Thinking Big with the Small Exchange

Donnie Roberts, CEO and President of the Small Exchange joins Steve Sosnick, IBKR’s Chief Strategist, to discuss how he helped pioneer electronic trading during his career, their product mix of futures contracts, and how their recent acquisition by Crypto.com may benefit customers in the future.

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Summary – Traders’ Insight Radio Ep. 17: Thinking Big with the Small Exchange

The following is a summary of a live audio recording and may contain errors in spelling or grammar.  Although IBKR has edited for clarity no material changes have been made.

Steve Sosnick

Hi everybody. This isSteve Sosnick, Chief Strategist at Interactive Brokers, and welcome to another episode of Traders’ Insight Radio. Today my guest isDonnie Roberts of the Small Exchange and he’s going to tell us about their offerings. We’ve done plenty of stuff with Small Exchange before. They’re very active on the Traders’ Insight platform. As a firm, we’ve done various webinars and other educational events with them, but I’m going to let Donnie introduce himself since he can do it better than I can, so go ahead.

Donnie Roberts

Hi Steve, how you doing? Thank you for Interactive Brokers for allowing me to come on. I really appreciate it. Well, some people have mentioned that I’ve had a little bit of a colorful career. I think that that’s a little accurate. I’ve done everything I think that somebody can do in the financial industry. From trade checking on the floor, to being a floor trader, to selling electronic trading platforms, to opening new accounts, funding new accounts, Risk Manager, Chief Compliance Officer, operations guy and now I’ve moved on to starting an exchange, which was a great little effort. An awesome puzzle to put together and we’re still moving and growing and enjoying the ride so to speak.

Steve Sosnick

One of the things I would say about your biography is I don’t know that I’d use colorful. It is colorful actually, but diverse certainly is the case. Walk us through it because I think people would be very interested to hear your metamorphosis, which I think is a phenomenal one.

Donnie Roberts

Alright, I can do that.  I had been attending Saint Bonaventure University in Western New York. I had taken a class on options as an elective in senior year and I became enamored with them. I became enamored with the possibilities of trading options and then when I got to grad school, Saint Bonaventure was good enough to have a derivatives class, a futures class, and an options class. So, I went and took those and again, I became enamored with it. I was like my goodness; I didn’t know that this type of trading existed.

I was just like everybody else. I had an IRA account that had mutual funds and a couple of stocks in it, right? So, I came out to Chicago and a friend of mine had been trading and “arbing” [arbitraging] the floor from an upstairs position. He was one of the first guys I think to do it electronically and he was trading electronically and on the telephone at the same time, right? Because of the technology restrictions or limitations back then.

I’m going to age myself, but this was back in 1997, and I had been scrounging around the floor and looking for introductions to firms.  So, I went and visited the CME, the CBOE and the Board of Trade, and every time I went to see an opening of a market, my hair stood on end. I got goose pimples and I was like I got to do this and eventually I ran into a nice gentleman by the name of Mike Juneman who worked for Timber Hill.

Steve Sosnick

Just for those of you who are not familiar, Timber Hill is the predecessor firm of Interactive Brokers.

When I joined, we were Timber Hill. We had this weird little sideline gig called Interactive Brokers which Donnie will get to. So, spoiler alert: Timber Hill does come up importantly in this.

Donnie Roberts

Oh yeah, it was one of my amazing first jobs and one of my — I took a lot of jobs in my life Steve for experiences.  My education, I went to graduate school, I was fortunate enough to go to Oxford. Prior to that, I was in the Marine Corps, so everything I did was for the experience, right? And I started talking with Mike Juneman and he says, “hey, I think you should come and work with us and try floor trading. Come in for an interview.”

I went and saw him and talked to him. He called me the next day and he said, “when can you start? “I said I could come out next Monday. He goes “You don’t have to go that fast what?” But we do want you to come out as soon as you are able. So, I went home, collected my thoughts, let my family know what I was doing, filled up a cardboard box with everything I could carry and jumped on a bus and took a bus to Chicago.

