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ETFs 201: How To Trade ETFs
Sponsored by:
SPEAKERS
Matt Hougan Chief Executive Officer
Inside ETFs
Will Wall Head Trader
Riverfront Investment Group
SPEAKER
SPEAKER
• Why Are We Here Today
• Back To Basics: Understanding On-Screen Trading
• Underlying Liquidity: How Big Trades Happen In Small ETFs
• The Matrix of ETF Trading
• Practicum: Strategies for Execution
Agenda
Why Are We Here Today?
“I can’t buy an ETF that trades less than 100,000 shares a day!”
“I don’t want to be more than 5% of daily volume!”
“I know I can get in, but what if I want to get out?”
For internal use only
The Problem “I can’t buy an ETF that trades less than 100,000 shares a day!”
“I don’t want to be more than 5% of daily volume!”
“I know I can get in, but what if I want to get out?”
For internal use only
Myth 1: You Can’t Trade an ETF with less than 100k shares of ADV
For internal use only
For internal use only
Myth #2: An ETF Is As Liquid As Its Underlying
Trade
For internal use only Source: Bloomberg,
Elephants & Knotholes
Trade
For internal use only Source: Bloomberg,
Bulls & China Shops
Back To Basics: Understanding On-
Screen Trading
Sell at Bid, Buy at Ask
Back to Basics: Bid/Ask Spread
Sell at Bid, Buy at Ask Source: ETF.com, as of 7/12/2016
Back to Basics: Bid/Ask Spread
Source: FactSet, as of 12/31/2015
0.00% 0.02% 0.04% 0.06% 0.08% 0.10% 0.12% 0.14% 0.16%
U.S. Equity
International Equity
U.S. Fixed Income
International Fixed Income
Commodities
Currency
Leveraged
Inverse
Asset Allocation
Alternatives
All ETFs:
Median Spread %
Different Asset Classes, Different Spreads
Source: ETF.com, as of 7/12/16
Spreads Can Vary Over Time: QAI Example
Market Order: Buy 1000 Shares
Market Order: Buy 1000 Shares
But Sometime You Can Do So Much Better
How Big Trades Happen In Little
ETFs
CSCO
AAPL
CAT
MSFT
IBM
$2.5 million
100K @ $25 ETFs, Inc.
Authorized Participant
ETF Anatomy: Creation/Redemption Refresh
100K @ $25
IBM
MSFT
AAPL
CAT
CSCO
ETFs, Inc.
Authorized Participant
ETF Anatomy: Creation/Redemption Refresh
50K @ $25
Authorized Participant
IBM MSFT AAPL CAT CSCO ETFs, Inc.
ETF Anatomy: Creation/Redemption Refresh
Authorized Participant
$25.00
Fair Value $25.00
$25.00
Why Do APs Do What They Do?
Fair Value $25.00
Authorized Participant
$25.00
$25.10
Why Do APs Do What They Do?
Fair Value $25.00
Authorized Participant
$25.00
$25.10
Sell 100K of the ETF @ $25.10
Why Do APs Do What They Do?
Fair Value $25.00
$25.00
$25.10
Buy An Equal Value Of The Underlying!
IBM
MSFT
AAPL
CAT
CSCO
Authorized Participant
Why Do APs Do What They Do?
Selling Pressure
Buying Pressure
Authorized Participant
Fair Value $25.01
$25.01 $25.01
Why Do APs Do What They Do?
Selling Pressure
Buying Pressure
Authorized Participant
Fair Value $25.01
$25.01 $25.01
Bought: $25.00 Sold: $25.10 Margin: $.10
Why Do APs Do What They Do?
Authorized Participant
$24.90
Buy 100K Of The ETF @ $24.90
Fair Value $25.00
$25.00
Why Do APs Do What They Do?
Authorized Participant
IBM
MSFT
AAPL
CAT
CSCO
Sell An Equal Value Of The Underlying!
Fair Value $25.00
$24.90
$25.00
Why Do APs Do What They Do?
Authorized Participant
Buying Pressure
Selling Pressure
Fair Value $24.99
Bought: $24.90 Sold: $25.00 Margin: $.10
$24.99
$24.99
Why Do APs Do What They Do?
Underlying NAV
Brokerage Fees
Market Maker P&L
Creation Costs
Forex Hedging Costs
Taxes
Bid Price
Ask Price
Market Maker P&L
Brokerage Fees
Taxes
Forex Hedging Costs
Redemption Fees
Underlying Bid/Ask
Spr
ead
ETF Spread
Source: SSgA.
What Goes Into An ETF Spread?
Source: Fox River Execution. Data as of 12/1/09.
