TRADESTATION GROUP INC - Annual Report: 2006 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended DECEMBER 31, 2006

OR

For the transition period from                      to                     

Commission file number: 0-31049

TradeStation Group, Inc.

(Exact name of registrant as specified in its charter)

954-652-7000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨  Yes    þ  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨  Yes    þ  No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨                    Accelerated filer  þ                    Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ¨  Yes    þ  No

The aggregate market value of voting stock held by non-affiliates as of June 30, 2006 (based upon the closing price of $12.67 per common share as quoted on The NASDAQ Global Select Market on such date), was approximately $343,677,000.

The registrant had 44,755,691 shares of common stock, $.01 par value, outstanding as of March 1, 2007.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s definitive proxy statement to be filed within 120 days after December 31, 2006 in connection with its 2007 annual meeting of shareholders are incorporated by reference in Part III of this report.

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PART I

Overview and Recent Developments

TradeStation Group, Inc., a Florida corporation formed in 2000, is the successor company to a publicly-held trading software company that was formed in 1982. TradeStation Group is listed on The NASDAQ Global Select Market under the symbol “TRAD.” TradeStation Securities, Inc., an online broker-dealer and futures commission merchant, and TradeStation Technologies, Inc., a trading technology company, are TradeStation Group’s two operating subsidiaries. The company’s core product/service, which is offered by TradeStation Securities, is TradeStation, an award-winning, direct market access (DMA) electronic trading platform that enables traders to test and automate “rule-based” trading strategies (both technical and fundamental) across multiple asset classes, namely, equities, equity options, futures and, expected later this year, foreign currencies (forex). The company’s other subsidiary, TradeStation Europe Limited, a United Kingdom private company, authorized and regulated by the UK Financial Services Authority (FSA) as an introducing broker, is in its start-up phase.

TradeStation Securities is a leading online brokerage firm that serves the active trader and certain institutional trader markets, and is the company’s principal operating subsidiary. TradeStation Securities is a member of the New York Stock Exchange (NYSE), NASD, Securities Investor Protection Corporation (SIPC), National Futures Association (NFA), National Securities Clearing Corporation and the Depository Trust Company (together, the Depository Trust & Clearing Corporation or “DTCC”), Options Clearing Corporation (OCC), American Stock Exchange (AMEX), Boston Options Exchange (BOX), Chicago Board Options Exchange (CBOE), Chicago Stock Exchange (CHX), International Securities Exchange (ISE), NYSE ARCA and Philadelphia Stock Exchange (PHLX). TradeStation Securities’ business is also subject to the rules and requirements of the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC) and state regulatory authorities (the firm is registered to conduct its brokerage business in all 50 states and the District of Columbia). TradeStation Securities self-clears most of its equities and equity options business, and uses an established futures clearing firm and an established forex dealer firm to clear its futures and forex business.

The TradeStation electronic trading platform seamlessly integrates powerful strategy trading software tools, historical and streaming real-time market data, and direct-access order-routing and execution. Direct-access (also known as direct market access or DMA) trading means, with respect to equities, equity options, futures and forex transactions, direct Internet connections to electronic marketplaces. These include: for stocks and Exchange Traded Funds (ETFs), electronic communication networks (ECNs), the NYSE’s SuperDOT (for NYSE and other listed securities) and NASDAQ Market Center (for NASDAQ and other listed securities); for futures, electronic futures exchanges such as the Chicago Mercantile Exchange’s (CME’s) Globex and the Chicago Board of Trade’s (CBOT’s) eCBOT; for equity options, electronic options exchanges offered by the AMEX, BOX, CBOE, ISE, NYSE ARCA and PHLX; and, for forex, the electronic inter-bank market or a seamless connection through a dealer system that is itself connected to the electronic inter-bank market. In each of these electronic marketplaces, buyers and sellers (or counterparties) participating on the network are matched, often instantaneously following the placement of their orders. In addition to strategy trading tools, real-time market data and direct-access order execution, the TradeStation electronic trading platform offers state-of-the-art advanced order placement functions, powerful automated and manual order placement capabilities, and numerous advanced charting and analytics features.

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In the Technical Analysis of Stocks and Commodities magazine Readers’ Choice Awards published in February 2007, TradeStation Securities was named, for the third consecutive year, Best Futures Brokerage, and was also named in Stocks & Commodities magazine, for the fifth year in a row, best Direct Access Stock Brokerage, best Institutional Platform, and best Professional Platform.

At December 31, 2006, TradeStation Securities had approximately 31,500 equities, futures and forex accounts, the vast majority of which were equities and futures accounts, as compared to nearly 24,500 accounts at the beginning of 2006. During the 2006 fourth quarter, TradeStation Securities’ brokerage customer account base averaged nearly 63,000 daily average revenue trades (often called “DARTs”), as compared to 49,000 during the 2005 fourth quarter. During 2006, the average TradeStation Securities account made over 500 revenue trades. As of December 31, 2006, the average asset balance of an equities account was approximately $80,000 and the average asset balance of a futures account was approximately $19,000. Total account assets were approximately $1.6 billion.

TradeStation Technologies, one of the company’s other operating subsidiaries, owns all of our intellectual property. A formal patent application covering major aspects of the TradeStation electronic trading platform was filed by TradeStation Technologies with the United States Patent and Trademark Office in October 2001. Final action on this application by the patent office is expected later this year. TradeStation Technologies also filed, early in 2005, a patent application relating to the display and execution of options trades, and owns a patent, issued January 2000 with a priority date of August 1995, that covers methods, computer systems and software that combine or integrate technical and fundamental market data and analysis into a common or unified display. TradeStation Technologies also provides subscription services for TradeStation. The subscription version of TradeStation is an institutional-quality service that offers strategy trading software tools that generate real-time buy and sell alerts based upon the subscriber’s programmed strategies, but does not include order execution. Subscribers are charged a monthly subscription fee. Last year, the TradeStation trading software platform was named, for the fourth year in a row, best Subscription Internet Analytical Platform in the Technical Analysis of Stocks and Commodities magazine Readers’ Choice Awards published in February 2007, as well as, for the third year in a row, best Options Analysis Software, best Trading Systems-Stocks, best Trading Systems-Futures, and best Trading Systems-Options.

In February 2007, Salomon Sredni, the company’s President and Chief Operating Officer since 1999, was promoted to Chief Executive Officer and President, and William and Ralph Cruz, the company’s co-founders, and Co-Chairmen and Co-Chief Executive Officers since 1996, announced that they would be transitioning out of their day-to-day roles with the company by continuing as non-executive Co-Chairmen of the Board of Directors and in an advisory capacity on key projects and initiatives.

Our principal executive offices are located in The TradeStation Building, 8050 S.W. 10^th Street, Suite 4000, Plantation, Florida 33324, and our telephone number is (954) 652-7000.

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THIS REPORT (PARTICULARLY “ITEM 1. BUSINESS,” “ITEM 3. LEGAL PROCEEDINGS” AND “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”) CONTAINS STATEMENTS THAT ARE FORWARD-LOOKING WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SEE “ITEM 1A. RISK FACTORS.”

Industry Background

Active Trader Market

An active trader has been defined by Celent Communications in a May 2005 research report as one who trades on average at least 10 times per month, or 120 times per year. Celent believes there are approximately 350,000 active traders under that definition. Celent also defined a broader active trader market, which includes all who trade, on average, at least 50 times per year, and estimates that broader market to include 750,000 to 800,000 traders. That research report also offers an estimate of 100,000 individuals who trade between 500 and 1,000 times per year, and of 30,000 individuals who trade 1,000 times or more a year. Similarly, a November 2005 research report by Fox-Pitt, Kelton characterized active traders as those who tend to trade from 10 to 20 times a month, with account balances in the $25,000 to $75,000 range, and who utilize margin to some degree in their trading. Celent’s May 2005 report estimated that the top 6% of all online brokerage accounts (Celent estimated there to be 25 million online brokerage accounts in 2005, 6% of which equals 1.5 million accounts) make up 56% of all trading and margin revenue for retail brokerage firms serving the active trader market.

The most active traders, the 30,000 or so who, Celent estimates, trade at least 1,000 times a year, are often called “semi-professional” or “hyper-active” traders. These traders are generally considered to be the most profitable portion of the active trader market. Bear, Stearns & Co., in a January 2006 equity research report, defined the semi-professional market as one whose participants trade, on average, nearly 60 times per day (roughly 15,000 trades per trader, per year), and estimated the size of that market at the end of 2005 to be approximately 27,000 traders. According to the Bear Stearns report, those 27,000 or so semi-professional traders made up, in 2005, an estimated 27% of total NYSE and NASDAQ daily share volume and an estimated 77% of total online trade volume. The Bear Stearns report emphasized the importance to this market of multiple asset classes, stating that: “Today, we believe that the biggest focus is on trading multiple asset classes from a single, yet global, platform,” and that traders “are demanding trading platforms that are capable of connecting them to the cash equities markets, the futures markets, the options markets, and the foreign exchange (FX) markets, among others.” The November 2005 Fox-Pitt, Kelton report added that semi-professional traders use highly sophisticated software, often engage with higher stakes, and are much more likely to utilize strategies across asset classes beyond just equities and equity options, such as futures and forex, with trading on margin being prevalent. Richard Bove, a research analyst for Punk Ziegel & Company, goes even further in his January 6, 2006 research report, suggesting that the trading of common stock (cash equities) is no longer a growth business and that the industry is seeking to diversify outside of the equity markets.

It is worth noting that all of the above-mentioned statistics appear to relate solely to equities accounts and equities trade volume, meaning that the futures and forex online trader markets, which are a fraction of the size of the online equities market but are growing, are in addition to the estimates described above.

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The vast majority of active traders are believed to be with “traditional” online brokerage firms (e.g., E*Trade, Fidelity, Schwab and TD Ameritrade). It is generally accepted in the online brokerage industry that 5% to 10% of each large online brokerage firm’s customer base consists of active traders, and that those active traders are responsible for the vast majority of those firms’ trades. Accordingly, nearly all of the large online brokerage firms have tried over recent years to acquire direct-access firms or technology, and more sophisticated trading analysis platforms, in order to retain and grow this most valuable segment of their customer bases.

We believe an online brokerage firm focused on active traders, in order to maximize its potential for successful market penetration, needs to deliver:

TradeStation Securities offers each of the above-mentioned features.

Institutional Trader Market

We see the institutional trader market, as it relates to potential customer relationships for direct market access brokerage firms like TradeStation Securities, as hedge fund and money managers, commodity trading advisors and commodity pool operators, and registered investment advisers who use short-term trading strategies. According to recent estimates, there are approximately 9,000 hedge funds today, which are estimated to manage up to $1.25 trillion of invested assets, and 8,000 registered investment advisers, which are estimated to manage more than $23 trillion of invested assets. Also, of the largest hedge fund complexes, those with over $1 billion in assets, a majority have funds or commodity pools sponsored, operated or advised by CFTC-registered commodity trading advisors and/or commodity pool operators. The CFTC recently reported that there are approximately 3,250 commodity pools and more than 2,000 registered commodity pool operators.

Many believe that buy side institutional traders have become less and less pleased with Wall Street (traditional sell side brokerage firms) and are moving, to one degree or another, towards using direct market access execution of their trading decisions. The January 2006 Bear Stearns report states that “the impact of financial technology on the securities markets cannot be understated,” noting that “the technologies originally developed to give the ‘day trader’ the ability to trade with professionals is now, ironically, being targeted at institutional customers by most brokerage firms.” According to an April 2004 report by The Tabb Group, institutional “[b]uy side traders now have access to powerful technologies to better understand, manage, and execute trades faster, more efficiently, less expensively, and more effectively than at any point in the past,” and that these technologies offer capabilities “which automatically execute large orders in accordance with a chosen trading strategy.”

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Features and services that are important to many buy side institutional traders include sophisticated decision-support front ends that enable analysis and development of sophisticated rule-based trading strategies, automated strategy trading, intuitive order placement, advanced portfolio/basket trading, multiple account trade allocation, a detailed, flexible order management/portfolio management system (or the ability to integrate with their management systems), and a broad scope of assets (equities, equity options, futures and forex) that can be analyzed and traded using the same platform. TradeStation contains decision-support and automated trading and manual order placement functionality, list/basket trading, multiple account trade allocation, and state-of-the-art direct-access execution services for equities, equity options and futures trading (and soon for forex trading), and continues to work on more advanced portfolio/basket trading features and new order and risk management system compatibilities and features.

Products and Services

Overview – TradeStation

Our main product/service offering is the TradeStation electronic trading platform, complete with electronic order execution services, for self-directed, active, including semi-professional, traders and certain segments of the institutional buy side trader market. TradeStation does not provide investment or trading advice or recommendations, or recommend the use of any particular strategy, but rather enables the trader to design, test, optimize and automate his own, custom trading strategies. TradeStation is a registered trademark in the United States, Australia, Canada, the European Union, Indonesia, Korea, Singapore, South Africa and Taiwan.

In addition to offering the TradeStation electronic trading platform to the brokerage customers of our TradeStation Securities subsidiary, we offer, through our TradeStation Technologies subsidiary, TradeStation subscriptions. The difference between the TradeStation electronic trading platform and the TradeStation subscription service is that the subscription service does not include order execution or account management capabilities.

TradeStation has, since its initial release as a strategy trading software program in 1991, been our flagship product. From 1996 until October 2001 it was marketed worldwide to institutional traders on a monthly subscription basis by Telerate, Inc. as a premium tool for the Telerate data feed service. It has also served, and continues to serve, as a strategy trading platform for numerous third-party trading software applications. Its state-of-the-art technology empowers the trader to design and develop a rule-based trading strategy based upon the trader’s objective rules and criteria, test the potential profitability of that trading strategy against historical data, and then computer-automate it to monitor the applicable market and alert the trader in real-time (or instantaneously place the trade order) when the criteria of the trading strategy have been met and an order should, therefore, be placed. The principal features of TradeStation that enable the trader to design and develop trading strategies are EasyLanguage and the PowerEditor. EasyLanguage is a proprietary computer language we developed consisting of English-like statements and trading terms which can be input by the trader to describe particular objective rules and criteria. The PowerEditor is a compiler of EasyLanguage statements that provides the trader with considerable flexibility to modify and combine different trading rules and criteria, which ultimately result in the design of the trader’s trading strategies. EasyLanguage and PowerEditor are also registered trademarks.

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Brokerage Services

TradeStation Securities’ principal offering today is online brokerage services, covering equities (principally stocks and ETFs), equity options, futures (including futures options) and forex transactions, through the TradeStation electronic trading platform. Equities, equity options and futures are all direct market access offerings, and a direct market access offering for forex is expected to be launched later this year. TradeStation Securities’ targeted customer base for brokerage services includes active, including semi-professional, traders and certain institutional traders, such as hedge fund and money managers and investment advisors who use short-term trading strategies. In addition to providing online services through the TradeStation electronic trading platform, the brokerage firm offers personal support services by its registered trade-desk representatives who execute customers’ orders through direct-access order execution systems if the customer is for some reason unable or unwilling to place the order using his or her own computer.