I got off the bus and I really didn’t know where the hell I was, but I could see the Board of Trade down the street and I was like, OK now I’m familiar with kind of where I am and started working and working on the floor for Timber Hill. I remember 5:00 o’clock in the morning sitting in front of a green screen matching trades and trying to make sure everything balanced. And then I got a promotion and then I started going down to the floor and talking about trade checking with other trade checkers and making sure everybody was balanced before the end of the day. So that was a pretty cool experience, to say the least. It was my first exposure to the financial industry in some of its glory.

Steve Sosnick

Even if it’s the most inglorious parts of it…

Donnie Roberts

Yeah, yeah, yeah… So you know, it’s funny you say that because people think they just click a button, and all this magic happens, and the trade shows up in their account. Well, there’s about 500 to 1,000 moving parts that happened before that actually occurs, but I digress. I passed my CBOE test and became a market maker. Did all the mock trading and everything that I could possibly do, thought I was prepared, walked into a pit to shadow a trader for a day and I was like, wow this is really something else.  The market went into a Fast Market.

Steve Sosnick

Day one you were in Fast Market?  That’s impressive.

Donnie Roberts

Day one I saw a Fast Market and I was like geez can I do this? Can I keep up with these guys? I just resolved myself to learn and don’t make any major mistakes. Small ones you can fix, major mistakes put you in the unemployment line.

Steve Sosnick

Let’s just digress for a second because Fast Market is a term that I think a lot of our listeners haven’t heard. You have to be of a certain age to have heard that. Every exchange had a slightly different way of defining Fast Market, but essentially that meant that the market was moving faster than the floor traders could keep up.

Donnie Roberts

Keep up with the quoting, yep.

Steve Sosnick

So as a result, you had some discretion to whether to honor the quotes or not because the quotes weren’t keeping up with the underlying prices. That’s not something you could really imagine right now, but that that was a not infrequent occurrence.

Donnie Roberts

That was a very real thing, and like I talked to retail customers throughout my career. Sometimes they wonder why market makers widen out their quotes etc. And if I hadn’t been a floor trader, I would wonder the same thing myself, right? Because it was very, very challenging. If you think about the amount of quotes and the amount of data that comes through a set of computers for, say, trading 5 stocks, trying to mentally keep up and update your quotes so they’re on the board and posted at your pricing — that was pretty challenging and it was an adventure to say the least.

Steve Sosnick”

Some of the listeners have probably heard me say this before: We had a big sign in the trading room – or “the bridge” as we used to call it.  I forget if the exact verbiage, if it was “in Fast Markets” or “if it hits the fan” or something of that nature, but it was [1] widen markets, [2] reduce sizes, [3] raise volatility.

Donnie Roberts

There you go.

Steve Sosnick

And while we don’t necessarily do that same sort of overt calculation day to day, it goes on in the market still. Like people wonder “Oh, you know the market it’s really moving fast. Why did the quotes widen or why did the sizes shrink?” Guess what, that’s now instead of like having to do it by hand, or tell the machine to do it, it’s now being automatically programmed into algorithms.

But remember that the algorithms are just reflecting human behavior, just faster. You know all these all these behaviors that we used to do, which was widen markets, shrink sizes, raise volatilities, is now being done dynamically.  So, except in the case of limit up/limit down halts, the trading doesn’t slow down. But I think people lose sight of the fact that liquidity is neither constant nor given.

Donnie Roberts

That’s correct.

Steve Sosnick

And when markets get crazy, it behooves the individual who’s trading to think about “How can I provide liquidity as opposed to how can I consume it?” Because consuming it gets very expensive in those situations.

Donnie Roberts

Very expensive, but those three tenets that you mentioned earlier, well those are good ones for even a retail customer to look at and honor. Reduce size, reduce the amount of capital you’re using in volatile markets. I mean, look, you can profit just as well as you can get run over, right?

Steve Sosnick

The risk/reward tradeoff is always there.

