In the cafeteria at the headquarters of Susquehanna International
Group, a short cab ride from Philadelphia's 30th Street Station, there is a reminder of the firm's youthful culture. Employees enjoy a free lunch of fast food. On a recent Friday, the spread included pizza, fried chicken, mozzarella, buffalo wings, onion rings, a few bins of lettuce, some celery sticks. Dozens of boxes of dry cereal occupied a shelf.
The food was of a certain generation: Not the stuff for some oldtimers. Susquehanna likes its specialists and designated primary market makers young. And the food must delight their taste buds.
There is another reminder of the firm's obsession with competition and intelligence: sign-up sheets on the refrigerator for chess classes and an upcoming tournament.
At Susquehanna, based in the endearingly-named Bala Cynwyd, market makers and traders have given a new meaning to the term mental dexterity. They join the same two-year training bootcamp. And all are selected with an eye toward fitting them into Susquehanna's carefully cultivated team approach. Odds are they tend to be more quantitative than not.
The Undergrads
"We hire mostly people with undergraduate degrees," admitted Eric Noll, an associate director and head of strategic planning and business development. "We want them smart and educated but we don't want them to have learned bad habits – or what we'd consider bad habits – from some other source."
On the other hand, Susquehanna's quantitative research department is typical of most sophisticated quant shops. It is stocked with many professionals holding doctorates. The firm sets great store by the way it recruits and develops talent. It considers its recruiting practices proprietary.
Susquehanna, unsurprisingly, says it knows where the market is at any moment and can supply liquidity and market depth to institutional customers. That's because Susquehanna officials claim the firm is a market maker in a broad range of names and because it has trained an army of specialists, traders and market makers. All these professionals are trained by the firm to think and handle risk in the same way.
Susquehanna and its subsidiaries make markets in 2,000 option names and 1,400 Nasdaq stocks. (Susquehanna's series of predecessor companies began in 1981.) The firm runs a large program trading operation, has a New York Stock Exchange specialist unit and floor brokerage, and is the largest equity index trader in the United States. The privately held firm claims it transacts more QQQs, the Nasdaq 100 Tracking Stock, than anyone else and it trades 15 percent of total exchange-traded-fund volume.
Susquehanna also makes markets on exchanges in more than a dozen countries and has a strategic alliance with the Bank of New York. Most important, the firm also has a reputation as a well run, technology-intensive market maker.
Over the last half-dozen years, there have been dramatic changes in the trading industry, particularly in the options world. The cross-listing of options in 1999 fueled competition and it shrank commissions. While all specialists and market makers took home less on a per-contract or per-share basis, Susquehanna increased profits by making more markets and capturing more order flow. When industry consolidation put pressure on that flow, Susquehanna took an aggressive approach to paying brokerages for customer orders. At the same time, consolidation prompted buyside investors to look for more liquidity outlets.
Tech Bust
When the tech bust took a further toll on customer order flow, Susquehanna decided to expand into institutional sales. A couple of years ago, it sent some of its salespeople to call on buyside firms. The results were mixed. The firm made inroads into hedge funds, which prized liquidity and speed, but traditional asset managers were not budging.
So Susquehanna changed its approach. It rediscovered the economic value of other business relationships. "About seven months ago, we asked some of these traditional asset managers why we couldn't have their business," said Drew Milstein, a director and trading pro at Susquehanna who's been at the firm since it was founded. "They said," Milstein recalls, "We give our business to Steve. We've known him for 12 years and we trust him.' That's when we decided to hire a bunch of these Steves to go tell our story."
Susquehanna's decision to hire a group of institutional sales traders was smart. Institutional money managers relied on relationships and trust to transact large trades. Susquehanna, which wanted access to the firms, could take advantage of changes in the marketplace. Goldman Sachs had purchased Spear, Leeds & Kellogg. Merrill Lynch had acquired Herzog Heine Geduld. And other niche market makers had been absorbed into investment banks – all of which enabled Susquehanna to attract talented sales traders with a track record.
"We saw it as a real opportunity to take advantage of market conditions and, in the absence of other liquidity providers, to grow closer to the buyside community," Noll said.
Institutional Offices
Now, with new institutional sales offices in New York, Boston and San Francisco (and a ramped-up sales operation in its headquarters), the firm plans to extend the efficiencies and price-discovery facility developed in its market-making operation to meet the needs of institutional customers. Susquehanna's sales offices, which have 40 to 45 people, will focus on ETFs, listed Nasdaq stocks, ADRs and equity options.
"Susquehanna has been an innovator," said Paul Schoemaker, CEO of Decision Strategics International, a consulting firm that has worked with Susquehanna. "This may be another sandbox, if you will, in which they're going to outperform others," added Schoemaker, who is the author of Profiting from Uncertainty.
Will this institutional brokerage effort succeed? Susquehanna is known on the sellside for sophisticated electronic trading and skilled traders, but these days everyone is facing choppier waters. "The company can market the expertise it developed trading its own book to clients," said one industry veteran. "But it's a little like if Pimco started executing options trades." Susquehanna will have to make its case to vanilla mutual funds and state pension funds that don't see the firm as a large liquidity provider.