Having a “direct-access” order execution system, whether accessed directly by the brokerage customer through the TradeStation electronic trading platform or by a TradeStation Securities broker on behalf of the brokerage customer, means that both the online services and the firm’s trading desks are directly connected to electronic equities, equity options and futures market centers. This system often results in the simplest, most direct and speediest execution of orders at the best available price. With respect to pit-traded futures contracts, TradeStation is directly connected to its futures clearing agent’s online execution system, which sends the order directly to the trading pit. Approximately 98% of the company’s futures trades are on the electronic futures exchanges. With respect to forex deals, the TradeStation electronic trading platform is currently directly connected to a third-party forex dealer’s online deal system, which then electronically places the forex orders, but the company plans to launch a “direct-access” forex offering later this year.

TradeStation Securities self-clears for its active trader equity securities accounts. Institutional accounts for equity securities and futures are carried on a “fully disclosed” basis by the brokerage’s clearing agents or are given order execution services on a “delivery vs. payment / receipt vs. payment (DVP/RVP) basis for equities, or a “give-up” basis for futures, in either case with the orders cleared and settled by the client’s prime brokerage firm. All individual futures accounts are carried on a “fully-disclosed” basis by the brokerage’s futures clearing agent. TradeStation Securities executes its customers’ securities and futures transactions on an agency basis only, as opposed to a principal basis. That is, it acts as the agent for its customers directly in the market. When brokerage firms perform transactions on a principal basis, they are permitted to accept a customer’s order to purchase, purchase the securities in the market for the brokerage firm, and then sell the securities to the customer. TradeStation Securities does not do this. It always charges only an agreed-upon commission and never earns income from marking up or marking down its customers’ securities or futures transactions. For forex deals, an unaffiliated forex dealer firm acts as principal/counterparty for, and clears, all deals with the company’s forex customers.

Software Products and Services

In December 2000, we launched the TradeStation electronic subscription service. The TradeStation electronic subscription service includes our award-winning strategy trading features and functions, streaming real-time charts and quotes, streaming news, state-of-the-art analytical charting, and all other features included in the TradeStation electronic trading platform other than trade order placement and other trading or brokerage-related features or services. Effective May 1, 2006, the TradeStation electronic subscription service was offered to new subscribers at the monthly rate of $249.95 and to legacy customers who had “upgraded” at a monthly rate of $179.95. We evaluate our approach to subscription fee pricing on an ongoing basis, which may result in different

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price offerings during 2007. TradeStation (both as a subscription service and as a brokerage account trading platform) also offers our OptionStation and RadarScreen functions and features. OptionStation, also an award-winning technology, is an options trading analysis product for equity, index and futures options that enables traders to explore options trading strategies. RadarScreen enables traders to scan securities markets to identify potential buying or selling opportunities based upon the traders’ own trading strategies.

We ceased marketing our legacy software products in May 2000 and ceased marketing our subscription software services in December 2000. Accordingly, in 2004, 2005 and 2006, and, we expect, for the foreseeable future, our brokerage operations produced and should continue to produce the majority of our revenues. In 2004, 2005 and 2006, revenues from brokerage services (consisting primarily of brokerage commissions and fees and net interest income) accounted for approximately 86%, 89% and 92%, respectively, of our total consolidated net revenues, and software products and services accounted for approximately 14%, 11% and 8%, respectively, of our total consolidated net revenues over that three-year period.

Sales and Marketing

Our marketing in 2006 consisted principally of print advertising in Active Trader, Futures, SFO, and Technical Analysis of Stocks & Commodities magazines, direct mail and e-mail, sales seminars, and our Web sites, and television advertising on financial news channels. The mix and frequency of television, print, Web-site, direct-mail and in-person marketing methods that we use to try to achieve results will likely be continually modified as we test such methods and mixtures and analyze and interpret the results.

Revenues derived from customers outside of the United States for the years ended December 31, 2006, 2005 and 2004, were approximately 11%, less than 10% and approximately 12%, respectively. International revenues are collected in U.S. dollars. We conduct no marketing, sales or other operations, and maintain no assets, outside of the United States, other than relating to our start-up operations in London via our United Kingdom subsidiary, TradeStation Europe Limited.

Strategic Relationships

Clearing Services. Our brokerage’s clearing services for institutional securities accounts, and for all futures accounts, are currently provided by Bear, Stearns Securities Corp. and R.J. O’Brien & Associates, Inc., respectively, pursuant to industry-standard clearing agreements.

Forex Deal Services. Our forex deal services are currently provided through an arrangement with GAIN Capital Group, Inc. Forex customers design, test, optimize and automate their forex strategies using TradeStation, then, when a deal order is to be placed, the customer connects directly to GAIN Capital’s online deal system, and places the order. GAIN Capital is the counterparty/principal for each forex deal.

Technology Development

We believe that our success depends, in large part, on our ability to offer unique, Internet-based trading technologies with state-of-the-art order execution technologies, and continuously enhance those technologies, as well as develop and implement well-designed and user-friendly Web sites. To date, we have relied primarily on internal development of our products and services. We

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currently perform all quality assurance and develop user education and other training materials internally. In 2006, 2005 and 2004, technology development expenses were approximately $5.2 million, $4.5 million and $4.4 million, respectively. As of December 31, 2006, our technology development team was comprised of 85 people, as compared to 80 as of December 31, 2005, a 6.3% increase.

We view our technology development cycle as a four-step process to achieve technological feasibility. The first step is to conceptualize in detail the defining features and functions that we believe our targeted market requires from the product or service, and to undertake a cost-benefit analysis to determine the proper scope and integration of such features and functions. Once the functional requirements of the product or service have been determined, the second step is to technically design the product or service. The third step is the detailed implementation, or engineering, of this technical design. The fourth step is rigorous quality assurance testing to ensure that the final product or service generally meets the functional requirements determined in the first step. Several refinements are typically added and tested in the quality assurance phase of development. Once this process is completed, technological feasibility has been achieved and the working model is available for release to our customers.

The market for strategy trading software tools, streaming real-time market data and news services, and online order execution services is characterized by: rapidly changing technology; evolving industry standards in computer hardware, programming tools and languages, operating systems, database technology and information delivery systems; changes in customer requirements; and frequent new product and service introductions and enhancements, as well as technical consolidation of products and services. Our success will depend, in part, upon our ability to develop and maintain competitive technologies and to develop and introduce new products, services and enhancements in a timely and cost-effective manner that meets changing conditions such as evolving customer needs, existing and new competitive product and service offerings, emerging industry standards, changing technology, and increased capacity and stability requirements as we grow our business and as minimum customer acceptability standards for capacity and stability increase in our industry. There can be no assurance that we will be able to develop, introduce and market, on a timely basis, if at all, products, services or enhancements that respond to changing market conditions or that will be accepted by customers. Any failure by us to anticipate or to respond quickly to changing market conditions, or any significant delays in the introduction of new products and services or enhancements, could cause customers to delay using, or decide against the use of, our products and services and could have a material adverse effect on our business, financial condition and results of operations.

Customer Services and Support and Training

We provide customer services and support and product-use training in the following ways:

Customer Services and Support. Telephone account and technical support service is provided to brokerage customers through a trained customer service team. Advanced EasyLanguage consulting services (services that technically assist customers in the use of EasyLanguage to write the customers’ own trading strategies) are available from internal resources and from unaffiliated, independent EasyLanguage consultants. A substantial amount of technical support information is also provided on our Web sites.

Product-use Training. We consider user education important to try to help our customers increase their abilities to use our products and services fully and effectively. The majority of our training materials consist of extensive online documentation and technical assistance information on our Web sites, including online tutorials, as well as in-person training seminars, so that our

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customers may learn to use and take full advantage of the sophisticated technology of the TradeStation electronic trading platform. The TradeStation.com Support Center includes access to an interactive community for active traders who engage or have interest in the development, testing and use of objective trading strategies. The community provides numerous discussion forums on a variety of topics related to strategy development and technical trading, as well as TradeStation product and service features, articles about trading from industry leaders, and a “library” of strategy indicators, rules and components written in our proprietary EasyLanguage, many of which are donated by third parties.

Competition

The market for online brokerage services is intensely competitive and rapidly evolving, and there appears to be substantial consolidation in the industry in three different ways. First, there has been over the past several years and continues to be consolidation of three types of services that traditionally were offered separately: online brokerage services; real-time market data services; and trading analysis software products and services. With the TradeStation electronic trading platform, we have embraced this consolidation by offering all three of these services in a fully-integrated, seamless manner. Second, we believe consolidation is occurring in the four major online execution markets for active traders – equities, equity options, futures and forex – meaning that, contrary to specializing in offering services for only one of those market instruments, more and more firms are offering or plan to offer three or four of those services. With our offering of online trading services for all four of these markets, we have embraced this consolidation as well. Third, as a result of price pressure, unused infrastructure capacity at the largest online brokerage firms, and the desire of the larger firms to acquire sophisticated electronic trading technologies, there have been numerous acquisitions in our industry, mostly by larger firms that are seeking to increase their ability to compete on both quality and price.

We believe that competition, as well as consolidation, will continue to increase and intensify in the future. We believe our ability to compete will depend upon many factors both within and outside our control, including: price pressure; the timing and market acceptance of new products and services and enhancements developed by us and our competitors; our ability to design and support efficient, materially error-free Internet-based systems; market conditions, such as recession and volatility; the size of the active trader market today and in the future; the extent to which institutional traders are willing to use electronic brokerage services offered by firms that have traditionally served mostly retail customers; product and service functionality; data availability and cost; clearing costs; ease of use; reliability; customer service and support; and sales and marketing decisions and efforts.

We face direct competition from several publicly-traded and privately-held companies, principally online brokerages and futures commission merchants, including providers of direct-access order execution services. Our competitors include the many online brokerages currently active in the United States, some of which offer both equities and futures brokerage services, including Banc of America Investment Services, Charles Schwab & Co. (including CyberTrader), E*Trade Securities, Fidelity Brokerage Services, Interactive Brokers, Merrill Lynch Direct, OptionsXpress, Redi Products - a division of Spear, Leeds & Kellogg (which is owned by Goldman Sachs), Scottrade Financial Services, TD Ameritrade, and Townsend Analytics (which is owned by Lehman Brothers). Those brokers currently serve, in the aggregate, more than 90% of existing online accounts, and many are focused on attracting and retaining active traders. Many online brokerages currently claim to offer direct-access service. Even though we are rated as one of the

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best online brokerage firms in the United States, there can be no assurance that we will be able to maintain such ratings, be rated that highly in the future, compete effectively with our competitors, adequately educate potential customers about the benefits our products and services provide, or continue to offer such products and services.

Many of our existing and potential competitors, which include large, online discount and traditional national brokerages and futures commission merchants, and financial institutions that are focusing more closely on online services, including electronic trading services for active traders, have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and a larger installed customer base than do we. Further, there is the risk that larger financial institutions which offer online brokerage services as only one of many financial services may decide to use extremely low commission pricing or free trades as a “loss leader” to acquire and accumulate customer accounts and assets to derive interest income and income from their other financial services. We do not offer other financial services, and have no plans to do so; therefore, such pricing techniques, should they become common in our industry, could have a material, adverse effect on our results of operations, financial condition and business model.

Generally, competitors may be able to respond more quickly to new or emerging technologies or changes in customer requirements or to devote greater resources to the development, promotion and sale of their products and services. There can be no assurance that our existing or potential competitors will not develop products and services comparable or superior to those developed and offered by us or adapt more quickly to new technologies, evolving industry trends or changing customer requirements, or that we will be able to timely and adequately complete the implementation, and appropriately maintain and enhance the operation, of our business model. Recently, some of our larger competitors have been adding or emphasizing rule-based or strategy trading products and features to the active trader market, including comparison advertisements with our active trader offering. Increased competition could result in price reductions, reduced margins, failure to obtain any significant market share, or loss of market share, any of which could materially adversely affect our business, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current or future competitors, or that competitive pressures faced by us will not have a material adverse effect on our business, financial condition and results of operations.

Intellectual Property

Our success is and will be heavily dependent on proprietary software technology, including certain technology currently in development. We view our software technology as proprietary, and rely, and will be relying, on a combination of copyright, trade secret and trademark laws, nondisclosure agreements and other contractual provisions and technical measures to establish and protect our proprietary rights. We also have formal patent applications pending for the TradeStation trading platform, and own a patent that covers product features that have recently been incorporated into TradeStation. With respect to the pending patent applications, there can be no assurance that we will obtain patents broad enough in scope to have value, or obtain them at all. We also have registered copyright rights in our EasyLanguage dictionary and documentation and TradeStation software.

We have obtained trademark registrations for the TradeStation mark in the United States, Australia, Canada, the European Union, Indonesia, Korea, Singapore, South Africa and Taiwan. We have obtained registrations for the OptionStation mark in the United States, Canada and the European Union. We have obtained registrations for the EasyLanguage mark in the United States and the European Union. We have obtained registrations in the United States for the marks ActivityBar, PositionGraphs, PowerEditor, ProbabilityMap, ProSuite, RadarScreen, Test Before You Trade and other marks.

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We use an online subscription agreement for our Internet trading software and data services between TradeStation Technologies and each of the users (whether the users are brokerage customers or monthly subscribers) in order to protect our copyrights and trade secrets and to prevent such users from commercially exploiting such copyrights and trade secrets for their own gain. Since these licenses are not physically signed by the licensees, it is possible their enforceability is limited under certain state laws and the laws of many foreign jurisdictions.

Despite our efforts to protect our proprietary rights, unauthorized parties copy or otherwise obtain, use or exploit our software or technology independently. Policing unauthorized use of our software technology is difficult, and we are unable to determine the extent to which piracy of our software technology exists. Piracy can be expected to be a persistent problem, particularly in international markets and as a result of the growing use of the Internet. In addition, effective protection of intellectual property rights may be unavailable or limited in certain countries, including some in which we may attempt to expand sales efforts. There can be no assurance that the steps taken by us to protect our proprietary rights will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to ours.

There has been substantial litigation in the software industry involving intellectual property rights. We do not believe that we are infringing, or that any technology in development will infringe, the intellectual property rights of others. However, there can be no assurance that infringement claims will not be asserted by our competitors or others, and, if asserted, there can be no assurance that they would not have a material adverse effect on our business, financial condition and results of operations.

To the extent that we acquire or license a portion of the software or data included in our products or services from third parties (some data and software are licensed from third parties), or market products licensed from others generally, our exposure to infringement actions may increase because we must rely upon such third parties for information as to the origin and ownership of such acquired or licensed software or data technology. Software patent infringement cases in financial service industries are becoming more frequent, and we may be subject to litigation to defend against claimed infringement of the rights of others or to determine the scope and validity of the intellectual property rights of others. In the future, litigation will likely be necessary to establish, define, enforce, defend and protect patents, trade secrets, copyrights, trademarks and other intellectual property rights. Any such litigation would likely be costly and divert management’s attention, which could have a material adverse effect on our business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties, which could be expensive, or prevent us from selling our products or services or using our trademarks, any one of which could have a material adverse effect on our business, financial condition and results of operations.

Government Regulation

Our brokerage subsidiary, TradeStation Securities, is subject to extensive securities and futures industry regulation under both federal and state laws as a broker-dealer with respect to its equities and equity options business and as a futures commission merchant with respect to its futures and forex business. Broker-dealers and futures commission merchants are subject to regulations covering all

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aspects of those businesses, including: sales methods; trade practices; use and safe-keeping of customers’ funds and securities; clearing, processing and settlement of trades, and arrangements with clearing houses, exchanges and clearing corporations; capital structure; cash deposit or escrow requirements (or their equivalent); record keeping; conduct of directors, officers and employees; and supervision. To the extent TradeStation Securities solicits orders from customers or makes investment recommendations, it is subject to additional rules and regulations governing, among other things, sales practices and the suitability of recommendations to its customers.

