My gut would tell me the slippage on the "large transaction in the ETF" would account for this sort of risk. Yes, you could get the rare event when it doesn't but that's the nature of risk and return.
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ETF - priced by underlying or trades ??
- Thread starter Tarl_Cabot
- Start date
Quote from chud:
Dan, do you watch the component stocks trading in Singapore to arb the EWS? They don't trade on US exchanges do they?
I have questions myself on how these foreign ETFs work. For example EWS's top holding is SingTel which only trades on the Singapore and Australian exchanges. So if none of their holdings trade on exchanges that are open during US hours, what would cause these ETFs to change price during US hours ?
On 2/27 many of these foreign ETFs broke down at the open much much more than they should have, so I didn't really arb the EWS to its underlying holdings since the holdings weren't trading at the time, but it was plainly obvious that the ETFs were breaking under the selling pressure and not maintaining the bid that they should have, which was easy to take advantage of by buying low. EWM, EWS and EWH were the three worst offenders that I saw that day.
Actually, you're right, the question is even more pointed if the underlying stocks are not traded at all during the time period that the ETF traded (such as ETFs of foreign stocks).
Then you have the same question, but it is even clearer:
- Suppose you have an ETF of Asian stocks, and the Asian markets are closed. The total cap of the ETF is a tiny fraction of the cap of the underlying stocks (again large cap stocks like Toyota).
- Then suppose a very large holder of the ETF dumps his stock all at once.
- Does the price in the ETF dip down ( as any stock would dip if a large holder dumped it ), or does it stay the same all day because the underlying Asian stocks are not being traded ?
Then you have the same question, but it is even clearer:
- Suppose you have an ETF of Asian stocks, and the Asian markets are closed. The total cap of the ETF is a tiny fraction of the cap of the underlying stocks (again large cap stocks like Toyota).
- Then suppose a very large holder of the ETF dumps his stock all at once.
- Does the price in the ETF dip down ( as any stock would dip if a large holder dumped it ), or does it stay the same all day because the underlying Asian stocks are not being traded ?
So I was WRONG on the makeup of the more exotic ETFs.Quote from chud:
Single stocks routinely make up over 20% of an ETF. Just a few examples: QCOM is 38% of the Broadband Holdrr (BDH). DNA is 38% of the Biotech Holdr (BBH). XOM is 22% of the Energy Spider (XLE).
Know what you're talking about before you call somebody's question pointless.
But I would never trade such an ETF for 2 reasons:
(1) You are effectively trading a pair: one stock vs ETF.
(2) Any ETF that's > 30% one stock...
Is going to be electronically arbed to death... with 10-20 ms latency.
So not tradeable unless you are seriously automated.
(3) You will be systematically cheated on any ETF that trades on the AMEX.
Why is every single poster here IGNORING these facts?
It makes the entire discussion MOOT...
unless you have 6 figures worth of infrastructure...
And can trade for $0.002/share.
I have that infrastructure, BUT...
Let me give you an important poker analogy.
When you walk into a casino or Party Poker...
You are looking for the ** weakest opponents ** at your betting level...
Choosing weaker opponents is the KEY to winning poker... by far #1 KEY.
Same with trading.
By choosing very liquid securities that are electronically arbed by dozens of firms...
You are choosing the ** strongest opponents ** in the game.
There ARE more artful and complex approaches to trading ETFs...
Or baskets of stocks and ETFs...
That might make them profitable...
In 2006, I made about 2,000 trades in the 4 REIT ETFs... ICF, IYR, RWR, VNQ.
Overall I am very profitable...
But I basically broke even on these ETFs... and dropped it.
I have MUCH better things to trade.
I'm up to my arse with great stuff to scalp.
XLE exotic? It trades on average 20 million shares a day.Quote from HoundDogOne:
So I was WRONG on the makeup of the more exotic ETFs.
BBH moves approximately dollar-for-dollar with DNA. I've traded it a couple times when there's some announcement involving DNA after hours. There's often an ask that somebody left unattended that's underpriced. It doesn't look like it's arbed, at least out of hours.
(2) Any ETF that's > 30% one stock...
Is going to be electronically arbed to death... with 10-20 ms latency.
So not tradeable unless you are seriously automated.
This isn't a discussion about trading, it's a discussion about execution, which is why it is in the Execution Forum, and not the Trading Forum.Why is every single poster here IGNORING these facts?
It makes the entire discussion MOOT...
In order to trade intelligently, you first have to know exactly what is going on. I'm still trying to find out exactly how ETF's are priced, hence the thread. I'm hoping that someone reading this actually knows, but if not, then I'll take the far longer route of asking Barclay's...
Creation and redemption of ETF units keeps their relationship in-tact. The ETF's value is derived from a portfolio of the underlying stocks.