Donnie Roberts

But you should always look to survive to fight another day, right? Don’t put all your eggs in one basket.

Learn how to hit singles and doubles, especially in really volatile markets, or play defense and protect your capital. Hey, that’s just the way the world works, and professionals have been doing it for as long as I can remember. And now retail customers, with the advent of the accessibility that they have and the tools that they have, can also practice things that only pro traders could do 10 or 20 years ago.

Steve Sosnick

And this will lead us into the next chapter, because you had a big role in that in all your career moves. I think it’s one of the things that individual traders, particularly newer ones, have a tough time realizing because of the tools that an average person can show up with — the tools that we provide, either here at Interactive Brokers or any number of firms.  We like to think we do it better, but let’s be real, there’s tools everywhere. Those tools were only for the most dedicated professionals and now everybody can use them, but the strategies, the psychology. I’m going to argue hasn’t really changed for hundreds of years. It’s human nature.

Donnie Roberts

I don’t think it has either Steve, but the main thing, like you’ve mentioned, are the tools that people have been provided.  When I first started trading on the floor, that’s when we started talking about electronic trading and the access. And the first time that I heard a couple of other employees, senior level employees, at Timber Hill and then Interactive Brokers describe the electronic access, the tools that could provide it. Leveling the playing field. Look I just got goose pimples again thinking about some of the discussions I had that got me excited about it.

So, I saw the advent of electronic trading. I saw the advent of the RAES system for the options exchanges, meaning all the options exchanges back then displayed separate bids and offers. They initiated the RAES system, national best bid and offer, et cetera, and it just continuously leveled the playing field. And then a company called Interactive Brokers created this amazing piece of software. The first time I saw it, I was like, “why wouldn’t people trade on this thing?” And then I learned more and more about it, and I got more demonstrations about the product, and I was like–

Steve Sosnick

We haven’t named the product; it was the Smart Router.

Donnie Roberts

It was the Smart Router and the Trader Workstation yeah. And then I had been in a conversation. I used to play in the Chicago Traders Basketball League with a whole bunch of guys from Timber Hill and it was a lot of fun, right?

Steve Sosnick

Mike Juneman, by the way, is like 6’6” so he’s a good guy to have there.

Donnie Roberts

Yeah, and he was pretty good. I was having a conversation with him — and I mean no disrespect to some of the very smart people that worked on the trading floors — but I looked at him and I said, “Mike, I kind of see the handwriting on the wall. The world is going to go electronic sooner rather than later, and I don’t want to add and subtract fractions.”  Yes, they traded in fractions at one time.  “I don’t want to add or subtract fractions faster than the guy next to me. I want to see what the electronic trading world is all about.”

He goes, “Well Don, be very careful what you wish for. We’re going to start a company called Interactive Brokers and start putting it out there for the public, and it’ll use this Trader Workstation that you’ve seen.  But you have to speak to a couple people before I can say anything else.”

So, from there I met a nice guy by the name of David Downey.  A very passionate, intense man, smart as a whip, but he was a very good mentor for me. One day I was placing trades and I inadvertently did a call versus put and I was like, “Ah crap. Wait ‘til this shows up at the bridge,” and I turn around and there’s David Downey badge, DGD. I was like, “How did they figure out that I did this bonehead trade already, right?” And he wasn’t there to ask me about that. He was asking me to come up and see him after the exchange floor closed, and I did. I went up there. He talked to me about Interactive Brokers. Was wondering if I was interested. Of course, I was. It was going to be the next step in the level of the financial industry, and I wanted to be part of it, and I wanted to learn all about it. And David said, “OK, well, have you come up to the office every day for about a week.” And I said great, and he goes “Oh, by the way, don’t ever do will call versus put again.”

So, I walked out and then started showing up in the office on West Jackson in Chicago, and David said you’ll go to the CBOE. You’re going to work on the floor there again. You’re going to learn about electronic trading. You’re going to go to the CME and learn about electronic trading ’cause they came out with Globex back then. And then he goes, “You’re going to go board a train and figure out what they’re not doing wrong and why they can’t get their own electronic trading platform.” and I got a chuckle out of that one.