TradeStation Securities’ mode of operation and profitability may be directly affected by: additional legislation; changes in rules promulgated by the SEC, NASD, NYSE, CFTC, NFA, the Board of Governors of the Federal Reserve System, DTCC, OCC, various securities and futures exchanges, and other self-regulatory associations and organizations; and changes in the interpretation or enforcement of existing rules and laws, particularly any changes focused on online brokerages that target an active trader customer base.

With respect to active trading, the NASD has adopted rules that require firms to provide customers with a risk disclosure statement about active trading. Further, the NASD and NYSE’s margin rules impose more restrictive requirements for “pattern” active traders. Governmental concern is focused in two basic areas: that the customer has sufficient trading experience and that the customer has sufficient risk capital to engage in active trading. A minimum equities account balance of $25,000 is required. TradeStation Securities’ customer account documentation specifies that being a brokerage customer of TradeStation Securities is only for traders who have experience in active trading, are willing to risk considerable amounts of capital (at least $50,000), and are interested in engaging in high-risk, short-term, speculative trading activity. We believe our brokerage firm’s minimum account opening requirements, as well as the extensive user education documentation and tutorials offered on our Web site, are consistent with both the letter and the spirit of current rules and regulations concerning active trading.

TradeStation Europe Limited, which was formed to introduce brokerage customers from the European Union to TradeStation Securities, is authorized and regulated by the FSA, and, in using its European “passport” to conduct such business throughout the European Union, is subject to the marketing, solicitation and other customer protection rules in effect in each European Union country in which it conducts such business.

The SEC, NASD, NYSE, CFTC, NFA, FSA and other self-regulatory associations and organizations (SROs) and state and foreign securities commissions and agencies can censure, fine, enjoin, suspend, expel or issue cease-and-desist orders to a broker-dealer or futures commission merchant or any of its officers or employees. For information about certain pending SRO inquiries and actions, see Item 3 – Legal Proceedings.

Marketing campaigns by TradeStation Securities to bring brand name recognition to its services and to promote the benefit of those services, such as the TradeStation electronic trading platform and its various features, are regulated by the NASD and NFA, and all marketing materials must be reviewed by an appropriately-licensed TradeStation Securities principal prior to release, and must conform to standards articulated by the SEC, NASD and NFA. The NASD or NFA may request that revisions be made to marketing materials, and can impose certain penalties for violations of its advertising regulations, including censures or fines, a requirement of advance regulatory approval of all advertising, the issuance of cease-and-desist orders, and the suspension or expulsion of a broker-dealer or futures commission merchant or any of its officers or employees.

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The SEC, NASD, NYSE, CFTC, NFA, DTCC and OCC and various other regulatory associations and organizations have stringent rules with respect to the maintenance of specific levels of net capital or cash deposit requirements and reserves by securities broker-dealers and futures commission merchants. Net capital is the net worth of the regulated company (assets minus liabilities), less deductions for certain types of assets as well as other charges. If a firm fails to maintain the required net capital it must cease conducting business and, if it does not do so, it may be subject to suspension or revocation of registration by the SEC or the CFTC and suspension or expulsion by the NASD, NYSE or NFA, and it could ultimately lead to the firm’s liquidation.

TradeStation Securities is registered as a broker-dealer in every U.S. state and the District of Columbia, and is subject to regulation under the laws of those jurisdictions, including registration requirements and being subject to sanctions if a determination of misconduct is made.

TradeStation Securities is a member of the SIPC. SIPC provides protection of up to $500,000 for each securities account brokerage customer, subject to a limitation of $100,000 for cash balances, in the event of the financial failure of a broker-dealer. For securities brokerage accounts the custody and trade clearing of and for which are handled by TradeStation Securities, an excess securities bond through HSBC Insurance Brokerage Limited, as agent of Lloyd’s of London, provides protection for any loss of securities and/or cash in excess of primary SIPC protection, up to $300 million in the aggregate (and up to $24.5 million per any one account). Based upon the asset size per account and in the aggregate of TradeStation Securities’ securities account customer base as of the date of this report, this excess-SIPC protection, combined with primary SIPC protection, should be more than adequate to cover the loss of 100% of those customer assets in the very unlikely event that TradeStation Securities experienced financial failure and all customer assets were somehow lost. To the extent TradeStation Securities clears its securities brokerage transactions through Bear, Stearns Securities Corp. (which, currently, it does only for institutional accounts), Bear, Stearns has obtained an excess securities bond that provides protection for any loss of securities and/or cash in excess of the primary SIPC protection. Neither SIPC nor excess-SIPC coverage applies to fluctuations in the market value of securities or any losses other than those directly caused by the financial failure of the broker-dealer, or to futures or forex accounts.

It is possible that other federal or state agencies will attempt to regulate our current and planned online and other electronic service activities with rules that may include compliance requirements relating to record keeping, data processing, other operation methods, privacy, pricing, content, and quality of goods and services as the market for online commerce evolves. Given the continuing growth of the electronic commerce market, federal or state authorities may enact additional laws, rules or regulations, not only with respect to online brokerage services, but to other online services we provide or may in the future provide. Such laws, rules and regulations, if and when enacted, could have a material adverse effect on our business, financial condition, results of operations and prospects.

Employees

As of December 31, 2006, we had 302 full-time equivalent employees, consisting of 104 in brokerage operations (which include clearing and account services, trade desk service and client service, including technical support), 85 in technology development (including software engineering, product management, user education and quality assurance), 64 in sales and marketing relating to

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brokerage services, subscriptions and software products (including 52 in sales and 12 in marketing and fulfillment), and 49 in general and administrative (including executive management, finance, information technology services, compliance and human resources). Our employees are not represented by any collective bargaining organization, and we have never experienced a work stoppage and consider our relations with our employees to be good.

Our future success depends, in significant part, upon the continued service of our key senior management and technology development personnel. The loss of the services of one or more of these key employees could have a material adverse effect on us. There can be no assurance that we will be able to retain our key personnel. Departures and additions of personnel, to the extent disruptive, could have a material adverse effect on our business, financial condition and results of operations.

Available Information

We offer access to our corporate TradeStation Group Web site via www.tradestation.com. We make available free of charge through our Web site this Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. We also make available, through our Web site, statements of beneficial ownership filed by our directors, officers, shareholders who own more than 10% of our issued and outstanding capital stock, and others under Section 16 of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such material is filed with, or furnished to, the Securities and Exchange Commission.

The Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this report, as well as the preceding “Business” section of this report, should be read and evaluated together with the issues, uncertainties and risk factors relating to our business described below. While we have been and continue to be confident in our business and business prospects, we believe it is very important that anyone who reads this report consider these issues, uncertainties and risk factors, which include business risks relevant both to our industry and to us in particular. These issues, uncertainties and risk factors are not intended to be exclusive. Issues, uncertainties and risk factors are also included in other sections of this report when specifically relevant to a statement we have made about an aspect of our business, or our financial condition or results of operations.

This report also contains statements that are forward-looking within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. When used in this report, the words “anticipate(s),” “anticipated,” “anticipation,” “assume(s),” “assumption(s),” “become(s),” “belief(s),” “believe(s),” “believed,” “could,” “designed,” “estimate,” “estimates,” “estimated,” “expect(s),” “expected,” “expectation(s),” “going forward,” “future,” “hopeful,” “hope(s),” “intend(s),” “intended,” “look forward,” “may,” “might,” “opportunity,” “opportunities,” “outlook(s),” “pending,” “plan(s),” “planned,” “potential,” “scheduled,” “shall,” “should,” “think(s),” “to be,” “upcoming,” “well-positioned,” “will,” “wish,” “would,” and similar expressions, if and to the extent used, are intended to identify the forward-looking statements.

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All forward-looking statements are based on current expectations and beliefs concerning future events that are subject to risks and uncertainties, including the risks and uncertainties described below and elsewhere in this report. Actual results may differ materially from the results suggested in this report. Factors that may cause or contribute to such differences, and our business risks and uncertainties generally, include, but are not limited to, the items described below, as well as those described in other sections of this report, our other public filings and our press releases.

There Are Several Factors That May Cause Fluctuations In Our Quarterly Operating Results, Which Could Result In Significant Volatility In Our Stock Price

Quarterly revenues and operating results of TradeStation Group have fluctuated significantly in the past, and our quarterly revenues and operating results are likely to fluctuate in the future. Causes of such significant fluctuations may include, but are not limited to:

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Conditions In The Securities And Financial Markets May Affect Our Rates Of Customer Acquisition, Retention And Trading Activity, And Level of Interest Income

Our products and services are, and will continue to be, designed for customers who trade actively in the securities and financial markets. To the extent that interest in active trading, or trading generally, decreases due to low trading volumes, lack of volatility, significant downward movement in the securities or financial markets, or negative market sentiment, or future tax law changes, recessions, depressions, wars, terrorism (including “cyberterrorism”), or otherwise, our business, financial condition, results of operations and prospects could be materially, adversely affected. Unfavorable market conditions have, historically, seemed to severely negatively impact the share price of publicly-held online brokerage firms, and also usually result in more losses for our customers, which could result in increases in quantity and size of errors or omissions or other claims that may be made against us by customers. We do not currently carry any errors or omissions insurance that might cover, in part, some of those potential claims. See “The Nature Of Our Business Results In Potential Liability To Customers” below.

Also, we derive a significant portion of our brokerage revenues from interest income on customers’ credit balances and account borrowings. Therefore, changes in interest rates or in the size of such balances and borrowings, depending upon the extent of the change, could materially change, positively or negatively (depending upon the direction of the change) the amount of our interest income.

Our Industry Is Intensely Competitive, Which Makes It Difficult To Attract And Retain Customers

The markets for online brokerage services, trading software tools, and real-time market data services are intensely competitive and rapidly evolving, and there has been substantial consolidation of those three products and services in the industry, as well as consolidation of the types of financial instruments (equities, equity options, futures, forex) offered by firms. There has also been consolidation of online brokerage firms generally, as well as intense price competition. We believe that competition from large online and other large brokerage firms and smaller brokerage firms focused on active traders, as well as consolidation, will continue. Recently, some of our larger competitors have been adding or emphasizing rule-based or strategy trading products and features to the active trader market, including comparison advertisements with our active trader offering. Competition may be further intensified by the size of the active trader market, which is generally thought to be comprised of less than 10% of all online brokerage accounts. We believe our ability to compete will depend upon many factors both within and outside our control. Factors outside of our control include: price pressure (on transactional commissions, monthly platform fees and interest rates offered to customers for both credit balances and account borrowings); the timing and market acceptance of new products and services and enhancements developed by our competitors (including strategy back-testing and automation capabilities); market conditions, such as recession; the size of

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the active trader market today and in the future; the extent to which institutional traders are willing to use electronic brokerage services from firms that have traditionally served mostly retail customers; data availability and cost; and exchange and third-party clearing costs. Factors over which we have more control, but which are subject to substantial risks and uncertainties with respect to our ability to effectively compete, include: timing and market acceptance of new products and services and enhancements we develop; our ability to meet changing market demands for a unified, integrated trading platform that offers customers the ability to trade and manage portfolios containing multiple asset classes; our ability to design, improve and support materially error-free and sufficiently robust Internet-based systems; ease-of-use of our products and services; reliability of our products and services; and pricing decisions and other sales and marketing decisions and efforts (we have recently reduced futures commission pricing and our monthly platform fee waiver thresholds).

Systems Failures May Result In Our Inability To Deliver Accurately, On Time, Or At All, Important And Time-Sensitive Services To Our Customers

The online electronic trading platform we provide to our customers is based upon the integration of our sophisticated front-end software technology with our equally-sophisticated, Internet-based server farm technology. Our server farm technology is the foundation upon which online trading customers receive real-time market data and place buy and sell orders. However, in order for this technology to provide a live, real-time trading platform, it requires integration with real-time market data, which are currently provided directly by the exchanges or by systems of independent third-party market data vendors (who obtain the data directly from the exchanges), the electronic order book systems of ECNs and electronic systems offered by the exchanges, the clearing and back-office systems we license from SunGard for self-clearing and of the clearing agents we use for trades that we do not self-clear, and the forex deal order placement, settlement and back-office systems of or licensed to the forex dealer firm which is responsible for all of our customers’ forex trades. Accordingly, our ability to offer a platform that enables the development, testing and automation of trading strategies and the placement, execution, clearing and settlement of buy and sell orders depends heavily on the effectiveness, integrity, reliability and consistent performance of all of these systems and technologies. In particular, the stress that is placed on these systems during peak trading times could cause one or more of these systems to operate too slowly or fail. Outages and other system failures may also be caused by natural disasters and other events and circumstances beyond our control.

We have experienced several delays and outages since we launched our online trading platform, many of which related to data vendor, clearing agent, exchange and ECN outages or issues which are beyond our control. There have also been several market data and order execution outages recently, as well as failures to perform on the part of the brokerage firm’s back-office system vendor. Any major system failure or outage (or series of frequent failures or outages), regardless of the cause, could result in a business or legal requirement to issue large credit amounts to customers, loss of accounts, reduced trading activity, loss of or diminished reputation and recognition in the industry, increased monetary costs and diversion of internal resources, regulatory inquiries, fines and sanctions, and other material adverse consequences. Also, we do not maintain a seamless, redundant back-up system to our order execution systems, which could materially intensify these negative consequences.

Additionally, as a general matter not applicable only to our company, the integrity of these types of systems may be attacked by persons sometimes referred to as “hackers” who intentionally introduce viruses or other defects to cause damage, inaccuracies or complete failure. Also, “cyberterrorism,” should it occur, may significantly affect people’s willingness to use Internet-based services, particularly ones that involve their personal or company’s assets.

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During a system outage or failure, our brokerage may be able to take orders by telephone; however, only associates with appropriate licenses, knowledge and experience can accept telephone orders, and an adequate number of associates likely would not be available to take customer calls in the event of a system outage or failure. System delays, errors, outages and failures, depending upon how serious and how often they occur, could have a material adverse effect on our business, financial condition, results of operations and prospects. See “The Nature Of Our Business Results In Potential Liability To Customers” below.

The Loss Of Key Employees Could Decrease The Quality Of Our Management And Operations – Most Recently, The Company’s Co-Founders, Co-Chairmen and Co-CEOs Have Announced They Are Transitioning Out of Their Day-To-Day Roles And Will No Longer Serve As Executive Officers

Our success depends to a very significant extent on the continued availability and performance of a number of senior management and product development personnel. The loss of one or more of these key employees could have a material adverse effect on our company. In particular there may be adverse consequences to the company and/or its operations as a result of the recent change in company senior management roles, which included the transition of William and Ralph Cruz, the company’s co-founders and co-chairmen, out of their day-to-day senior management roles as Co-CEOs. The causes of potential adverse consequences may include changes in management styles or decisions that produce less favorable results than would have been produced under the prior management structure.

