ETFs 201 - ETF.comApproach custodian to receive permission to trade away If they allow it but charge a fee, assess if fee is prohibitive to step-away trading

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?”


Myth 1: You Can’t Trade an ETF with less than 100k shares of ADV



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.



50K @ $25


IBM MSFT AAPL CAT CSCO ETFs, Inc.



$25.00

Fair Value $25.00

$25.00

Why Do APs Do What They Do?

Fair Value $25.00


$25.00

$25.10


Fair Value $25.00


$25.00

$25.10

Sell 100K of the ETF @ $25.10


Fair Value $25.00

$25.00

$25.10

Buy An Equal Value Of The Underlying!

IBM

MSFT

AAPL

CAT

CSCO



Selling Pressure

Buying Pressure


Fair Value $25.01

$25.01 $25.01


Selling Pressure

Buying Pressure


Fair Value $25.01

$25.01 $25.01

Bought: $25.00 Sold: $25.10 Margin: $.10



$24.90

Buy 100K Of The ETF @ $24.90

Fair Value $25.00

$25.00



IBM

MSFT

AAPL

CAT

CSCO

Sell An Equal Value Of The Underlying!

Fair Value $25.00

$24.90

$25.00



Buying Pressure

Selling Pressure

Fair Value $24.99

Bought: $24.90 Sold: $25.00 Margin: $.10

$24.99

$24.99


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

Documents

ETFs 201 - ETF.comApproach custodian to receive permission to trade away If they allow it but charge a fee, assess if fee is prohibitive to step-away trading