Susquehanna isn't likely to compete with the franchises established by Salomon Smith Barney, Goldman and other investment banks, say some market observers. Susquehanna officials disagree, however. Bulge-bracket firms offer customers traditional research, investment banking services, prime brokerage, and access to an IPO calendar (although the last isn't much of a priority at the moment). "We don't do those things," Noll said. "So you would never come to Susquehanna for that. But we, better than any other firm out there, know what's happening in the marketplace in a stock. Nobody else has 300 traders all over the country linked together in a chat group sharing information."
Client Research
Susquehanna is also exploring the idea of providing non-traditional research to clients. Susquehanna says its strength for institutional clients is that it can tap into the information flow generated by its market-making business. The firm makes markets in size in illiquid and highly volatile names because of its options pricing models, its reliance on IT systems, and its macro approach to risk management. Susquehanna manages its risks on a macro basis. It calculates the overall risk statistics on a single portfolio, and runs value-at-risk analyses and stress tests on its entire portfolio intraday. Managing a global book also allows Susquehanna to lay off pieces of its risk in a variety of markets.
Susquehanna's compensation system reflects the company's approach to risk. A Nasdaq trader, for example, isn't paid based on how well he or she does, or on how well the Nasdaq desk does. The idea is that if a trader needs to make a real market for a customer, he'll do so because he's not afraid of taking on too much risk and because he knows that, at the end of the year, he won't pay the price for handling a trade that hurt his account.
Individuals are paid a salary and bonus based on managers' goals for them: "We can estimate what a person would make if he were just trading on his own, so we have an expected value for him," said Don Hart, who, with Milstein, established the firm's institutional sales desk.
"Our value-added is that we can do the hard trades, the trades that are bigger than can be done on an ECN," Noll said. Susquehanna can give a customer a quick price on the phone for trades where price slippage and size limitations are a concern. It is also willing to commit significant sums of capital to make a market. Milstein puts it another way: "You go with a machine, you don't know where the bodies are buried. We know where the shares are being held, who has them – our value is to add that liquidity and do it with little market impact. We're going to take the volatility out of the stock."
Across Markets
Susquehanna also collaborates across markets. If a liquidity provider in London finds out something about a stock, he shares it with others at the firm. "Susquehanna is good at understanding how, for instance, a rumor might manifest itself in prices on five exchanges around the world," Schoemaker said. Ultimately, this information contributes to a more granular information flow for customers.
"We mentor younger traders," said Hart, an options trader and 13-year veteran at Susquehanna. "We teach them how to make decisions about risk, about variance expectancy, under pressure. We get them to think, If I do this trade, I expect to make X amount of money, but it has a different risk profile than something where the payoff is very low but there's an 80 percent chance I'll hit it.' We teach them how to evaluate different proposition bets under pressure, whereas a lot of our competitors, especially in the options world, have only a few people who can make those decisions."
This approach to the markets comes from game theory in general and the ability to understand games – backgammon, chess, poker, and anything that involves probabilities and decision theory.
"We spend a lot of time on decision theory, a lot of time on game theory, on probability, on understanding what's actually happening out there in the marketplace, and on using human judgment," Noll said. "That's why it's highly unlikely we'll ever see the day at Susquehanna when a computer is going to tell us what we're supposed to do. The computer gives us the information and technology, gives us the tools we need to use, but it ultimately won't make that decision. We rely on the human brain to make that decision."
Technology is central to Susquehanna's modus operandi. There are more than 200 people in its tech department – and the firm is still hiring. Susquehanna's liquidity providers have at their fingertips proprietary pricing models, trading analytics, market data services, news services. They also have all the technology that allows them to provide liquidity to customers efficiently and quickly. But knowing when a price is soft, knowing when a market maker can be a bit more aggressive providing liquidity – knowing when a stock will move a nickel because a large order just walked into the options market – comes from experience.
Price Changes
The QQQs and the options on the trip-Q's are a case in point. Both are gargantuan products in terms of volume, and both are subject to extremely rapid price changes. "You have to be able to synthesize information incredibly quickly in order to provide liquidity," Noll said. "You also need to know where the futures are trading and what's happening with some of the large component stocks. The volatility in the market magnifies everything you need to do elsewhere."
Traders and market makers are primed to know where related products and sector indices are trading. They are also trained to continually ask themselves what would make them take the other side of a trade and what risk they may not be pricing properly. Integrating this information from the order flow enables them to give end-users a good picture of what's happening in the market. If someone walks into the AOL options crowd and buys 1,000 calls, says Milstein, Susquehanna knows that AOL is going up on approximately 100,000 shares, so it's probably going up about 15 cents.
"If you need capital, if you need market intelligence, if you need speed of execution, here it is," he said. "We may just execute the order flow, but if the customer needs us to commit capital, we can interact with the order."
In the customer business, Susquehanna also has its front-end systems covered. Susquehanna can get its market intelligence in front of customers in a way they are likely to find useful. It also has the technology that allows customers to access them electronically.
Some end-users come to Susquehanna through order management systems. Some do baskets of stock at a time. Some give the order on the phone but send the paperwork electronically and get the confirmations back electronically. The information flow that's passed around, however, is what Susquehanna says it has over other market making firms. That information – so vital in the trading business – is what Susquehanna is betting on in its attempt to win institutional customers.