We Are Exposed to Credit Risk

We make margin loans to clients collateralized by client securities, and borrow securities to cover trades. In fact, nearly all of our clients’ accounts are margin, as opposed to cash, brokerage accounts. A portion of our net revenues is derived from interest on margin loans. To the extent that these margin loans exceed client cash balances maintained with us, we must obtain financing from third parties. We may not be able to obtain this financing on favorable terms or in sufficient amounts. By permitting clients to purchase securities on margin, we are subject to risks inherent in extending credit, especially during periods of rapidly declining markets in which the value of the collateral substantially decreases in proportion to the amount of a client’s indebtedness. While we have implemented additional risk-management procedures designed to reduce this risk, there can be no assurance that we will not experience periodic or frequent unsecured account debits that materially and adversely affect our results of operations. In addition, in accordance with regulatory guidelines, we collateralize borrowings of securities by depositing cash or securities with lenders. Sharp changes in market values of substantial amounts of securities and the failure by parties to the borrowing transactions to honor their commitments could have a material, adverse effect on our revenues and profitability.

The Nature Of Our Business Results In Potential Liability To Customers

Many aspects of the securities, futures and forex brokerage business, including online trading services, involve substantial risks of liability. In recent years there has been a high incidence of litigation involving the securities and futures brokerage industry, including both class action and individual suits and arbitrations that generally seek substantial damages, including in some cases punitive damages. Our proprietary order routing technology, in addition to offering charting, trade analysis and trade execution

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services of various kinds, is designed to automatically locate, with immediacy, the best available price in the appropriate market in completing execution of a trade triggered by programmed market entry and exit rules. There are risks that the electronic communications and other systems upon which these products and services rely, and will continue to rely, or our products and services themselves, as a result of flaws or other imperfections or limitations in their designs or performance, may operate too slowly, fail, cause confusion or uncertainty to the user, or operate or produce results not understood or intended by the user. An investor or trader using either our full electronic trading platform or our subscription service might claim that investment or trading losses or lost profits resulted from use of a flawed version of one of our trading software tools or systems, or inaccurate assumptions made by the trading software tools regarding data, or inaccurate data. Major failures of this kind may affect all customers who are online simultaneously. Any such litigation could have a material adverse effect on our business, financial condition, results of operations and prospects. We do not currently carry any errors or omissions insurance that might cover, in part, some of the above-described risks. While our contracts with customers are, we believe, clear that customers who do business with us must knowingly assume all of the risks described above, there can be no assurance that a judge, arbitrator or regulator would enforce or honor such contractual provisions. See “Conditions In The Securities And Financial Markets May Affect Our Rates Of Customer Acquisition, Retention And Trading Activity, And Level of Interest Income” and “Systems Failures May Result In Our Inability To Deliver Accurately, On Time, Or At All, Important And Time-Sensitive Services To Our Customers” above.

Dependence Upon Outside Data Sources And Clearing Relationships Creates Risks Outside Of Our Control Which May Affect Our Ability To Provide, And Our Cost To Provide, Market Data And Clearing And Account Services

Our business is currently dependent upon our ability to maintain contracts with private market and news data vendors and clearing and dealer firms in order to provide certain market data and news, and clearing and account services, respectively, to our customers. We currently obtain NYSE, AMEX, NASDAQ, regional equities exchange, Options Price Reporting Authority (OPRA), CME, CBOT, New York Mercantile Exchange/ Commodities Exchange (NYMEX/COMEX), New York Board of Trade (NYBOT), OneChicago and EUREX futures real-time market data directly from those exchanges, and real-time market depth displays directly from ECN book services, but obtain other market data (such as forex data) and news pursuant to non-exclusive licenses from private data vendors who in turn obtain the data from exchanges or other sources. Clearing and back-office account services for our brokerage customers are obtained from established clearing agents and, with respect to our self-clearing operations, our software system licensing agreement with SunGard. For our forex services, we rely on a third-party forex dealer firm for all trade activity account services. The data and news contracts typically provide for royalties based on usage or minimums, the clearing contracts provide for transactional clearing fees and charges, and the contract with the forex dealer provides for sharing a fixed amount of the spread made by the forex dealer in each deal. There can be no assurance that we will be able to renew or maintain contracts or acceptable clearing cost or vendor fee rates. In fact, in 2003 we needed to quickly change our futures clearing agent in response to a substantial increase in our clearing costs imposed by our former futures clearing agent. Changes (or, in some cases, the failure or inability to make changes) in our relationships with one or more of these third parties, or involuntary termination of one or more of those relationships, could have a material adverse effect on our business, financial condition, results of operations and prospects.

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We May Be Subject To Intellectual Property Litigation

There has been substantial litigation in the software industry involving intellectual property rights. Although we do not believe that we are or will be infringing upon the intellectual property rights of others, there was recently an infringement claim asserted against us and eight other online brokerage firms by a company named Datamize, Inc., which could have had a material adverse effect on our business, financial condition, results of operations and prospects if it was successful (we settled the suit in December 2004 for an amount immaterial to our financial statements). Such a case, as well as any other infringement case that may be brought against us, could result in our being unable to use intellectual property which is integral to our business.

We May Not Be Able To Adequately Protect Or Preserve Our Rights In Intellectual Property

Our success is and will continue to be heavily dependent on proprietary technology, including existing trading software, Internet, Web-site and order-execution technology, and those types of technology currently in development. We view our technology as proprietary, and rely, and will be relying, on a combination of copyright, trade secret and trademark laws, nondisclosure agreements and other contractual provisions and technical measures to protect our proprietary rights. We also have pending patent applications covering the TradeStation electronic platform, but we do not yet know if the patents will be issued. Policing unauthorized use of our products and services is difficult, however, and we may be unable to prevent, or unsuccessful in attempts to prevent, theft, copying or other unauthorized use or exploitation of our product and service technologies. There can be no assurance that the steps taken by us to protect (or defend) our proprietary rights will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to our technologies or products and services.

Self-Clearing Equity Trades For Active Trader Accounts Has Risks

Self-clearing operations for our active trader equities accounts began in September 2004 and for options trades began in March 2005. Prior to the September conversion of clearing services, all of our customers’ equities trades were cleared through Bear Stearns, as our clearing agent, which also provided to our active trader clients its short sale borrowing inventory. Cost savings and efficiencies of self-clearing may in future periods turn out to be less favorable than we expect as a result of unanticipated increased fixed, infrastructure or incremental costs, mistakes or other factors. Further, errors made by us related to the confirmation, receipt, settlement and delivery functions involved in securities transactions, the custody and control of client securities and other assets, or otherwise relating to the handling of our clients’ securities and funds, could lead to civil penalties and increased deposit and other requirements by governmental and self-regulatory organizations, as well as losses and liability in lawsuits relating to client accounts affected by such errors. Also, our savings may be more than offset by account losses or reduced trading activity if we experience difficulties in providing to our clients sufficient short sale borrowing inventory or if any self-clearing mistakes or failures occur which undermine our customers’ or prospects’ confidence in our ability to conduct reliable self-clearing operations. Also, our self-clearing back-office operations rely on the Phase3 self-clearing software licensed to us by SunGard, and our business would likely suffer substantial harm if that software fails, fails to be adequately supported by SunGard, or otherwise causes unintended results.

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We May Need Cash In The Foreseeable Future

While we anticipate having sufficient cash to meet our needs over the next 12 months, our future liquidity and capital requirements will depend upon numerous factors, including: the rate of customer acceptance of our products and services, including the number of new brokerage accounts acquired and the number and volume of trades made by our brokerage customers; the effect of price reductions; price competition that may result in our continuing to charge lower commissions and fees to customers; significant, increased infrastructure and operating costs as our business grows, large cash or security deposits (which were $20.2 million as of March 1, 2007, and which are expected to increase as our business grows); increased net capital or excess net capital requirements and unanticipated reserve and settlement requirements; unanticipated costs relating to our planned forex service offering; costs of technology development and sales, marketing, compliance, technical and administrative operations relating to increased and intensified pursuit of institutional customers; substantial legal costs and/or unexpected unfavorable outcomes in lawsuits and arbitrations currently pending against us; and competing technological and market developments. Funds, if and when needed, may be raised through debt financing and/or the issuance of equity securities, there being no assurance that any such type of financing on terms satisfactory to us will be available or otherwise occur. Any equity financing or debt financing which requires issuance of equity securities or warrants to the lender, or any securities litigation settlement or judgment that requires issuance of equity securities to the claimants, would reduce the percentage ownership of the shareholders of the company. Shareholders also may, if issuance of equities occurs, experience additional dilution in net book value per share, or the issued equities may have rights, preferences or privileges senior to those of existing shareholders.

Operation In A Highly-Regulated Industry And Compliance Failures May Result In Severe Penalties And Other Harmful Governmental Or SRO Actions Against Us

The securities and commodity futures industries are subject to extensive regulation covering all aspects of those businesses. Regulation of forex dealer and brokerage services is increasing as well. The various governmental authorities and industry SROs that supervise and regulate our brokerage firm have broad enforcement powers to censure, fine, suspend, enjoin, expel or issue cease-and-desist orders to our brokerage firm or any of its officers or employees who violate applicable laws or regulations. Additionally, rules relating specifically to active traders have been enacted and more may be enacted which severely limit the operations and potential success of our business. For example, about six years ago, the NYSE and NASD required brokerage firms to establish systems that enabled them to identify “pattern day traders” and to ensure that those types of accounts maintained higher minimum account balances and stricter margin maintenance requirements. In a more recent example, in January 2005 new “short sale” rules promulgated by the SEC became effective that could have materially, adversely affected our ability to provide quality short sale brokerage services to our equities brokerage customers. Our ability to comply with all applicable laws and rules is largely dependent on our brokerage’s maintenance of compliance and reporting systems, as well as its ability to attract and retain qualified compliance and other operations personnel and enter into suitable contractual relationships with appropriate vendors, lenders and counterparties. We currently have pending issues relating to NASD OATS reporting, NYSE OTS reporting, and NASD short sale procedures that could have negative consequences for our brokerage. In general, our brokerage could be subject to disciplinary or other regulatory or legal actions, fines and penalties in the future due to noncompliance.

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Our Brokerage Must Meet Net Capital And Other Financial Requirements As A Broker-Dealer That, If Not Satisfied, Could Result In Severe Penalties Or Other Negative Consequences, And Which At All Times Limit Our Right To Use All Of The Brokerage’s Cash

The SEC, the NASD, the CFTC, the NFA, the DTCC (i.e., NSCC and DTC), the OCC, certain exchanges and other regulatory and self-regulatory agencies or organizations have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and futures commission merchants, large, fluctuating cash deposit requirements, and reserve, settlement and other financial requirements. Net capital is the net worth of the regulated company (assets minus liabilities), less deductions for certain types of assets as well as other charges. If a firm fails to maintain the required net capital it may be subject to suspension or revocation of registration by the SEC or CFTC and suspension or expulsion by the NASD or NFA, and it could ultimately lead to the firm’s liquidation. If such net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the use of capital would be restricted. Also, our ability to withdraw capital from our TradeStation Securities brokerage subsidiary is subject to SEC rules, which in turn could materially impact our available working capital and materially impact or limit our ability to repay debt as and when due, redeem or purchase shares of our outstanding stock, if required or desirable, and pay dividends in the future. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our then present levels of business, which could have a material adverse effect on our business, financial condition, results of operations and prospects. See “We May Need Cash In The Foreseeable Future” above.

There Are Risks Relating To Our Ability To Maintain Customer Privacy And Security And That Increased Government Regulation Of Internet Business May Occur

Customers may refuse to transact business over the Internet, particularly business, such as ours, that involves the handling of significant amounts of customers’ funds, due to privacy or security concerns. This risk will grow if, as and to the extent “cyberterrorism” occurs or is perceived to be a viable, prominent threat or likelihood to occur (or recur on a regular basis). We do incorporate security measures into our privacy policies. However, no assurances can be made that a breach of such measures will not occur, and a major breach of customer privacy or security could have serious consequences for our Internet-based operations, which are central to our business. Use of the Internet, particularly for commercial transactions, may not continue to increase as rapidly as it has during the past few years as a result of privacy or security concerns, or for other reasons. If this occurs, the growth of our operations would be materially hindered. If Internet activity becomes heavily regulated in these respects or otherwise, that could also have significant negative consequences for the growth of our current and planned operations.

Control Of TradeStation Group By The Cruzes Means That Important Decisions Affecting The Company Are Concentrated In The Judgment Of Two Related Individuals

As of March 1, 2007, affiliates of William R. Cruz and Ralph L. Cruz (the non-executive Co- Chairmen of our company) owned approximately 37% of the outstanding shares of our common stock, and we believe that no other shareholder or related group owned more than 7%. Therefore, the Cruzes have significant control over TradeStation Group on matters subject to shareholder approval, including the election of our Board of Directors and any merger, consolidation or sale of all or substantially all of TradeStation Group’s assets that may be proposed.

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Not applicable.

We have a ten-year lease expiring in August 2012 (with two 5-year renewal options) that commenced in the summer of 2002 for an approximately 70,000 square-foot corporate headquarters in Plantation, Florida. Plantation is just west of Ft. Lauderdale, Florida (Broward County). This headquarters consolidated the personnel and operations of our former Miami and Boca Raton offices.

Our brokerage operations were formerly headquartered from 11,800 square feet of office facilities in Boca Raton, Florida pursuant to a lease that expired in February 2007. All of this space was subleased through February 2007 at lease rates significantly lower than the rates we paid.

Our brokerage operations include a 10,400 square foot branch office in Chicago, Illinois, pursuant to a lease that expires at the end of February 2012.

Our technologies subsidiary has an approximately 13,500 square foot leased facility in Richardson, Texas from which certain technology development and technical operations are conducted. A portion of those facilities serve as a branch office for TradeStation Securities. That lease expires July 31, 2007. We also lease exclusive rack space for our data server farms at two sites, one in Richardson, Texas (which is currently month-to-month) and one in Chicago, Illinois (expiring in August 2007).

Our United Kingdom subsidiary leases a two-room office in London, England, pursuant to a License that expires following 90 days written notice by either party.

We believe that our facilities are adequate to support our current operations and that, if needed, we will be able to obtain suitable additional facilities on commercially reasonable terms.

Three lawsuits were filed in 2003 by former principal owners of onlinetradinginc.com corp. (the predecessor of TradeStation Securities) against TradeStation Group, certain of its directors and executive officers and certain family partnerships owned by the two former Co-Chief Executive Officers. On July 25, 2003, Benedict S. Gambino, from whom the company, as of October 18, 2002, purchased 2,417,000 shares of its common stock in a private transaction, filed a lawsuit against the company and three of its executive officers, William R. Cruz, Ralph L. Cruz and Marc J. Stone, in the Circuit Court of Broward County, State of Florida. This lawsuit’s allegations included violation of the Florida Securities and Investor Protection Act, common law fraud, negligent misrepresentation, breach of fiduciary duty and breach of contract. On August 18, 2003, Andrew A. Allen Family Limited Partnership (owned and controlled by Andrew A. Allen), from whom the company, as of November 26, 2002, purchased 1,000,000 shares of its common stock in a private transaction, filed a lawsuit against the same defendants in the same court. This lawsuit’s allegations include violation of the Florida Securities and Investor Protection Act, common law fraud, breach of fiduciary duty, negligent misrepresentation and fraudulent inducement. On August 28, 2003, Farshid Tafazzoli and E. Steven zum Tobel filed a lawsuit against the company, William and Ralph Cruz, family partnerships owned and controlled by William and Ralph Cruz, Mr. Stone, Charles

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Wright and David Fleischman in the Circuit Court of Miami-Dade County, State of Florida. Mr. Tafazzoli’s claims relate to his family partnership’s sale, as of May 1, 2002, of 3,000,000 shares of company common stock to family partnerships owned by William and Ralph Cruz, and Mr. zum Tobel’s claims relate to his family partnership’s sale, as of May 3, 2002, of 133,942 shares of company common stock to Charles Wright. This lawsuit’s allegations include violation of the Florida Securities and Investor Protection Act, common law fraud and breach of fiduciary duty. Each of the three lawsuits has sought rescission of the share purchases and/or compensatory damages, plus interest, costs and attorneys’ fees.