But then I started working for Interactive Brokers selling electronic trading platforms. They taught me about clearing worldwide, 27 exchanges worldwide et cetera, and that got me started and got me excited about where the rest of the world can go on the financial industry.

Steve Sosnick

And so, after a few years selling Trader Workstation to clients, you then made a very important move, one that proved to be very good for you.

Donnie Roberts

I did, I did. I had been at the CBOE pitching electronic trading to market maker firms and two gentlemen in the audience, Tom Sosnoff and Scott Sheridan, said, “Hey, why don’t you come and see us and show us this system and the API that could be used to route trades electronically to the various exchanges?” So, I did that and then it became very clear that they were as interested in the system as they were in me. And one day I showed up and I had my blue blazer on, a powder blue shirt, a tie, a pair of khakis, and a pair of shoes, right? And I walked in, and they said, “Hey, we want to start a company and we would like you to come on board.” I said, “Oh what’s the name of the company” and he goes, “It’s called Thinkorswim.”

I was like, “well, I don’t know if that’s a great name for a firm in the financial industry,” but we talked about it and thinking was the analytical part of trading and swimming was jumping in the pool and making the trade for yourself, right? So, then it made sense.

Steve Sosnick

In hindsight, I think it’s a very clever name by the way.

Donnie Roberts

Yeah, yeah, me and you both. I said, yeah, but I I’m going to need a little bit to think about this. He goes, “What, is an hour good enough?” They were all traders, right. So, they were very used to instant decisions, and I said a little bit longer than that and I mused about it for about 24 hours and the thought of starting a firm and being in on the ground floor was totally appealing to me, and so I signed on with Thinkorswim.

I went to their office, I had a different colored shirt on a different pair of pants, but still the same blue blazer and a tie and they said to me “Look, you could start in a week or so, but you got to lose that Morgan Stanley look” and I was like “OK, that’s something we can do.” The next time I showed up I had a pair of jeans on, a New York Yankee shirt and a pair of sneakers and they were like, “That’s much better.”

Steve Sosnick

Yeah, awesome, and so you were there from the genesis ‘til when they were acquired, correct?

Donnie Roberts

That’s correct, I stayed there and then TD Ameritrade bought us. I was the Chief Compliance Officer. I was the Operations guy. I was soothing customers’ ills. Many different hats, just like we did with Interactive Brokers when we all started there. And TD Ameritrade, they had just about all the pieces, but they weren’t as efficient as like we were at Interactive Brokers. They weren’t as efficient as we were at Thinkorswim, but they had the client base right?

So, we went through the integration, and we had futures and forex trading on Thinkorswim and they did not and. They said look “We’re going to get better at the option trading thing and with your systems” ‘cause it wasn’t a client asset acquisition, it was a potential acquisition with technology etc.

Steve Sosnick

I was going to say it sounds like they were really buying the system as much as anything else.

Donnie Roberts

They were. They were buying the front-end system and one of the things I learned from Interactive Brokers, if you’re going to allow people to trade, you’ve got to have damn good risk controls. So, we had very good risk control system. We call it our admin app. So, the integration goes through and the debate started whether we should keep futures and forex trading, and I was like “Oh my God, this is what keeps customers sticky.” You have to offer these products, right?

Donnie Roberts

So, guy says to me “Well Dani, we’re getting better at options, but we don’t know anything about futures and absolutely nothing about Forex. We’re going to start a company and to take advantage of that stickiness and we want to become an FCF. I was like “OK, we can do that” and they said, “Well, would you stay on and be the president of our company cleverly entitled TD Ameritrade Futures and Forex LLC.”

Steve Sosnick

Much less catchy.

Donnie Roberts

Yeah yeah, yeah. So, I stayed on, and I was allowed to hire my own team, incorporate a lot of the lessons learned in my life and in the industry and regulated regulatory environment, trading environment and risk. And that was very rewarding, but Steve, I did that for a period of time, and I enjoyed it, but started chatting with my wife and I just let her know that I think I was going to retire for a period of time.

