Plus500 (LON:PLUS) - Correction

In response to my article on Monday, Plus500's PR agent, and indeed readers in the comments section, corrected me that Plus does not make money directly from client losses. 

I am only human, and I get things wrong. So I am happy to accept correction on this point, and retract my statement that Plus500 directly profits from client losses.

My belief that it did was based on my understanding that the company rarely uses an external hedge to protect itself against the net position of clients.

How Plus500 manages risk

I still believe that the company rarely uses an external hedge.

According to the presentation forwarded to me by the company's PR agent, under Risk Management, the company says "hedging would be undertaken if market movement breach the Group's risk appetite limits".

In other words, Plus500 does have risk appetite when it comes to taking on client net positions. It would hedge if client net positions became too extreme.

Profit from client net positions is listed explicitly as a source of revenue by the company, though it claims to have generated no revenues from this source for the past three financial years.

The company presentation also refers to "monitoring of instrument level correlations and volatility".

What that says to me is that the company is willing to take on a net long position in one instrument, so long as it also has a net short position in a correlated instrument.

For any single instrument, ignoring its correlations with other instruments, the only way that Plus500 could have a zero exposure in the absence of an external hedge is if the client book perfectly balanced itself. Needless to say, this is unlikely.

At a normal CFD provider, the external hedge is how the broker protects itself from an imbalanced client book.

At Plus500, it is doing two things to balance its client book, whose importance I did not appreciate:

  • Using correlations of instruments to manage its overall exposure
  • Blocking client trades when the net position gets too large

Consequences of using these techniques

The first technique relies on correlations remaining within some kind of normal range in order for it to work.

The second technique risks creating unhappy clients. The company presentation says "when limits are reached, no further trades accepted."

This chimes with…

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