The Tafazzoli/zum Tobel case is well into the discovery phase of litigation and, in the Allen case, the discovery phase has been completed, plaintiff’s motion to amend its complaint to add a claim for punitive damages was denied, and a trial has tentatively been scheduled for May 2007. The Gambino case has been settled and, pursuant to the settlement agreement dated November 3, 2006, was dismissed with prejudice. The Gambino settlement is not material to our consolidated financial position, results of operations or cash flows in any period.

We continue to believe all of the claims in the remaining two cases are baseless; however, no assurances can be given that a judge or jury will agree with our assessment.

TradeStation Securities is also engaged in routine regulatory matters and civil litigation or other dispute resolution proceedings, including matters which are currently pending relating to NASD OATS reporting, short sales procedures and short interest reporting, and two pending NASD arbitrations, incidental to, and part of the ordinary course of, its business. The NASD regulatory matters could ultimately result in censures, sanctions, fines and other negative consequences.

While no assurances can be given, we do not believe that the ultimate outcome of any of the above legal matters or claims will result in a material adverse effect on our consolidated financial position, results of operations or cash flows.

We decided, as of June 1, 2002, to no longer carry errors or omissions insurance that covers third-party claims made by brokerage customers or software subscribers as a result of alleged human or system errors, failures, acts or omissions. This decision was made based upon our assessment of the potential risks and benefits, including significant increases in premium rates, deductibles and coinsurance amounts, reductions in available per occurrence and aggregate coverage amounts, and the unavailability of policies that sufficiently cover the types of risks that relate to our business. We recently reviewed this insurance with insurance agents and our view remains unchanged.

No matters were submitted to a vote of security holders during the fourth quarter of 2006.

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PART II

Common Stock Information

Our common stock, par value $.01 per share, is listed on The NASDAQ Global Select Market under the symbol “TRAD.” The high and low closing sales prices based on actual transactions on The NASDAQ Global Select Market during each of the quarters presented were as follows:

As of March 1, 2007, there were 77 holders of record of our common stock, and, based upon information previously provided to us by depositories and brokers, we believe there are more than 13,000 beneficial owners.

Divi dend Policy

We intend to retain future earnings to finance our growth and development and therefore do not anticipate paying any cash dividends in the foreseeable future. Payment of any future dividends will depend upon our future earnings and capital requirements and other factors we consider appropriate. We did not distribute any dividends during the years ended December 31, 2006, 2005, or 2004.

Recent Sales of Unregistered Securities

During the three months ended December 31, 2006, we did not issue or sell any unregistered securities. In January and February 2007, we issued to 250 employees (including 6 executive officers) and one consultant options to purchase an aggregate 372,350 shares of common stock. Such options vest ratably in annual increments over a five-year period and are exercisable at $12.43 or $13.12 per share, which were the closing prices of our stock on the dates the options were granted. All of the options were granted under the Incentive Stock Plan in the ordinary course, and expire, if they remain unexercised, on the tenth anniversary of the date on which they were granted.

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We also issued 152,439 restricted shares of common stock to Salomon Sredni, our Chief Executive Officer, in connection with and at the time of his promotion to that position in February 2007. The restricted shares, which had a fair market value of $2.0 million, were granted as a stock award under the Incentive Stock Plan and vest ratably in annual increments over a five-year period. If Mr. Sredni’s employment terminates prior to full vesting (other than by reason of death or disability), he will automatically forfeit, and the company will reacquire, the unvested shares for no consideration. Vesting accelerates 100%, automatically, in the event of Mr. Sredni’s death or disability, or a change in control of the company.

All the foregoing options were issued by us in reliance upon the exemption from registration available under Section 4(2) of the Securities Act of 1933, as amended. The 152,439 restricted shares were issued by us pursuant to our effective registration statement on Form S-8.

Share Rep urchases

In October 2006, our Board of Directors authorized, and we announced, the use of up to $60 million of our available and unrestricted cash, over a four-year period, to repurchase shares of our common stock in the open market or through privately-negotiated transactions. The stock repurchases are authorized to be made pursuant to a Rule 10b5-1 plan. The four-year period commenced on November 13, 2006 and ends on November 12, 2010. Pursuant to the buy back plan, $1,250,000 of company cash during each full calendar month (and prorated amount during the first and last months) of the four-year period (i.e., $15 million per 12-month period and $60 million for the four-year period) has been authorized to be used to purchase company shares at prevailing prices, subject to compliance with applicable securities laws, rules and regulations, including Rules 10b5-1 and 10b-18. The buy back plan does not obligate us to acquire any specific number of shares in any period, and may be modified, suspended, extended or discontinued at any time without prior notice.

The following table sets forth information on our common stock buy-back program for the quarter ended December 31, 2006:

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The following selected consolidated financial data should be read in conjunction with “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” and the Consolidated Financial Statements and Notes thereto included in this report. The Consolidated Statement of Income Data presented below for the years ended December 31, 2006, 2005 and 2004, and the Consolidated Balance Sheet Data as of December 31, 2006 and 2005, have been derived from our Consolidated Financial Statements included on pages F-1 through F-34 of this report, which have been audited by Ernst & Young LLP, an independent registered public accounting firm. The Consolidated Statement of Income Data presented below for the years ended December 31, 2003 and 2002, and the Consolidated Balance Sheet Data as of December 31, 2004, 2003 and 2002, have been derived from audited financial statements not included in this report. See also Note 17 of Notes to Consolidated Financial Statements - UNAUDITED QUARTERLY FINANCIAL INFORMATION for quarterly unaudited financial information for fiscal years 2006 and 2005.

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This discussion should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and Notes to Consolidated Financial Statements contained in this report and the Risk Factors set forth in Item 1A of this report.

Overv iew

TradeStation Group, Inc., a Florida corporation formed in 2000, is the successor company to a publicly-held trading software company that was formed in 1982. TradeStation Group is listed on The NASDAQ Global Select Market under the symbol “TRAD.” TradeStation Securities, Inc., an online broker-dealer and futures commission merchant, and TradeStation Technologies, Inc., a trading technology company, are TradeStation Group’s two operating subsidiaries. The company’s core product/service, which is offered by TradeStation Securities, is TradeStation, an award-winning, direct market access (DMA) electronic trading platform that enables traders to test and automate “rule-based” trading strategies (both technical and fundamental) across multiple asset classes, namely, equities, equity options, futures and, expected later this year, foreign currencies (forex). The company’s other subsidiary, TradeStation Europe Limited, a United Kingdom private company, authorized and regulated by the UK FSA as an introducing broker, is in its start-up phase.

TradeStation Securities is a leading online brokerage firm that serves the active trader and certain institutional trader markets, and is the company’s principal operating subsidiary. TradeStation Securities is a member of the NYSE, NASD, SIPC, NFA, DTCC,

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OCC, AMEX, BOX, CBOE, CHX, ISE, NYSE ARCA and PHLX. TradeStation Securities’ business is also subject to the rules and requirements of the SEC, CFTC and state regulatory authorities (the firm is registered to conduct its brokerage business in all 50 states and the District of Columbia). TradeStation Securities self-clears most of its equities and equity options business, and uses an established futures clearing firm and an established forex dealer firm to clear its futures and forex business.

TradeStation Securities’ revenues consist primarily of transactional commissions and fees (including monthly platform fees) and interest derived from customer balances and margin lending to customers. With respect to monthly platform fees (a $99.95 charge made to less active brokerage customers for being granted access to use the TradeStation trading platform), beginning September 1, 2005 we launched a series of strategic marketing initiatives, the most recent as of November 1, 2006, which have reduced materially the trading activity thresholds that need to be met to qualify for a waiver of the monthly platform fee. Effective December 1, 2005, we also launched a strategic marketing initiative designed to attract high-volume futures traders – a change from our one-price-fits-all futures commission structure to a tiered commission structure that rewards more active traders with lower pricing. Under the revised pricing structure, the commission charged over the applicable exchange fee ranges from $1.20 down to 25 cents per contract (per side). We believe such marketing initiatives contributed to our account growth during 2006; however, we cannot measure specifically how many accounts have been added because of these initiatives. The latest reduction in trading activity thresholds required to qualify for a waiver of the monthly platform fee (the one effective November 1, 2006), assuming no benefits from additional account growth or trading, was a decrease in monthly revenues of approximately $100,000 and monthly net income by approximately $62,000.

Beginning in September 2004, TradeStation Securities commenced equities self-clearing operations for its active trader client base and commenced omnibus clearing of its standardized equity option trades through Broadcort, a division of Merrill Lynch. Beginning March 29, 2005, following issuance of its membership in the OCC, TradeStation Securities commenced full self-clearing of its standardized equity options trades for its active trader client base and terminated Broadcort’s clearing services. Self-clearing has provided substantial cost savings and efficiencies. TradeStation Securities currently clears institutional account securities trades through Bear, Stearns Securities Corp. on a fully-disclosed basis, or provides order execution services on a DVP/RVP basis with the orders cleared and settled by the client’s prime brokerage firm. Futures trades are cleared through R.J. O’Brien & Associates on a fully-disclosed basis, and for certain institutional futures accounts, order execution services are provided on a “give-up” basis with the orders cleared and settled by the client’s prime brokerage firm. Forex trades, through July 15, 2005, were cleared through R.J. O’Brien Foreign Exchange, and subsequent to July 15, 2005, through Gain Capital Group, Inc., each on a fully-disclosed basis (Bear, Stearns Securities Corp., Broadcort, R.J. O’Brien & Associates, R.J. O’Brien Foreign Exchange, and Gain Capital Group, Inc. are collectively referred to as “clearing agents” or “clearing agent firms”). In connection with an extension of its futures clearing agreement (which was set to expire December 31, 2005) and the agreement with its new forex clearing agent, TradeStation Securities began receiving in July 2005 materially more favorable interest-sharing and clearing fee/deal-spread sharing arrangements. These benefits are not based on growth in trading volume or any other contingency.

Effective January 1, 2006, a brokerage account has been defined as an account that either has a positive asset balance of at least $200 or has had activity within the past 180 days. In other words, an account is deemed inactive and is not included in counting total brokerage accounts if it has less than a $200 balance and has had no activity within the past 180 days. The effect of this modified account definition was a net positive adjustment of 511 accounts as of January 1, 2006 (i.e., a positive adjustment to the number

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of futures and forex accounts exceeded a negative adjustment to the number of equities accounts by 511). Periods prior to 2006 have not been and will not be restated to reflect the modification to the definition. As of December 31, 2006, TradeStation Securities had 31,502 equities, futures and forex accounts (the vast majority of which were equities and futures accounts), a net increase of 7,018 accounts, or 29%, when compared to the 24,484 accounts (as adjusted) as of January 1, 2006.

During the year ended December 31, 2006, TradeStation Securities’ brokerage customer account base averaged 60,706 daily average revenue trades (often called “DARTs”), an increase of 42% when compared to 42,714 during 2005. The following table presents certain brokerage metrics and account information:

We compute DARTs as follows: For equities and equity options, a revenue trade included to calculate DARTs is a commissionable trade order placed by the customer and executed, regardless of the number of shares or contracts included in the trade order. For futures and forex, a revenue trade included to calculate DARTs is one round-turn commissionable futures contract traded, or one round-turn lot (or forex deal) traded, regardless of the number of individual orders made and executed (i.e., one futures or forex order may contain numerous contracts or deals, but each round-turn contract and deal is counted as a separate revenue trade). When viewing our DARTs, it should be taken into account that, for equities and equity options, we charge commissions based on share volume and number of contracts traded (and not by revenue trade used to calculate DARTs). For futures, we charge commissions on a per contract basis (so each futures revenue trade included to calculate DARTs represents a round-turn commissionable contract traded). It should be noted that all DARTs are not equal. The revenue we derive from each revenue trade depends on the asset in question (equities, equity options, futures, forex – each has a different per unit revenue structure), and, within each asset class, revenue per equity, contract or deal varies to the extent higher volume traders receive more favorable pricing, which they often do.

TradeStation Technologies, the company’s other operating subsidiary, owns all of our intellectual property. TradeStation Technologies also provides subscription services for TradeStation. The subscription version of TradeStation is an institutional-quality service that offers strategy trading software tools that generate real-time buy and sell alerts based upon the subscriber’s programmed strategies, but does not include order execution. Subscribers are charged a monthly subscription fee.

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We also have a United Kingdom subsidiary, TradeStation Europe Limited, which is currently in its start-up phase. In February 2006, TradeStation Europe became authorized by the United Kingdom’s FSA to act as a Securities and Futures Firm in the United Kingdom to introduce accounts to TradeStation Securities. The FSA category of authorization is “ISD Category D Arranger,” meaning that TradeStation Europe may now solicit and introduce UK clients who are active, experienced traders to its US affiliate for equities, options, futures and forex account services. In February 2007, TradeStation Europe obtained its European “passport” pursuant to which the company may use its FSA authorization to qualify to conduct similar business throughout the European Union.

Critical Accounting Policies and Estimates

Our significant accounting policies are described in Note 2 of Notes to Consolidated Financial Statements included in this report – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Brokerage Commissions and Fees and Net Interest Income. Brokerage commissions and fees and net interest income are the key components of our results of operations and are comprised mainly of: (i) brokerage commissions and fees earned from securities, futures and forex transactions and, to a lesser extent, monthly platform fees earned from brokerage customers using the TradeStation online trading platform; and (ii) net interest earned and paid from self-clearing operations (primarily interest earned on brokerage customer cash balances and interest earned from brokerage customer margin debit balances), interest revenue sharing arrangements with clearing agent firms, and interest on corporate cash and cash equivalents. Brokerage commission income and related clearing costs are recorded on a trade date basis as transactions occur. Platform fees are recorded on an accrual basis as monthly services are provided. Interest revenue and interest expense are recorded on an accrual basis as interest is earned or incurred.

Income Taxes. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 109, Accounting for Income Taxes, deferred income tax assets should be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Management evaluates and determines on a periodic basis the amount of the valuation allowance required and adjusts the valuation allowance as needed. As of December 31, 2006 and 2005, we had no valuation allowance on our deferred income tax assets. In June 2004, we reversed approximately $8.4 million of the valuation allowance that was provided on our deferred income tax assets and, in December 2005, we reversed the remaining valuation allowance of $926,500. In the opinion of management, it was more likely than not that these benefits would be realized. The result of the approximately $8.4 million reversal was a reduction of $5.3 million to the 2004 income tax provision in the consolidated statement of income and a $3.1 million credit to additional paid-in capital (relating to the tax benefit of stock option exercises). The result of the $926,500 reversal was a reduction to the 2005 income tax provision recorded in the consolidated statement of income. The 2004 decision to reverse approximately $8.4 million of the valuation allowance was triggered by events which revised our expectations of the amount of future taxable income. These events included receipt of the final approval by the DTCC for TradeStation Securities to begin self-clearing for equities, the rollout of TradeStation 8 (which included integrated options execution), as well as eight consecutive quarters of income

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from operations at the end of the 2004 second quarter. The 2005 decision to reverse the remaining portion of the valuation allowance was triggered by our continued profitability and the accelerated growth of our income before income taxes during the last four years, as well as the expectation that we will continue to have income before income taxes in future years. On a periodic basis, we will continue to evaluate our remaining deferred income tax assets to determine if a valuation allowance is required.