So, I did that and then it became quickly noticeable that my golf swing wasn’t going to get me on the PGA Tour, and quite frankly they were never used to having me around the house so much. So I started talking to a couple people and potential investors about starting a new business, which he eventually became the Small Exchange. I was chief cook and bottle washer, which we affectionately call the CEO, and President.

Steve Sosnick

OK.

Donnie Roberts

I was able to put together a great team. We put together some great technology, some great ideas for moving forward and lo and behold. We went through the process, set up a system, got approved by the CFTC and then COVID-19 happened, and we were — The day that we got our CFTC approval, the very next day the mayor shut down the city of Chicago, so.

Steve Sosnick

Even for an electronic exchange, that’s tough because it had to mean that getting in front of clients, doing everything was just that much harder.

Donnie Roberts

It was, it was, but you know, resiliency and challenges, that’s what makes people stronger. The old expression “what doesn’t kill you, makes you stronger”, and that was so true. And if it was easy, Steve, everybody would do it, and Mr. Peterffy will tell you that from the way he started Timber Hill. Nothing is easy, it takes a lot of drive, a lot of passion and quite frankly a lot of chutzpah. You’ve got to have some courage, right?

Steve Sosnick

So, let’s talk. We’ve covered a lot of ground. Let’s talk about that secret sauce. What do you see that makes the Small Exchange special?

Donnie Roberts

So, we’re a little bit different in respect to we always felt strongly that there was a hole in the financial world. Meaning, everybody went to the retail options trader and equity options trader and index trader, but nobody was looking at the futures trader and the accessibility was not there for the futures trader. So, we wanted to create a low-cost environment, superior technology for access and in providing tools and education to the end customer, but a lot of it has to do with the products, right?

Because of the size of contracts, futures contracts around the world excluded a huge part of the market, right? So, we came through and just started designing smaller notional sized products, standardizing them as best we can. And then we wanted to provide exposure to both commodities and equity indices because they couldn’t access them before or there were these very large contracts.  Quite frankly, some people got ran over on big moves because of the leverage in the futures markets, and we were like, well, not everybody can trade futures, right?

There’s risk and reward with it, and they’re not for everybody. So, by creating a smaller size product, and teaching them how to educate people, we want to create sustainable customers in the marketplace just like everybody else. Nobody wants customers that come in and churn and burn through $30,000. We want them to take that $30,000, hit singles and doubles, and grow their portfolio. The Small Exchange allowed to people to speculate and hedge their portfolios, which we thought was amazing for the individual customer.  Then eventually we wanted to provide them exposure to commodities that they couldn’t trade on the larger futures markets — again, for portfolio diversification and managing risk as well as trying to capitalize on short term speculation.

Steve Sosnick

Now, we’re in an environment where commodities have burst back into vogue. What are some of the ones that are really captivating Small Exchange customers?

Donnie Roberts

So, treasuries have seemed to caught the imagination of the Small Exchange customer. Smaller oil contracts. Metals exposure has been great, and as you know we might have started something here, but there’s a lot of smaller size products all around the world traded on many different exchanges. And I’m glad we started a little bit of revolution to help bring in that retail trader with the smaller account size. Everything from a $5000 account to a $500,000 account we want to provide access to.

Steve Sosnick

Now another thing that’s exciting for you guys is you have a new partner.

Donnie Roberts

We do.

Steve Sosnick

How is that working into your? — I’ll let you do the announcing of who it is, but then talk about how that’s coming into your product mix.

Donnie Roberts

So, we were acquired by a company called Crypto.com. Worldwide they stuck up on everybody in the digital asset space, and now they’re probably in the top three or four worldwide, which is great.

Steve Sosnick

If you’re not familiar with Crypto.com, just turn on a financial network, look for the incessant LeBron James ads and you’ll know who we’re talking about. Or think about Matt Damon telling you were kind of a wus ’cause you didn’t favor the bold.