ETFs Should Trade Within Their Arbitrage Band … Mostly
Diffi
culty
Size of Order For internal use only
ETFs Trading Is Hardest In The Middle
0.00%
0.10%
0.20%
0.30%
0.40%
0.50%
9:30AM
10:00AM
10:30AM
11:00AM
11:30AM
12:00PM
12:30PM
1:00PM
1:30PM
2:00PM
2:30PM
3:00PM
3:30PM
IGV Spread Weighted Avg. Spread of Underlying Holdings
Source: Bloomberg, as of 10/19/12
And At The Beginning and End of the Day
Source: Bloomberg, as of 10/19/12
And In Fixed Income
A Matrix For ETF Trading
A Matrix For ETF Trading
OPPORTUNITY
NIRVANA
CHALLENGING
OPPORTUNITY
Und
erly
ing
Liqu
idity
Low >>> High
On-Screen Liquidity
Low
>>>
Hig
h
An Example of Nirvana
• Extreme Volumes: The most liquid security in the world, trading 80+ million shares per day
• Extremely Tight Spreads: Averaging $0.01/share on a $214.95 handle, or 0.00%/share
• Excellent Underlying Liquidity: Five out of Five Rating
• Can be traded on-screen in any volume
An Example of Challenging
• Limited Volume: Median Daily Trading Volume of 5,000 shares
• Wide Spreads: Averaging $0.65/share on a $66.94 handle, or 0.99%/share
• Poor Underlying Liquidity: Two out of Five Rating
• Still A Great Fund – In Fact, An Analyst Pick! But reflects a challenging market.
• Must be traded carefully on or off screen
An Example of Opportunity
• Massive Onscreen Liquidity: >13 Million Shares Per Day
• Miniscule Spreads: Averaging $0.01/share on a $36.23 handle, or 0.02%/share
• Mixed Underlying Liquidity: Five Out of Five Rating, But Junk Bonds Are A Challenging Market
• The Most Efficient Way To Trade High Yield On The Market … But Premiums & Discounts Can Develop During Periods of Market Stress.
An Example of Opportunity
• New Fund, Limited On-Screen Liquidity
• Wide Quoted Spreads: Averaging 0.87%/share
• But Perfect Underlying Liquidity: Five out of Five Rating; Only U.S. Stocks
• Easy To Trade 50,000 or 100,000 Shares At Very Tight Spreads … If You Know How
Practicum: Strategies for
Execution
Advantages: Ease of Use
Disadvantages: Limited Information & Access to Underlying Liquidity
Works Best For: Nirvana ETFs, High On-Screen Liquidity ETFs
Considerations: Always Use Limit Orders Never Use Sleeping Stop Orders Did I Mention: Always Use Limit Orders
Option 1: Trading On-Exchange
Firm Fund Families # of ETFs
Fidelity iShares, Fidelity 70+
TD Ameritrade iShares, iPath, Vanguard, SSgA, PowerShares, Van Eck, PIMCO 100+
E*TRADE Global X, DB-X, WisdomTree 100+
Schwab Schwab, SSgA, Guggenheim, PowerShares, ETF Securities,
US Commodity Funds 200+
Vanguard Vanguard 60+
Consideration: Commission-Free Trading
Source: Bloomberg, as of 2/19/13 For internal use only
Consideration: Access Level II Screens
Advantages: Expertise, guidance and access to underlying liquidity
Disadvantages: Potential for information leakage, commissions, time, restrictions
Works Best For: Larger trades of all sorts.
Considerations: Authorized Participant, Market-Maker or
Agency Broker
Option 2: Working With Liquidity Providers
Approach custodian to receive permission to trade away
If they allow it but charge a fee, assess if fee is prohibitive to step-away trading
Set up any necessary delivery and payment accounts
Deliver clearing instructions from your custodian to the broker
Have broker allocate shares to appropriate custodians
Custodians will then allocate shares to sub-accounts
Option 2: Working With Liquidity Providers
“I want 150,000 shares of XYZ ETF”
Option 2: Working With An AP or Market Maker
“I want 150,000 shares of XYZ ETF”
“Give me your best bid and
offer!”
Option 2: Working With An Agency Broker
Large ETF trader Handles all ETFs Heavily focused on trading technology
Managed by “Godfather of ETFs” Reggie Browne
Growing position in market Strong international/institutional
relationships Quantitative trading firm Aggressive growth in recent years Reputation for execution excellence Ability to trade in multiple manners
Examples of APs/Market Makers
Lead the charge of agency brokers Covers all ETFs Doesn’t do business with Knight
Subsidiary of Wolverine Broker neutral Technology driven
Bank of New York company ETF Direct – Online RFQ program
Examples of Agency Brokers
Optimizing Baskets
Customized Baskets
Accepting Cash in Lieu
Tightening Up Onscreen Spreads
Recommending Where to Route Trades
Option 3: Working With ETF Issuers
Any Questions
SPEAKERS
Matt Hougan Chief Executive Officer
Inside ETFs
Will Wall Head Trader
Riverfront Investment Group
SPEAKER
SPEAKER
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