Allowance for Potential Credit Losses. We perform periodic credit evaluations and provide allowances based upon our assessment of specifically identified unsecured receivables and other factors, including the customer’s likelihood to pay and payment history. As of December 31, 2005, we had an allowance for a potential credit loss of $226,000. There was no allowance as of December 31, 2006, since we collected $200,000 and wrote-off the balance of this receivable (mostly accrued interest) against this reserve during the first quarter of 2006. See Note 4 of Notes to Consolidated Financial Statements – RECEIVABLES FROM BROKERAGE CUSTOMERS, NET, and Note 15 – COMMITMENTS AND CONTINGENCIES – General Contingencies and Guarantees.

Uninsured Loss Reserves. We decided, as of June 1, 2002, to no longer carry errors or omissions insurance that covers third-party claims made by brokerage customers or software subscribers as a result of alleged human or system errors, failures, acts or omissions. This decision was made based upon our assessment of the potential risks and benefits, including significant increases in premium rates, deductibles and coinsurance amounts, reductions in available per occurrence and aggregate coverage amounts, and the unavailability of policies that sufficiently cover the types of risks that relate to our business. We recently reviewed this insurance with insurance agents and our view remains unchanged. Each quarter, we continue to evaluate our accruals, if any, for settlements related to claims and potential claims. Estimates of settlements for such potential claims, including related legal fees, are accrued in the consolidated financial statements, as necessary. During 2006, the Gambino case was settled and was not material to our results of operations. During 2005, we recorded approximately $300,000 of expenses primarily as a result of the final resolution of two unreserved customer claims (one an arbitration award, one a settlement) initiated in prior periods. During 2004, we reversed $569,000 of our accruals ($500,000 of accrued settlements and $69,000 of accrued legal fees) related to a third-party claim which had been inactive for over one year (and has remained inactive). See “Expenses – Other” in both “Years Ended December 31, 2006 and 2005” and “Years Ended December 31, 2005 and 2004.” We have not created any uninsured loss reserves for any of the lawsuits or arbitrations described in Item 3 – Legal Proceedings, or to which the company is otherwise subject.

Results of Operations

For the three years ended December 31, 2006, we operated in two principal business segments: (i) brokerage services; and (ii) software products and services. The brokerage services segment primarily represents the operations of TradeStation Securities and the software products and services segment represents the operations of TradeStation Technologies. We ceased marketing our legacy software products and subscription software services in 2000. As a result, our primary sources of consolidated revenue are currently generated from the brokerage services segment, and the brokerage services segment should continue to produce the majority of our revenues for the foreseeable future. For the years ended December 31, 2006, 2005 and 2004, the brokerage services segment accounted for approximately 92%, 89% and 86%, respectively, of our total consolidated net revenues. For the years ended December 31, 2006, 2005 and 2004, approximately 56%, 60% and 62%, respectively, of net revenue from the brokerage services segment was derived from equities and standardized equity option accounts. Conversely, for the years ended December 31, 2006,

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2005, and 2004, approximately 44%, 40% and 38%, respectively, of net revenue from the brokerage services segment was derived from futures and forex accounts. Given the size of the percentage of revenue from the brokerage services segment, other than our discussion and table in Note 16 – SEGMENT AND RELATED INFORMATION, we will discuss our results of operations for the overall company instead of on a segmented basis. See also Note 17 of Notes to Consolidated Financial Statements - UNAUDITED QUARTERLY FINANCIAL INFORMATION, for quarterly unaudited financial information for fiscal years 2006 and 2005. The following table summarizes our consolidated statements of income data and presentation of that data as a dollar change and percentage of change from period to period:

Years Ended December 31, 2006 and 2005

Net revenues were $128.5 million for the year ended December 31, 2006, as compared to $97.0 million for the year ended December 31, 2005, an increase of $31.5 million, or 33%. The primary reasons for this growth were increased net interest income of $19.0 million, or 90%, as a result of higher interest rates, higher aggregate cash and margin balances and a full year of a more favorable interest-sharing arrangement with our futures clearing firm, and a $12.9 million, or 20%, increase in brokerage commissions and fees as a result of higher trade volume related mostly to growing our brokerage account base, partially offset by a decrease in other revenues.

Income before income taxes was $50.0 million (39% of net revenues) for the year ended December 31, 2006, as compared to $32.5 million (34% of net revenues) for the year ended December 31, 2005, an increase of $17.5 million, or 54%. Our improvement in income before income taxes was due primarily to our increased net interest income of $19.0 million and our increased brokerage commissions and fees of $12.9 million, partially offset by increased employee compensation and benefits of $6.4 million and increased clearing and execution costs of $6.0 million. The increase in our income before income taxes margin from 34% to 39% was due primarily to our increased net interest income.

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During the year ended December 31, 2006, we recorded an income tax provision of $19.0 million or 38% of our income before income taxes, as compared with $11.5 million or 35% of our income before income taxes during the year ended December 31, 2005. In 2005, our effective income tax rate of approximately 38% was partially offset by the reversal of the remaining $926,500 of our valuation allowance on our deferred income tax assets. See “Income Taxes” below.

Net income was approximately $31.0 million for the year ended December 31, 2006, as compared to approximately $21.0 million for the year ended December 31, 2005, an increase of approximately $10.0 million, or 47%, due primarily to our 33% year-over-year increase in net revenues and the increase of our income before income taxes margin from 34% to 39%, partially offset by a higher effective tax rate in 2006.

Revenues

Brokerage Commissions and Fees – Brokerage commissions and fees are comprised mainly of commissions for securities, futures and forex transactions and, to a lesser extent, monthly platform and other fees earned from brokerage customers using the TradeStation online trading platform. For the year ended December 31, 2006, brokerage commissions and fees were approximately $78.8 million, as compared to approximately $66.0 million for the year ended December 31, 2005. This $12.9 million, or 20%, increase was due primarily to increased brokerage commissions of $14.2 million from higher trading volume related mostly to growing our brokerage customer account base, partially offset by reduced futures commission pricing, and by a decrease in platform and other fees of $1.3 million as a result of reduced trading activity thresholds required to qualify for a waiver of our monthly platform fee, which was discussed in more detail in the “Overview” portion of this discussion. The industry has been experiencing price pressure and some of our competitors continue to reduce their online brokerage commissions and fees. One of our competitors recently launched a commission-free plan to a certain segment of its accounts. We continuously review and assess our pricing – both commissions and platform fees. Our most recent marketing initiative, effective November 1, 2006, to reduce further the trading activity threshold required to qualify for a waiver of the monthly platform fee, assuming no benefits from additional account growth or trading, was a decrease in monthly revenues of approximately $100,000 and monthly net income by approximately $62,000. No assurances can be given that material offsetting benefits have been or will be achieved.

Interest Income – Interest income is comprised of interest earned from self-clearing operations (primarily interest earned on brokerage customer cash balances and interest earned from brokerage customer margin debit balances), interest revenue-sharing arrangements with clearing agent firms, and interest on corporate cash and cash equivalents and marketable securities. For the year ended December 31, 2006, interest income was $44.6 million as compared to $24.5 million for the year ended December 31, 2005. This $20.1 million, or 82%, increase was due primarily to increased interest rates, a full year of a more favorable interest income-sharing arrangement with our futures clearing agent and increased base margin debit interest rates and increased balances from account growth. During 2005, the federal funds target rate of interest was increased eight times, from 2.25% to 4.25%. During the first half of 2006, the federal funds target rate of interest was increased by 25 basis points four times, from 4.25% to 5.25% (where it remains as of December 31, 2006 and through the date of this report). These increases resulted in increases in the amounts we earned

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on our clients’ cash account balances and the amounts we charged our customers for margin lending. During the year ended December 31, 2006, the weighted average federal funds target rate of interest was approximately 4.96%, an increase of 177 basis points, or 55%, as compared with the weighted average rate of 3.19% for the same period in 2005. Also, during the year ended December 31, 2006, the weighted average interest rate from income-sharing revenue earned from our futures clients was approximately 4.71%, an increase of 245 basis points, or 108%, as compared with the weighted average rate of 2.26% for the same period in 2005. During the year ended December 31, 2006, the weighted average base margin debit rate that we charged our customers was 8.19%, which was 79 basis points, or 11% higher than the weighted average rate of 7.40% that we charged to our customers during the same period of 2005. Interest income for future periods may be materially affected by further increases, “no actions” or decreases regarding the federal funds target rate and the extent, if any, by which our customer cash account balances increase or decrease, as well as any decisions we may make to provide more or less favorable debit or credit interest rates to our customers.

Brokerage Interest Expense – Brokerage interest expense consists of amounts paid or payable to brokerage customers based on credit balances maintained in brokerage accounts and other brokerage-related interest expense. Brokerage interest expense does not include interest on company borrowings, which, if any, would be included in Expenses – Other Expenses below. For the year ended December 31, 2006, brokerage interest expense was $4.6 million, as compared to $3.5 million for the year ended December 31, 2005. This $1.1 million, or 32%, increase was due primarily to account growth and increased interest rates. During 2006, the average annual credit interest rate paid to our customers was approximately 1.19%, as compared to 1.00% during 2005. As of December 31, 2006 and through the date of this report, our equities customers earn interest at the rate of 1.25% per annum on the portion, if any, of their cash balances in excess of $10,000, and futures and forex customers earn no interest on their cash balances. Factors that will affect brokerage interest expense in the future include: the growth and mix of growth of our brokerage customer base in equities, futures and forex; average assets per account and the portion of account assets held in cash; and future decisions concerning credit or debit interest rates offered to our equities, futures and forex customers.

Subscription Fees – Subscription fees are primarily comprised of monthly fees earned for providing streaming real-time, Internet-based trading analysis software tools and data services to non-brokerage customers. Subscription fees were approximately $8.6 million for the year ended December 31, 2006, as compared to approximately $8.1 million for the year ended December 31, 2005, an increase of $464,000 or 6%. This increase in subscription fees was due to a monthly price increase, effective May 1, 2006, of approximately $50. The increase in price was partially offset by a decrease in the number of subscribers. The continued impact, if any, of this price increase will depend upon how many customers terminate their subscription service or do not buy new subscriptions as a result of the price increase, and how many (if any) decide to become brokerage customers instead of continuing their subscriptions.

Other – Other revenues consist primarily of royalties and commissions received from third parties whose customers use our legacy software products and, to a lesser extent, fees for our training workshops that help customers take full advantage of the state-of-the-art features of the TradeStation electronic trading platform, direct sales of our legacy customer software products and revenues from user conferences that highlights strategy testing. Other revenues were approximately $1.2 million for the year ended December 31, 2006, as compared to approximately $1.9 million for the year ended December 31, 2005, a decrease of $768,000, or

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39%. This decrease was due primarily to a $539,000 decrease in royalties and commissions received from third parties and a $312,000 decrease in revenue from our 2005 users conference (not held in 2006), partially offset by increased revenues from training workshops. The decrease in royalties is the result of not having marketed legacy customer software products since 2000. We expect royalties and commissions from third parties to continue to decrease and to reach a de minimus amount in 2007.

Expenses

Employee Compensation and Benefits – Employee compensation and benefits expenses are comprised primarily of employee salaries, sales commissions and bonuses (and, beginning in 2006, stock-based compensation) and, to a lesser extent, payroll taxes, employee benefits (including group health insurance and employer contributions to benefit programs), recruitment, temporary employee services and other related employee costs. Employee compensation and benefits expenses were $29.4 million for the year ended December 31, 2006, as compared to $23.0 million for the year ended December 31, 2005, an increase of $6.4 million, or 28%. This increase was due primarily to increases in wages paid to employees of $2.5 million, stock-based compensation of $1.8 million, sales commissions of $852,000, accrued bonus of $400,000, and, to a lesser extent, increases in employee benefits, recruitment and related expenses, and payroll taxes. The increase in wages was due primarily to our annual salary merit increases (effective January 2006) and increased headcount. During the year ended December 31, 2006, there was an average of 284 full-time equivalent employees as compared to 263 full-time equivalent employees during the year ended December 31, 2005. At December 31, 2006, there were 302 full-time equivalent employees as compared to 266 full-time equivalent employees at December 31, 2005. Employee compensation and benefits expenses are anticipated to increase during 2007 due to annual merit increases and planned additions to employee headcount to support the anticipated growth of our business. For further discussion of stock-based compensation expense, see Recently Issued Accounting Standards below.

Clearing and Execution – Clearing and execution expenses include the costs associated with executing and clearing customer trades, including, fees paid to clearing agents and clearing organizations, exchanges and other market centers, fees and royalties paid for the licensing of self-clearing, back-office software systems and related services, and commissions paid to third-party broker-dealers. Clearing and execution expenses were approximately $26.1 million for the year ended December 31, 2006, as compared to $20.1 million for the year ended December 31, 2005, an increase of $6.0 million or 30%, as a result of higher trade volume. Clearing and execution costs as a percentage of brokerage commissions and fees increased to 33% during 2006, as compared to 30% during 2005. This increase in clearing and execution expenses, as a percentage of brokerage commissions and fees, was due primarily to lower platform fees as a result of reduced trading activity thresholds that needed to be met to qualify for a waiver of the monthly platform fee, a new futures brokerage commission structure that rewards more active traders with lower pricing, and a change in mix (i.e., futures versus equities) to lower margin trades, partially offset by the benefits received from self-clearing of equity option trades for the entire twelve-month period in 2006 (as opposed to three quarters in the same period of 2005) and the continued benefits of equities self-clearing and reduced clearing fee rates for futures.

Data Centers and Communications – Data centers and communications expenses are comprised of: (i) data communications costs necessary to connect our server farms directly to electronic marketplaces, data sources and to each other; (ii) data communications costs and rack space at our facilities where the data server farms are located; (iii) data distribution and exchange fees; and (iv) telephone, internet and other communications costs. Data centers and communications expenses were approximately

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$6.5 million for the year ended December 31, 2006, as compared to $5.7 million for the year ended December 31, 2005, an increase of $739,000, or 13%. This increase is due primarily to increased bandwidth charges and rack space at our server farms of $370,000, increased server maintenance related to our data server upgrades of $201,000, and, to a lesser extent, increased circuits to connect our data farms to data providers and electronic marketplaces and other communications costs. We anticipate data centers and communications to increase during 2007 due to the recent expanded capacity at our data server farms.

Advertising – Advertising expenses are comprised of marketing programs, primarily: advertising in various media, including direct mail, television and print media; account opening kits, including postage; brochures; and other promotional items, including exhibit costs for industry events. Advertising expenses for the year ended December 31, 2006 were $4.3 million, as compared to $3.8 million for the year ended December 31, 2005, an increase of $485,000, or 13%, due primarily to increased media placement during 2006. The quality and success of, and potential continuous changes in, sales or marketing strategies (which continue to evolve) are factors that may impact the level of advertising in the future.

