlier in the call."

Image source: Getty Images.

Looking forward

While Cboe refrains from providing revenue or earnings guidance, management does issue a few outlook items for investors to track during the year. This quarter, Cboe lowered its full-year capital expenditure target from a range of $50 million to $55 million, to a new band of $45 million to $50 million. It also affirmed adjusted operating expenses of $420 million to $428 million, which excludes the amortization of Bats intangibles mentioned above.

Investors will want to keep an eye on progress toward these targets, as well as any developments on the VIX auction front.