For your question, the fact that these two events happened at the same time probably isn't relevant. We can split them up, see how what their independent effects are, and then decide what the cumulative effect is.
When the values of the stocks change, the FV (or NAV, what have you) of the ETF will change and so will the price. This much is obvious.
What happens when selling pressure drops the ETF price? Traders (this will be automated by most MM's, as HDO so artfully put) will get hit on their ETF bids and instantly sell the underlying stocks to hedge.
Combining these effects results in a pretty reasonable situation, the ETF is bid back up slightly. In fact, it should be just to the amount that can be hedged off (profitably, I hope) by sell orders on the individual stocks. As a result, both moves are dampened - a slight correction of both should occur.
In any case, it's never entirely clear what the relative magnitude of the moves are. It's a function of liquidity. Traders should be willing to bid back for the ETF after the spike down only to the extent that they can profitably hedge off their exposure by selling the component stocks (including toyota which has spiked 5%). They will continue to sell the stocks and buy the ETFs until no more discrepancy exists. Put simply, the relative magnitudes of the moves are ambiguous - don't you love trading?
Market cap of the ETF isn't necessarily relevant except for it's impact on liquidity. Since we can assume that it's thin, we can expect more volatility (in the form of chop) - as far as I can tell, it shouldn't impact it's ability to move (or be moved) by the underlying stocks except in the very short term (time until arbs/traders/whatever come in).
This is just like any other relationship between derivative and underlying, deviations from FV (ignoring liquidity concerns which could result in premiums/discounts) are fair game for arbing. Push and pull.
For your question, the fact that these two events happened at the same time probably isn't relevant. We can split them up, see how what their independent effects are, and then decide what the cumulative effect is.
When the values of the stocks change, the FV (or NAV, what have you) of the ETF will change and so will the price. This much is obvious.
What happens when selling pressure drops the ETF price? Traders (this will be automated by most MM's, as HDO so artfully put) will get hit on their ETF bids and instantly sell the underlying stocks to hedge.
Combining these effects results in a pretty reasonable situation, the ETF is bid back up slightly. In fact, it should be just to the amount that can be hedged off (profitably, I hope) by sell orders on the individual stocks. As a result, both moves are dampened - a slight correction of both should occur.
In any case, it's never entirely clear what the relative magnitude of the moves are. It's a function of liquidity. Traders should be willing to bid back for the ETF after the spike down only to the extent that they can profitably hedge off their exposure by selling the component stocks (including toyota which has spiked 5%). They will continue to sell the stocks and buy the ETFs until no more discrepancy exists. Put simply, the relative magnitudes of the moves are ambiguous - don't you love trading?
Market cap of the ETF isn't necessarily relevant except for it's impact on liquidity. Since we can assume that it's thin, we can expect more volatility (in the form of chop) - as far as I can tell, it shouldn't impact it's ability to move (or be moved) by the underlying stocks except in the very short term (time until arbs/traders/whatever come in).
This is just like any other relationship between derivative and underlying, deviations from FV (ignoring liquidity concerns which could result in premiums/discounts) are fair game for arbing. Push and pull.
I did a little investigation...
iShares MSCI Japan Index (EWJ)
traded in a range today of:
14.56 - 14.75
and the open was 14.67 and the close was 14.57
Yet there is no overlap whatsoever between Japanese stock market and US stock market (in terms of open hours).
Ironically, today's close was exactly the same as yesterday's open - even though there had been a whole day of trading in Japan.
I'm thinking now that perhaps a voluminous prospectus for an ETF might have details in the fine print...
iShares MSCI Japan Index (EWJ)
traded in a range today of:
14.56 - 14.75
and the open was 14.67 and the close was 14.57
Yet there is no overlap whatsoever between Japanese stock market and US stock market (in terms of open hours).
Ironically, today's close was exactly the same as yesterday's open - even though there had been a whole day of trading in Japan.
I'm thinking now that perhaps a voluminous prospectus for an ETF might have details in the fine print...
ETF's are priced by supply and demand just like any other stock.
There is no one setting the price - market forces keep the price inline with the underlying, if it deviates too much someone will arb it back but dont confuse that action with the price being "set", its not set, it floats just like any other stock
There is no one setting the price - market forces keep the price inline with the underlying, if it deviates too much someone will arb it back but dont confuse that action with the price being "set", its not set, it floats just like any other stock
That doesn't make sense.Quote from GTS:
ETF's are priced by supply and demand just like any other stock.
There is no one setting the price - market forces keep the price inline with the underlying, if it deviates too much someone will arb it back but dont confuse that action with the price being "set", its not set, it floats just like any other stock
There would be be no "arb" unless the Fund Administrators take some action.
That action would be necessary - otherwise the stock would be worthless.