In SoFi Technologies' (SOFI 3.69%) most recent earnings call, CFO Chris Lapointe said the company's online brokerage would soon roll out options trading, which will give investors the right to buy or sell a stock at a certain price by a certain date. SoFi is a big company with lots of financial products, including loans, cash management accounts, personal budgeting tools, and more. Because of that diversity of offerings, it might not seem like it, but this feature within the SoFi Invest brokerage could be a big deal. Let me explain.
The power of options for brokerages
In case you didn't know, an option is, essentially, a bet on a stock hitting a certain price -- up or down -- by a certain date. For example, if you think a stock that's trading at $40 a share in March might hit $50 or more by July, you can buy "call options" on that stock to make that bet. Each option involves 100 shares, so if the stock exceeds $50 a share, known as the strike price, you are set to make some nice gains because it involves multiple shares.
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The risk with options is that if the stock you bet on doesn't hit $50 a share by the set time, you lose all the money you paid for the options, whereas if you were just to buy the shares, your money would still be intact, and your shares would have unlimited time to increase and reach your desired return.
SoFi runs a commission-free online brokerage for its members to buy and sell stocks and cryptocurrencies. However, it isn't a market maker, meaning it doesn't actually execute those trades. Rather, it helps source those trades to the digital custody and clearing company Apex, which then connects with market makers to facilitate the trades. SoFi earns fees, known as payment for order flow, for driving these trade orders to Apex.
While I do not know what kind of deal SoFi will have with Apex when it comes to options trading, these orders tend to be much more profitable than regular equity orders. For instance, Robinhood Markets, one of the larger payment for order flow brokerages, reported that options trading made up nearly 62% of total transaction revenue in the fourth quarter of 2021. Transaction revenue is Robinhood's largest revenue source.
That's because market makers make money in pretty much the same way normal traders do. They buy a bunch of stock orders at one price and hope to sell them at a higher price and make money on what is called the bid-ask spread. Options trading tends to carry larger spreads than regular equity orders, so market makers can pay higher fees for them.
How options can help SoFi's flywheel strategy
If you've been following SoFi, you know that it employs a flywheel strategy in which it hopes to sell customers multiple financial products and services. By selling multiple products, the company only has to invest in acquiring that customer once, increasing lifetime profit margins on that customer.
But for SoFi to succeed with its flywheel strategy, it must first bring people onto the flywheel and into the SoFi ecosystem. Most of SoFi's members tend to first come to SoFi through one of three products: its SoFi Money cash management product, its SoFi Relay budgeting tool, and, of course, the SoFi Invest online brokerage account.
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As you can see in the slide above, new members tend to funnel down through the Money, Relay, and Invest products, eventually using the company's more profitable credit card and lending products.
By having a better investing platform with more capabilities like options trading, more people are likely to sign up for a SoFi Invest account. Interestingly, in Q4 2020, SoFi had more people using its Money and Relay products over its Invest account. But at the end of Q4, SoFi Invest had topped Money and Relay, with nearly 1.6 million accounts, suggesting the Invest account got better at pulling in customers.
One reason that could explain this is that SoFi significantly grew the number of cryptocurrencies that could be bought and sold through the brokerage to 30 cryptocurrencies, which management said makes SoFi a leader in terms of online brokerages offering crypto.
So, again, the more capabilities on the Invest product, the more effective it will likely be at pulling in members. Additionally, SoFi houses its Invest, Money, and Relay products in its financial services division; although a huge part of the flywheel strategy, this has been a drag on the company's financials. Of SoFi's three divisions, it is the only one that has regularly reported a significant contribution loss in each of the last three years.
Looks like a positive development
In summary, options trading could be a big deal for SoFi because it makes the Invest product more attractive to prospective members and, therefore, brings more members into the SoFi ecosystem and onto the flywheel. Furthermore, it may improve revenue in the company's Financial Services division. We don't know what kind of fees SoFi would get for options from Apex, and options trading can draw more scrutiny from regulators, but the added functionality certainly looks like it would be a plus for the company.