Donnie Roberts

Yeah, yeah, right right. Fortune favors the brave and all that good stuff. It’s kind of the same thing as if it was easy, everybody’d do it but anyways. In the beginning Steve, acquisitions, everything is a one-way flow of information, right? So, we went through that phase, then the deal closed on March 1st. So now we’re getting exposure to their different teams, their product team, the strategy team, their technology team, their regulatory team. And I got to say, I’ve met a lot of interesting people, and while I’ve been in this business and they’re a pretty good darn group of people.

They remind me of several people that I’ve met at Timberhill Interactive Brokers, Thinkorswim, TD Ameritrade etc. Smart as whips, goal-oriented vision and passion which is great and that matches up with us very well. Now initially, the strategy is not going to change. We share a lot of the same vision: accessibility, capital efficiencies, low-cost access is really important to us, but with them coming we’ll have access to data feeds. Research that we couldn’t get before. And it’ll help us create a much more broader product set as we move forward to provide access to their customers to the Small Exchange as well, which is pretty good.

Steve Sosnick

As I see it, as the outsider, it seems like it seems like the synergy is you’re getting the crypto customer base and the crypto knowledge to standardize and financialize a lot of crypto products, whereas they get your knowledge with regulation and I guess let’s talk about this a little bit, but I can’t let this one not go through. I see regulation as being both inevitable for crypto and beneficial for crypto. Do you feel that this partnership helps because with your CFTC registration and regulation?

Donnie Roberts

Steve, you hit the nail on the head. It is very important that customers feel that they can trade on a regulated exchange through regulated entities. Not to say that there’s not some great actors in the digital space, but there’s some bad actors as well. There isn’t everything because there’s money involved, right?

Steve Sosnick

Of course, yeah.

Donnie Roberts

But you’re spot on. We’re going to work with them to create products to create and make derivatives and option trading and provide access and make these digital assets a more strategic investment than it was just simply buying or holding. Do you follow me?

Steve Sosnick

Absolutely, that tells me that our listeners should stay tuned to the developments coming out of Small Exchange and Crypto.com. I’m not going to ask you to go further ‘cause that would be unfair because I know you’re just going to shoot me down anyway but, but it does sound like there’s a lot of exciting stuff coming down the pipe. And I have a feeling when we talk again in a few months, whenever that is, you’re going to have some exciting stuff to talk about.

Donnie Roberts

I will Steve and thanks for not pressing me on that, but we are going to come up with some very innovative products and innovative type of trading here at the Small Exchange and we’re really looking forward to what’s in front of us. Very proud of the gang thus far and I’m going to be very proud of what they can provide in the future.

Steve Sosnick

Well, I can’t think of a better way to end on a high note than this, because I think there’s a lot of stuff that that we’ve covered, and it also means there’s a lot of stuff to cover. We’ll circle back and see what’s going on in a few months once the synergies take place.

I’m going to wish everybody, thank you for listening. I certainly want to thank you,Donnie Roberts, for joining the Interactive Brokers Traders Insight Radio podcast. We’ve spent a lot of time working up to the present, but I think it’s crucially important for newer investors to have the history to have the perspective, and so I think sometimes we give the present short shrift, but I think that there’s a lot of people discussing the present. There’s not always a lot of people discussing the historical precedent for that present.

Donnie Roberts

Oh I agree Steve, and I appreciate the time that I’ve been able to spend with you guys here at IBKR radio. Again, you got to know where you were, you got to know where you are now to know where you’re going in the future, and it’s been a great journey so far and I hope to continue it.

Steve Sosnick

You and me both. So, with that I’m just going to say thank you to everybody for listening. You’ve been listening to Interactive Brokers Traders Insight Radio. We’ve been talking withDonnie Roberts of the Small Exchange. You could find references on our website and their website. We’ve done a series of webinars which are available at ibkrwebinars.com. We have numerous articles on Tradersinsight.news and we’ve been partners with them from the beginning and we look forward to continuing into the future. Thanks everybody.