OptionsXpress Holdings: Overall Market Declines Could Spell Trouble

| About: optionsXpress Holdings, (OXPS)

Anyone paying attention to U.S. markets recently should have noticed many of the financial stocks getting clobbered. At first it appeared to be an isolated trend for firms involved in sub-prime issues, but soon the overall market became a minefield for nearly all financial related companies from banking, to brokerages, to lending, and trading firms. After Monday’s rebound, I think there are some low-quality names that were bid up that may make for interesting short plays.

OptionsXpress (NASDAQ:OXPS) is an online brokerage that caters to options traders but also offers a range of equity and futures based trading platforms. The company seeks to train novice investors by offering a series of online and physical seminars to educate new traders on systems and patterns that should help them make money in the markets.

Call me skeptical, but this idea raises all kinds of red flags when I think about untrained traders gaining expertise from an online broker firm who will show them how to make money in the markets.

The company recently reported numbers for its second quarter and they were relatively well accepted by the street. EPS was up 28% year over year to $0.37 with revenue up 26%. Daily Average Revenue Trades (DARTs) were up to 32,700 which was a 15% increase from Q2 2006 and the company added 11,500 new accounts to bring the total up to 235,300. Reading the press release, I was amused to read that this was the “second quarterly increase in net new accounts.” Ok - so for two quarters in a row the company added new customers! Is that really something to brag about? Shouldn’t you wait for at least 8-10 quarters before you start calling this a trend?

Moving right along (sorry for the outburst), I noticed that new margin rules allow investors to place more risk capital on margin which gives the company better interest income. Now this is purely conjecture, but my guess is that most investors are net long the market, I’m also guessing that most portfolios that use this additional margin have a beta above 1 (that’s putting it gently). The release stated that there were $5.3 billion in customer assets at the end of Q2. What do you bet there is a bit (quite a bit?) less than that now that the market has gyrated down a little? It should be interesting to see what the numbers say next quarter.

Other concerns include lackluster account growth, lower Payment For Order Flow [PFOF] as a result of the penny option pilot program, and a low number of average trades per year. For instance, it cost the company $300 for each new account. Each account trades roughly 36 times a year. Each trade generates $17.73. The pre-tax margin is 64%. That means each account brings in roughly $400 in revenue but it costs $300 to get that account.

I’m worried an overall decline in the market could cause much more acute trouble for this company. While it’s not trading at a high multiple, it is expensive enough with enough concerns to steer clear and possibly use Monday’s strength to initiate a short position. As always, use caution and exercise discipline.

Full Disclosure: Author has a short position in OXPS.

OXPS 1-yr chart:
oxps chart