Warren Buffett was eager to read Robinhood's IPO filing. The investing app's reliance on options trading won't have surprised him

• Warren Buffett said in May that he was looking forward to reading Robinhood's IPO filing.
• The investor has criticized the trading platform for encouraging gambling, not investing.
• Robinhood earned 38% of its first-quarter revenues from users trading options.

Warren Buffett declared in May that he was eager to read Robinhood's IPO registration statement, as he wanted to see how the zero-commission trading platform would explain its business model. The famed investor and Berkshire Hathaway CEO got his chance when Robinhood published its S-1 form last week.

"I'm concerned about how they handle the source of income when they say that they don't charge the customer anything," Buffett said at Berkshire's latest annual meeting. "It'll just be interesting to watch how they describe it."

Robinhood's filing revealed that it earns most of its revenue from transactions, primarily in the form of payment for order flow (PFOF), which is getting paid to route its users' trade orders to market makers for execution. PFOF from options and equity transactions, and "transaction rebates" from crypto trading, accounted for 75% of Robinhood's total revenue in 2020, and 81% in the first quarter of this year.

Buffett and his business partner, Charlie Munger, have repeatedly accused Robinhood of encouraging people to gamble on stocks, speculate with options, and make dozens of trades a day instead of investing sensibly for the long term. Given the platform makes more money when users make bigger and more frequent transactions, the pair might have a point.

Berkshire's CEO described Robinhood in May as a "very significant part of the casino group" that had joined the stock market over the preceding 18 months - undoubtedly a reference to the army of retail traders who have made risky bets on stocks such as GameStop, Hertz, and AMC Entertainment.

Buffett added that using puts and calls to speculate on short-term stock moves wasn't illegal or immoral, but he didn't consider it to be hugely beneficial to society.

Munger echoed that sentiment in a CNBC interview that aired last week. He called Robinhood a "gambling parlor masquerading as a respectable business." Buffett, who has owned stakes in companies such as Coca-Cola and American Express for decades, added that Robinhood likely wasn't encouraging its users to buy and hold an index fund for 50 years.

Robinhood's press team dismissed the pair's concerns in a May statement. "People are tired of the Warren Buffetts and Charlie Mungers of the world acting like they are the only oracles of investing. And at Robinhood, we're not going to sit back while they disparage everyday people for taking control of their financial lives."

They also noted that plenty of the platform's users have invested in Berkshire shares and other stocks in Buffett's portfolio, and said the "majority of Robinhood's customers are buying and holding."

Nonetheless, Robinhood S-1 shows it garnered $198 million or 38% of its total first-quarter revenues from options transactions, compared with $133 million from equities and $88 million from crypto. Options transactions also generated $440 million or 46% of its revenue last year - dwarfing the $251 million it earned from equities and the $27 million from crypto.

Moreover, Robinhood users haven't been buying the safest assets. Dogecoin, a meme-inspired cryptocurrency created as a joke, accounted for 34% of the platform's revenue from crypto trading in the first quarter, and for nearly 6% of its total transaction-based revenues.

Buffett probably wasn't surprised to learn that Robinhood earns most of its revenue by selling order flow, and has been cashing in on surging volumes of options and crypto trading. Given those facts, it's hard to imagine that he or Munger will change their view anytime soon.