It's been a wild 36 hours in the online brokerage industry. On October 2, shortly after the market closed, E*TRADE Financial Corp announced that its online brokerage would cut its base commission rate to $0, following in the footsteps of Charles Schwab and TD Ameritrade. The firm will eliminate retail commissions for online US-listed stock, ETF, and options trades. It will also reduce the options contract charge to $0.65 per contract for all traders while maintaining its active trader pricing at $0.50 per contract. These changes will take effect on October 7, 2019.
The current commission schedule shows tiered rates, depending on the client's trading frequency. The base rate was $6.95, dropping to $4.95 for clients who traded more often than 30 times per quarter. Options were charged at $6.95 per leg with $0.75 per contract; active traders paid $4.95 per leg with $0.50 per contract. This is a significant change for less active traders.
For the six months ending June 30, 2019, commission revenue made up 17.7% of E*TRADE Financial Corp's net revenue, so this is a significant hit, though not as big as TD Ameritrade's (32%). Schwab's commission revenue made up just 6% of its net. The firm estimates the quarterly pro forma revenue impact of the commission changes to be approximately $75 million based on Q2 2019 operating results.
E*Trade's commission revenue made up 17.7% of its net for the 6 months ending June 30, 2019.
Steve Ehrlich, a former senior executive at E*TRADE and the current CEO of Voyager, a cryptocurrency trading service, expects these rate wars to drive a merger between TD Ameritrade and E*TRADE, or that existing brokerage firms will be forced to buy up some registered investment advisories in order to add to their assets under management.
How Will Online Brokers Stay In Business?
What's next? We expect trading commissions to be completely eliminated at most online brokers. A recently-launched brokerage, dough, charges a $1 per month subscription fee and will not charge any commissions for stock, ETF or options trades. Interactive Brokers announced a limited zero-commission offering, IBKR Lite, which will launch later this month. Robinhood has offered zero-commission trading for 5 years.
Research and data come at a cost to the brokers themselves, which they offer as a value added service to their clients. Brokers generate revenue in a variety of creative ways, which range from earning interest on your cash balances, loaning out your stock to short sellers, payment for order flow, and trading against you from their own inventory. They also make money off fixed income transactions, and those that manage their own mutual funds and ETFs generate management fees.
Now that E*TRADE, TDA, and Interactive Brokers offer some form of free trading, the industry is closely waiting for Fidelity, TradeStation and other online brokers to respond. For an industry that has been around for 40 years, the last 36 hours have been explosive. It's not over yet.