How does a "Tracking ETF" work?

[Sekiyo]

Yes the return in %, that's obvious.
But the question is how is that possible at all when SOXS gets controlled by the management and by the external traders around the World... Ie. by two independent forces...

The law of one price is the only driving force.
Especially about an ETF replicating an underlying.

 

[Quanto]

Maybe it's possible when the management of SOXS (ie. its bots etc.) "immediately" reacts to BOTH the underlying index SOX AND to the external trades done on the SOXS... Ie. by doing almost like HFT...

 

[BMK]

I believe the % return more than the price. (Risk adjusted return is even better)

Good point. Sometimes it feels like the prices of QQQ and SPY are somewhat disconnected from their target indices. They're not, of course. The ratios are very stable over time. But sometimes the tracking error seems kinda wide. And the mathematical relationship between QQQ and the Nasdaq 100 index is not easy to do in your head LOL

And I did not realize that the OP was talking about a 3X leveraged ETF on a very narrow index.

Those things are the Wild West, man. I don't trade that stuff LMAO

 

[Quanto]

And I did not realize that the OP was talking about a 3X leveraged ETF on a very narrow index.
Those things are the Wild West, man. I don't trade that stuff LMAO

Hmm. it's not that "narrow", IMO:
SOX index: 52 Week Range 2,861.45 - 4,950.26
I trade them neither; it was just an example for a "Tracking ETF".

 

[2rosy]

Good point. Sometimes it feels like the prices of QQQ and SPY are somewhat disconnected from their target indices. They're not, of course. The ratios are very stable over time. But sometimes the tracking error seems kinda wide. And the mathematical relationship between QQQ and the Nasdaq 100 index is not easy to do in your head LOL

And I did not realize that the OP was talking about a 3X leveraged ETF on a very narrow index.

Those things are the Wild West, man. I don't trade that stuff LMAO

The issuer of the etf provides the calculation on its website. Anyone can then consume constituent data and compute indicative nav. 14 years ago Etfs were never out of line. And if they appeared to be there was no liquidity. I assume it's even more efficient today

 

[Quanto]

Here's issuer's page on SOXS (and SOXL):
https://www.direxion.com/product/daily-semiconductor-bull-bear-3x-etfs

 

[BMK]

Hmm. it's not that "narrow", IMO:

It is 30 semiconductor stocks. That is a narrow index in the sense that it is not a broad market index like SPX or DJIA.

it was just an example for a "Tracking ETF".

All passive ETFs are tracking something.

The concept of tracking was, in some sense, part of the original definition of an ETF.

Only recently have we begun to see active ETFs that are not managed solely by an algorithm.

All of the old-school ETFs are designed to track a target. The target may be an index or it may be something else, such as the price of the front month corn future.

 

[nitrene]

I believe most of these leveraged ETFs like SOXS (or SOXL) use swaps and not futures. Sector index futures are pretty illiquid. I remember when ICE offered the FANG+ index future it rarely ever traded.

There is a new ETN (XXXX) that tracks the S&P 500 Index but is 4X leveraged and it uses swaps and not futures (I think it is created by BMO).

 

[Slow Learning Elf]

authorized participants effectively cause the tracking. Other than setting up the etf legally I don't know what ishares or similar do...collect fees

Well, authorised participants are “involved but not committed”. It’s the manager that actually does rebalancing to follow the index, do whatever else is mandated by the prospectus and, most importantly, monitors risk and makes rare but important risk management decisions. For example, making a decision to rebalance early on Feb 5th, 2018 like the SVXY manager did.

PS modern actively managed ETFs are actually rebalanced by the manager - especially if there is no clear underlying index

 

[Slow Learning Elf]

I believe most of these leveraged ETFs like SOXS (or SOXL) use swaps and not futures. Sector index futures are pretty illiquid. I remember when ICE offered the FANG+ index future it rarely ever traded.

There is a new ETN (XXXX) that tracks the S&P 500 Index but is 4X leveraged and it uses swaps and not futures (I think it is created by BMO).

The reason to use swaps is primarily a PnL transfer to the delta-1 desk of their mothership. Even if the underlying is perfectly liquid, the d1 desk will handle the operations, take on whatever slippage etc.