Professional Services – Professional services expenses are comprised of fees for legal, accounting, tax, and other professional and consulting services. Professional services expenses were $3.4 million for the year ended December 31, 2006, as compared to $3.0 million for the year ended December 31, 2005, an increase of $424,000, or 14%, due primarily to increased legal fees, accounting fees and increased use of consultants.

Occupancy and Equipment – Occupancy and equipment expenses include rent, utilities, property taxes, repairs, maintenance and other expenses pertaining to our office space. Occupancy and equipment expenses were $2.5 million for the year ended December 31, 2006, as compared to $2.6 million for the year ended December 31, 2005, a decrease of $92,000, or 3%, due primarily to the reversal of most of the allowance established for a sub-tenant in default and partially offset by the increase in rent due primarily to our new offices in Chicago and London.

Depreciation and Amortization – Depreciation and amortization expenses consist primarily of depreciation on property and equipment and, to a lesser extent, amortization of intangible assets. Depreciation and amortization expenses were $2.5 million for the year ended December 31, 2006, as compared to $1.8 million for the year ended December 31, 2005, an increase of $737,000, or 42%. This increase was due primarily to higher depreciation of fixed assets related to an increase in the amount of capital expenditures in 2006. During 2006, we had capital expenditures of $8.1 million, as compared to $1.9 million in 2005. The 2006 capital expenditures were mostly computer hardware to support the growth of our data server farms and, to a lesser extent, fixed assets and leasehold improvements related to our Chicago office and an upgrade to our telephone and recording systems. We anticipate depreciation expense to continue to increase during 2007 due to recent hardware and software purchases (many of which were put into service during the fourth quarter of 2006) for our data server farms – which we deem necessary to support the growth in our business and to enhance and improve the quality and reliability of our brokerage services.

Other – Other expenses include insurance, regulatory fees and related costs, employee travel and entertainment, settlements for legal matters, costs related to our users conference and training workshops, software maintenance, public company expenses, supplies, postage, exchange memberships, customer debits and errors, bank charges and other administrative expenses. Other expenses were

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$3.9 million for the year ended December 31, 2006, as compared to $4.4 million for the year ended December 31, 2005, a decrease of $561,000, or 13%. This decrease was due primarily to $343,000 of expenses from our user conference held in 2005 (not held in 2006), decrease of $232,000 related to settlements, decreased customer debits and errors of $209,000, and a decrease in insurance of $145,000, partially offset by increases in software maintenance of $157,000, travel and entertainment of $134,000, and a gain from an exchange membership (recorded in 2005). The decrease in customer debits and errors was due primarily to the collection, in 2006, of $200,000 of a receivable from a brokerage customer, previously considered uncollectible and fully reserved. The decrease in settlements was primarily related to expenses recorded in 2005 for the final resolution of two unreserved customer claims (one an arbitration award, one a settlement) initiated in prior periods.

Years Ended December 31, 2005 and 2004

Net revenues were $97.0 million for the year ended December 31, 2005, as compared to $72.3 million for the year ended December 31, 2004, an increase of $24.7 million, or 34%, due to increases in net interest income of $15.3 million, or 271%, and increases in brokerage commissions and fees of approximately $9.5 million, or 17%, partially offset by slight decreases in subscription fees and other revenues.

Income before income taxes was $32.5 million (34% of net revenues) for the year ended December 31, 2005, as compared to $14.8 million (20% of net revenues) for the year ended December 31, 2004, an increase of $17.7 million, or 120%. This improvement was due primarily to increased net revenues (primarily net interest income and brokerage commissions and fees) and improved margins related to the self-clearing of equities and options, partially offset by increases in employee compensation and benefits, advertising, professional services and other expenses.

During the year ended December 31, 2005, we recorded an income tax provision of $11.5 million as compared to approximately $119,000 for the year ended December 31, 2004. In 2005, our effective income tax rate of 38% was partially offset by the reversal of the remaining $926,500 of our valuation allowance on our deferred income tax assets. In 2004, our effective income tax rate of approximately 38% was mostly offset by the reversal of a significant portion of our valuation allowance on our deferred income tax assets. Given that in 2005 our effective income tax rate was approximately 35.2%, as compared to an effective rate of less than 1% in 2004, we believe that income before income taxes is a more meaningful year-over-year comparison. See “Income Taxes” below.

Revenues

Brokerage Commissions and Fees – Brokerage commissions and fees were approximately $66.0 million for the year ended December 31, 2005, as compared to $56.5 million for the year ended December 31, 2004. This approximate $9.5 million, or 17%, increase was due primarily to brokerage customer account growth and the related increase in trading activity.

Interest Income – Interest income was $24.5 million for the year ended December 31, 2005 as compared to $6.4 million for the year ended December 31, 2004. This $18.1 million, or 285%, increase was due primarily to the self-clearing of equities for our active trader client base (which commenced in September 2004), account growth and increased interest rates. During 2005, the federal funds target rate of interest was increased by 25 basis points eight times, from 2.25% to 4.25%. These increases resulted in increases in the amounts we earned on our client’s cash account balances (net of the amount, if any, of interest paid to the clients on such balances). Also, during 2005 we increased the base margin debit interest rate that we charge our customers from 6.375% in January 2005 to 8.125% by August 2005.

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Brokerage Interest Expense – Brokerage interest expense was $3.5 million for the year ended December 31, 2005, as compared to $710,000 for the year ended December 31, 2004. This $2.8 million, or 395%, increase was due primarily to a full year of brokerage interest expense related to the self-clearing of equities (which commenced in September 2004), account growth and increased interest rates. During 2005, the average credit annual interest rate paid to our customers was approximately 1.00%, as compared to 0.75% during 2004. As of December 31, 2005, our equities customers earn interest at the rate of 1.125% per annum on the portion, if any, of their cash balances in excess of $10,000, and futures and forex customers earn no interest on their cash balances.

Subscription Fees – Subscription fees were approximately $8.1 million during both the year ended December 31, 2005 and 2004. Subscription services have not been actively marketed since December 2000.

Other – Other revenues were approximately $1.9 million for the year ended December 31, 2005, as compared to approximately $2.0 million for the year ended December 31, 2004, a decrease of $40,000, or 2%. This decrease was due primarily to lower royalties of $140,000, partially offset by increases in fees earned from training workshops and a user conference. The expected decrease in royalties is the result of not having marketed legacy customer software products since May 2000 and not having offered those products domestically since September 2001.

Expenses

Employee Compensation and Benefits – Employee compensation and benefits expenses were $23.0 million for the year ended December 31, 2005, as compared to $20.3 million for the year ended December 31, 2004, an increase of $2.7 million, or 13%. This increase was due primarily to increased wages to employees and commissions paid to sales representatives, and a higher number of employees in 2005. During the year ended December 31, 2005, there was an average of 263 full-time equivalent employees as compared to 247 full-time equivalent employees during the year ended December 31, 2004.

Clearing and Execution – Clearing and execution expenses were approximately $20.1 million for the year ended December 31, 2005, as compared to $18.9 million for the year ended December 31, 2004, an increase of $1.2 million or 6%. Clearing and execution costs as a percentage of brokerage commissions and fees improved to 30% during 2005, as compared to 33% during 2004. This improvement in clearing and execution expenses, as a percentage of brokerage commissions and fees, was due primarily to the benefits received from self-clearing of equities trades for our active trader client base during all of 2005, as compared to only the last four months of 2004, and reduced clearing fee rates for futures, partially offset by a change in mix to a higher percentage of lower-margin trades.

Data Centers and Communications – Data centers and communications expenses were $5.7 million for the year ended December 31, 2005, as compared to $5.9 million for the year ended December 31, 2004, a decrease of $191,000, or 3%. This decrease is due primarily to $308,000 of lower rent and bandwidth charges at our server farms, and $284,000 of lower data distribution and exchange fees, partially offset by $388,000 of increased circuits to connect our data farms to data providers and electronic marketplaces.

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Advertising – Advertising expenses were $3.8 million for the year ended December 31, 2005, as compared to $2.7 million for the year ended December 31, 2004, an increase of $1.1 million, or 40%, due primarily to increased media placement during 2005.

Professional Services – Professional services expenses were $3.0 million for the year ended December 31, 2005, as compared to $2.4 million for the year ended December 31, 2004, an increase of $573,000, or 24%, due primarily to increased legal fees.

Occupancy and Equipment – Occupancy and equipment expenses were $2.6 million for the year ended December 31, 2005, as compared to $2.5 million for the year ended December 31, 2004, an increase of $171,000, or 7%, due primarily to increased rent and related operating expenses.

Depreciation and Amortization – Depreciation and amortization expenses were $1.8 million for the year ended December 31, 2005, as compared to $2.0 million for the year ended December 31, 2004, a decrease of $208,000, or 11%. This decrease was due primarily to lower depreciation of fixed assets and amortization of intangible assets.

Other – Other expenses were $4.4 million for the year ended December 31, 2005, as compared to $2.7 million for the year ended December 31, 2004, an increase of $1.7 million, or 61%. This increase was due primarily to a $670,000 increase in expenses related to dispute resolutions (other than legal fees), increased customer debits and errors of $236,000, increased taxes - other than income taxes of $235,000, increased insurance of $229,000, increased exchange memberships of $134,000, increased bank charges of $99,000, and net increases in other expenses of $71,000. The increase in expenses related to dispute resolutions was due primarily to a 2004 reversal of an uninsured loss provision of $500,000 for a third party-claim which was inactive for over one year (and has remained inactive) and an increase of $170,000 in dispute resolution expenses (other than legal fees) during the year ended December 31, 2005. The increases in insurance, exchange memberships and bank charges are all related to having in 2005, as compared to 2004, a full year of self-clearing operations for our active trader client base. The increase in taxes - other than income taxes was due primarily to a 2004 reduction in expenses related to a favorable outcome of an audit of prior years’ state sales taxes.

Income Taxes

During the year ended December 31, 2006, we recorded an income tax provision of $19.0 million or 38% of our income before income taxes, as compared with $11.5 million or 35% of our income before income taxes during the year ended December 31, 2005. In 2005, our effective income tax rate of approximately 38% was partially offset by the reversal of the remaining $926,500 of our valuation allowance on our deferred income tax assets. During the year ended December 31, 2004, we recorded an income tax provision of $119,000. In 2004, our effective income tax rate of approximately 38% was mostly offset by the reversal of a significant portion of our valuation allowance on our deferred income tax assets.

In June 2004, we reversed approximately $8.4 million of the valuation allowance that was provided on our deferred income tax assets and, in December 2005, reversed the remaining valuation allowance of $926,500. In the opinion of management, it was more likely than not that these benefits would be realized. In accordance with SFAS No. 109, deferred income tax assets should be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred income tax assets will not be realized. On a periodic basis, management evaluates and determines the amount of the valuation allowance required and adjusts such valuation allowance accordingly. The result of the approximately $8.4 million reversal was a reduction of $5.3 million to the 2004 income

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tax provision in the consolidated statement of income and a $3.1 million credit to additional paid-in capital (relating to the tax benefit of stock option exercises). The result of the $926,500 reversal was a reduction to the 2005 income tax provision recorded in the consolidated statement of income. The 2004 decision to reverse approximately $8.4 million of the valuation allowance was triggered by events which revised our expectations of the amount of future taxable income. These events included receipt of the final approval by the DTCC for TradeStation Securities to begin self-clearing for equities, the rollout of TradeStation 8 (which included integrated options execution), as well as eight consecutive quarters of income from operations. The 2005 decision to reverse the remaining $926,500 of the valuation allowance was triggered by our continued profitability and the accelerated growth of our income before income taxes during the last four years, as well as the expectation that we will continue to have income before income taxes in future years. On a periodic basis, we will continue to evaluate our remaining deferred income tax assets to determine if a valuation allowance is required.

As of December 31, 2006, for financial reporting purposes, the company had available for federal income tax purposes total net operating loss carryforwards and income tax credit carryforwards of approximately $2.5 million and $124,000, respectively. The net operating loss carryforwards expire in 2019 and the tax credits expire between 2010 and 2019. These amounts are subject to annual usage limitations of approximately $545,000. These limitations are cumulative to the extent they are not utilized in any year.

In September 2006, a letter from the Internal Revenue Service was received notifying us that our federal income tax return for the year ended December 31, 2004 has been selected for examination. We believe this examination, which is currently in progress, to be routine. While no assurances can be given, we believe that the results of this examination will not have a material impact on our consolidated financial position, results of operations or cash flows.

See Note 11 of Notes to Consolidated Financial Statements – INCOME TAXES.

Variability of Results

The operating results for any quarter are not necessarily indicative of results for any future period or for the full year. Our quarterly revenues and operating results have varied in the past, and are likely to vary in the future. Such fluctuations are likely to result in volatility in the price of our common stock. See Item 1A. Risk Factors, and Note 17 of Notes to Consolidated Financial Statements – UNAUDITED QUARTERLY FINANCIAL INFORMATION.

Liquidity and Capital Resources

As of December 31, 2006, we had cash and cash equivalents of approximately $74.5 million, of which $1.4 million was restricted, supporting a facility lease. On January 3, 2007, as a result of TradeStation Securities’ December 31, 2006 month-end calculation under Rule 15c3-3 of the Securities Exchange Act of 1934 (see below), $7.6 million of the $417.5 million of cash segregated in compliance with federal regulations shown on our consolidated balance sheet at December 31, 2006 was transferred to cash and cash equivalents. We have marketable securities of approximately $9.3 million at December 31, 2006, the majority of which can be tendered for sale upon notice (generally no longer than seven days) to the remarketing agent. See Note 2 of Notes to Consolidated Financial Statements – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Marketable Securities.

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As of December 31, 2006, TradeStation Securities had: $417.5 million of cash segregated in compliance with federal regulations in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934 and other regulations; receivables from brokerage customers of $77.0 million; and receivables from brokers, dealers, clearing organizations and clearing agents of $34.9 million. Client margin loans are demand loan obligations secured in part by cash and/or readily marketable securities. Receivables from and payables to brokers, dealers, clearing organizations and clearing agents represent primarily current open transactions, which usually settle, or can be closed out, within a few business days.

Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in brokerage client accounts, which were $516.4 million at December 31, 2006. Management believes that brokerage cash balances and operating earnings will continue to be the primary source of liquidity for TradeStation Securities in the future.

TradeStation Securities is subject to the net capital requirements of the SEC’s Uniform Net Capital Rule (Rule 15c3-1) and the CFTC’s financial requirement (Regulation 1.17). TradeStation Securities calculates net capital requirements using the “alternative method,” which requires the maintenance of minimum net capital, as defined by the rules, equal to the greater of (i) $250,000 and (ii) 2.0% of aggregate customer debit balances. Customer debit items are a function of customer margin receivables and may fluctuate significantly, resulting in a significant fluctuation in our net capital requirements. At December 31, 2006, TradeStation Securities had net capital of approximately $56.1 million (47.4% of aggregate debit items), which was approximately $53.7 million in excess of its required net capital of approximately $2.4 million.

In addition to net capital requirements, as a self-clearing broker-dealer TradeStation Securities is subject to DTCC, OCC, and other cash deposit requirements, which are and may continue to be large in relation to TradeStation Group’s total liquid assets, and which may fluctuate significantly from time to time based upon the nature and size of TradeStation Securities’ active trader clients’ securities trading activity. As of December 31, 2006, we had interest-bearing security deposits and short-term treasury bills totaling $20.2 million with clearing organizations for the self-clearing of equities and standardized equity option trades.

As of December 31, 2006, we have no long-term debt obligations or capital lease obligations. A summary of our operating lease obligations (net of subleases) and minimum purchase obligations (related to back-office systems and telecommunications services) is as follows:

In addition to the purchase obligations set forth in the table above, we currently anticipate, in order to provide for additional growth of our brokerage business (there being no assurance additional growth will occur), capital expenditures of up to $3.5 million in 2007 (primarily for the purchase of computer hardware and software to support the growth of our data server farms and back-office systems to support our business). These expenditures are expected to be funded through operating cash flows, capital leases, or a combination of the two.

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In October 2006, our board of directors authorized, and we announced, the use of up to $60 million of our available and unrestricted cash, over a four-year period, to repurchase shares of our common stock in the open market or through privately-negotiated transactions. The stock repurchases are authorized to be made pursuant to a Rule 10b5-1 plan. The four-year period commenced on November 13, 2006 and ends on November 12, 2010. Pursuant to the buy back plan, $1,250,000 of company cash during each full calendar month (and prorated amount during the first and last months) of the four-year period (i.e., $15 million per 12-month period and $60 million for the four-year period) has been authorized to be used to purchase company shares at prevailing prices, subject to compliance with applicable securities laws, rules and regulations, including Rules 10b5-1 and 10b-18. The buy back plan does not obligate us to acquire any specific number of shares in any period, and may be modified, suspended, extended or discontinued at any time without prior notice.

During the year ended December 31, 2006, we used approximately $2.0 million to purchase 139,400 shares of our common stock at an average price of $14.34 per share. All shares purchased have been retired. See Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES – Share Repurchases.

We anticipate that our available cash resources and cash flows from operations will be sufficient to meet our presently anticipated working capital and capital expenditure requirements through at least the next twelve months.

Cash provided by operating activities totaled approximately $13.9 million, $37.9 million and $515,000 during the years ended December 31, 2006, 2005 and 2004, respectively. During the year ended December 31, 2006, net cash provided by operating activities of $13.9 million was due primarily to net income and adjustments for non-cash items, partially offset by timing differences related to an increase in net brokerage customer assets and liabilities (excluding deposits with clearing organizations) including timing differences related to funding cash segregated in compliance with federal regulations (on January 3, 2007, $7.6 million was transferred to Cash and cash equivalents from Cash segregated in compliance with federal regulations), and increases in deposits with clearing organizations. During 2005, net cash provided by operating activities of $37.9 million came primarily from net income as adjusted for non-cash items and, to a lesser extent, a decrease in net brokerage customer assets and liabilities (excluding deposits with clearing organizations) including timing differences related to funding cash segregated in compliance with federal regulations (on January 4, 2006, $9.5 million was transferred from Cash and cash equivalents to Cash segregated in compliance with federal regulations), a decrease in deposits with clearing organizations, and an increase in accrued expenses and accounts payable. During 2004, net cash provided by operating activities came primarily from net income, as adjusted for non-cash items, partially offset by net cash outflows associated with the commencement of self-clearing operations during September 2004, including $14.5 million of deposits paid to clearing organizations.

Investing activities used cash of $17.2 million and $1.5 million during the years ended December 31, 2006 and 2005, respectively, and provided cash of $450,000 during the year ended December 31, 2004. During the year ended December 31, 2006, investing activities were primarily for the purchase of marketable securities of $10.3 million and for capital expenditures (mostly

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computer hardware to support the growth of our data server farms and, to a lesser extent, fixed assets and leasehold improvements related to our Chicago office and an upgrade to our telephone and recording systems) of $8.1 million, partially offset by proceeds from the redemption of marketable securities of $1.0 million and to a lesser extent, a decrease in restricted cash. During 2005, investing activities used cash of $1.5 million primarily for capital expenditures (mostly computer hardware to support the growth of our data server farms) of $1.9 million, partially offset by $148,000 of proceeds from an exchange membership transaction and a $239,000 decrease in restricted cash. During 2004, investing activities provided cash of $450,000 due to $2.0 million of proceeds from the maturity of marketable securities and a $239,000 decrease in restricted cash, partially offset by capital expenditures of $1.4 million (mostly computer hardware and software for our data server farms and our back-office systems to support the growth of our business) and $415,000 paid for the acquisition of exchange membership seats.

Financing activities provided cash of $2.9 million, $6.8 million and $900,000 during the years ended December 31, 2006, 2005 and 2004, respectively. Proceeds from the issuance of common stock related to the exercise of stock options from our incentive stock plan, and purchases under our employee stock purchase plan, provided cash of $2.5 million, $6.8 million and $1.1 million during 2005, 2004 and 2003, respectively. During 2006, excess tax benefits from stock-based compensation provided cash of $2.3 million and the repurchase and retirement of common stock used cash of $2.0 million during 2006. During 2005 and 2004, repayments of capital lease obligations were $3,000 and $186,000, respectively.

Off-Balance Sheet Arrangements

In the ordinary course of business, there are various contingencies which are not reflected in the consolidated financial statements. These include customer activities involving the execution, settlement and financing of various customer securities and futures transactions. These activities may expose the company to off-balance sheet credit risk in the event the customers are unable to fulfill their contractual obligations.

Nearly all TradeStation Securities customer accounts are margin accounts. In margin transactions, TradeStation Securities may be obligated for credit extended to its customers by its clearing agents that are collateralized by cash and securities in the customers’ accounts with those clearing agents. In connection with securities activities, TradeStation Securities also executes customer transactions involving the sale of securities not yet purchased (“short sales”), all of which are transacted on a margin basis subject to federal, self-regulatory organization and individual exchange regulations and TradeStation Securities’ and its clearing agents’ internal policies. Additionally, TradeStation Securities may be obligated for credit extended to its customers by its clearing agents for futures transactions that are collateralized by cash and futures positions in the customers’ accounts with those clearing agents. In all cases, such transactions may expose TradeStation Securities to significant off-balance sheet credit risk in the event customer collateral is not sufficient to fully cover losses that customers may incur. In the event customers fail to satisfy their obligations, TradeStation Securities may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customers’ obligations.

TradeStation Securities seeks to manage the risks associated with its customers’ activities by requiring customers to maintain collateral in their margin accounts in compliance with various regulatory requirements, internal requirements, and the requirements of clearing agents. TradeStation Securities and its clearing agents monitor required margin levels on an intra-day basis and, pursuant to such guidelines, require the customers to timely deposit additional collateral or to reduce positions when necessary.

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TradeStation Securities provides guarantees to its clearing organization and exchanges under their standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing organization and exchanges, other members would be required to meet shortfalls. TradeStation Securities’ liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the possibility of the company being required to make payments under these arrangements is remote. Accordingly, no liability has been recorded for these potential events.

Recently Issued Accounting Standards

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also prescribes guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The cumulative effect of adopting FIN 48 is required to be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) in the year of adoption. We believe that the adoption of FIN 48, effective January 1, 2007, will not have a material impact on our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This statement addresses how to calculate fair value measurements required or permitted under other accounting pronouncements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim statements within those years. We believe that the adoption of SFAS No. 157 will not have a material impact on our consolidated financial position, results of operations or cash flows.

We adopted SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), effective January 1, 2006. SFAS 123R, which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of income based on their fair values. Pro forma disclosure is no longer an alternative. We have adopted the fair value provisions of SFAS 123R using the modified-prospective-transition method. Under the modified-prospective-transition method of adoption, compensation cost is recognized for all stock-based awards issued after the effective date, and for the portion of outstanding awards for which the requisite service has not yet been rendered (i.e., stock-based awards granted prior to the effective date, but not yet vested as of the effective date). Under this method of transition, results for prior periods are not restated. As a result of adopting SFAS 123R, the charge to income before income taxes for the year ended December 31, 2006 was $1.8 million of stock-based compensation included in employee compensation and benefits in our consolidated statement of income. The impact of adopting SFAS 123R was a reduction to net income for the year ended December 31, 2006 of $1.4 million. The impact of adopting SFAS 123R on both basic and diluted earnings per share for the year ended December 31, 2006 was a reduction of $0.03 per share.

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SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation costs to be reported as a financing cash flow, rather than as an operating cash flow as required under the previous literature. This requirement reduced net operating cash flows and increased net financing cash flows by approximately $2.3 million during the year ended December 31, 2006. See Note 9 of Notes to Consolidated Financial Statements – STOCK-BASED COMPENSATION for further information regarding our stock-based compensation assumptions and expenses.

We adopted SFAS No. 154, Accounting Changes and Error Corrections, effective January 1, 2006. SFAS No. 154, which is a replacement of APB Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements, provides guidance on accounting for, and reporting of, accounting changes and error corrections. It requires a voluntary change in accounting principle to be applied retrospectively to all prior periods’ financial statements as if the principle had always been applied. Previously, voluntary changes in accounting principles were required to be recognized by including the cumulative effect of changing to the new accounting principle in net income during the period of change. The adoption of SFAS No. 154 did not have any impact on our consolidated financial position, results of operations or cash flows.

We adopted the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements as of December 31, 2006. SAB No. 108 addresses the diversity in practice by registrants when quantifying the effect of an error on the financial statements. SAB No. 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements by requiring public companies to utilize a “dual-approach” when assessing the quantitative effects of financial misstatements. This dual approach includes both an income-statement-focused assessment and a balance-sheet-focused assessment. The adoption of the guidance in SAB No. 108 did not have a material impact on our consolidated financial position, results of operations or cash flows.

Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates or market prices. We have established policies, procedures and internal processes governing our management of market risks in the normal course of our business operations. We do not hold any market risk sensitive instruments for trading purposes.

TradeStation Securities seeks to manage the risks associated with our customers’ activities by requiring customers to maintain margin collateral and reduce concentrated positions in compliance with regulatory and internal guidelines. TradeStation Securities monitors required margin levels on an intra-day basis and, pursuant to such guidelines, requires customers to deposit additional collateral, or to reduce positions, when necessary.

As a self-clearing broker-dealer, TradeStation Securities holds interest-earning assets, mainly customer funds required to be segregated in compliance with federal regulations. These funds totaled $417.5 million at December 31, 2006. Interest-earning assets are financed primarily by short-term interest-bearing liabilities, which totaled $516.4 million at December 31, 2006, in the form of customer cash balances. In addition to earning interest on the customer funds segregated in compliance with federal regulations, TradeStation Securities earns a net interest spread on the difference between amounts earned on customer margin loans and amounts

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paid on customer cash balances. Since TradeStation Securities establishes the rate paid on customer cash balances and the rate charged on customer margin loans, a substantial portion of our interest rate risk is under our direct management. TradeStation Securities also earns interest from interest revenue-sharing arrangements with its clearing agents. We estimate that, based upon our brokerage customer balances at December 31, 2006, for each basis point increase or decrease in interest rates retained by the company there is an annual impact of approximately $44,000 to our net income.

Changes in interest rates also affect the interest earned on our cash and cash equivalents, marketable securities and security deposits. To reduce this interest rate risk, we are currently invested in investments with short maturities or investments that can be tendered for sale upon notice of no longer than seven days. As of December 31, 2006, our cash and cash equivalents consisted primarily of interest-bearing cash deposits and money market funds, our marketable securities consisted primarily of Federal tax-exempt variable rate demand note securities (see Note 2 of Notes to Consolidated Financial Statements – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES – Marketable Securities), and our security deposits consisted primarily of treasury bills and interest-bearing cash deposits. We estimate that, based upon the balances of our cash and cash equivalents, marketable securities and security deposits as of December 31, 2006, each basis point increase or decrease in interest rates, results in an annual impact of approximately $6,000 to our net income.

TradeStation Securities seeks to manage risks associated with its securities borrowing activities by requiring credit approvals for counterparties, by monitoring the collateral values for securities borrowed on a daily basis and by obtaining additional collateral as needed. See Note 15 of Notes to Consolidated Financial Statements – COMMITMENTS AND CONTINGENCIES – General Contingencies and Guarantees.

Our revenues and financial instruments are denominated in U.S. dollars, and we do not invest in derivative financial instruments.

The Consolidated Financial Statements and notes thereto and the reports of the independent registered public accounting firm set forth on pages F-1 through F-34 are filed as part of this report and incorporated herein by reference.

Not applicable.

As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the company’s disclosure controls and procedures was made under the supervision and with the participation of the company’s management, including the Chief Executive Officer and the Chief Financial Officer. Based on that evaluation, the company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the company’s disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this report. A system of controls, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the system of controls are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

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See pages F-2 through F-4 of the Consolidated Financial Statements for Management’s Report on Internal Control Over Financial Reporting and the related Report of Independent Registered Public Accounting Firm, each of which are filed as part of this report and incorporated herein by reference.

There have been no changes in the company’s internal control over financial reporting that occurred during the fourth quarter of 2006 that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

Not applicable.

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PART III

The information about Directors and Executive Officers required to be furnished pursuant to this item is incorporated by reference from our definitive proxy statement for our 2007 annual meeting of stockholders to be filed with the SEC pursuant to Regulation 14A within 120 days after December 31, 2006 (“2007 Proxy Statement”).

We have a Code of Ethics and Business Conduct that applies to all directors, officers and employees, including our principal executive officers, our principal financial and accounting officer, and our corporate controller. You can find our Code of Ethics and Business Conduct in the “Investor Relations” section of www.tradestation.com. We will post any amendments to the Code of Ethics and Business Conduct, and any waivers that are required to be disclosed by the rules of the SEC or any other regulatory agency, on that Web site.

The information required to be furnished pursuant to this item is incorporated by reference from our 2007 Proxy Statement.

The information required to be furnished pursuant to this item, with the exception of the equity compensation plan information presented below, is incorporated by reference from our 2007 Proxy Statement.

Equity Compensation Plan Information

The following sets forth information as of December 31, 2006 with respect to compensation plans under which the Company’s Common Stock is authorized for issuance:

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The information required to be furnished pursuant to this item is incorporated by reference from our 2007 Proxy Statement.

The information required to be furnished pursuant to this item is incorporated by reference from our 2007 Proxy Statement.

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PART IV

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

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TRADESTATION GROUP, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of TradeStation Group, Inc. and its subsidiaries (collectively, the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment, at the reasonable assurance level, of the effectiveness of internal control over financial reporting as of December 31, 2006. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Our management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based upon the criteria in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment in accordance with the criteria in Internal Control-Integrated Framework issued by COSO, our management has concluded that the Company’s internal control over financial reporting was effective at the reasonable assurance level as of December 31, 2006.

Our management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006, has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in its report which is included in these financial statements.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of TradeStation Group, Inc.

We have audited management’s assessment, included in the accompanying Management’s Report On Internal Control Over Financial Reporting, that TradeStation Group, Inc. and subsidiaries (collectively, “TradeStation Group”) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). TradeStation Group’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that TradeStation Group maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, TradeStation Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

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We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of TradeStation Group as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006 and our report dated March 8, 2007 expressed an unqualified opinion thereon.

Fort Lauderdale, Florida

    March 8, 2007.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of TradeStation Group, Inc.

We have audited the accompanying consolidated balance sheets of TradeStation Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of TradeStation Group, Inc. and subsidiaries as of December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 9 to the consolidated financial statements, in 2006 the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of TradeStation Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2007 expressed an unqualified opinion thereon.

Fort Lauderdale, Florida

    March 8, 2007.

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TRADESTATION GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS