Elisabeth Kashner, CFA ETFs 201: How to Trade ETFs Director of Research ETF.com Spencer Bogart ETF Specialist ETF.com Agenda     The Special Case for ETFs On the Screen and Behind the Scenes What’s a Fair Price? When to Call the Pros ETFs: Part Mutual‐Fund, Part Stock Mutual Fund ETF Stock Trades only at end of day Price determined exclusively by portfolio Pooled vehicle with NAV Price determined by interaction Trades of portfolio all day value and supply/demand for shares Price Determined exclusively by supply & demand for shares How Do You Trade a Platypus? Market Order: Buy 1000 Shares Market Order: Buy 1000 Shares Bulls & China Shops Elephants & Knotholes Working with Liquidity On‐Screen and Behind the Scenes On‐Screen Trading Metrics Average Volume Can Be Deceptive Median volume is more telling Bid/Ask Spread Sell at Bid, Buy at Ask Spreads – A Moving Target Source: IndexUniverse, as of 2/16/13 What’s Not on the Screen? Hidden Liquidity Creation/Redemption Mechanism Authorized Participant Stocks $2.5 million CSCO AAPL ETFs, Inc. 100K @ $25 CAT MSFT IBM Creation/Redemption Mechanism CSCO Authorized Participant AAPL 1 CAT MSFT IBM Stocks 3 ETFs, Inc. 2 ETF Shares ETF Shares ETF Shares Incentives of Authorized Participants Sell High ETF Shares Underlying Securities Scenario 1: Prices are balanced, No action from AP ETF Shares Buy Low Underlying Securities Scenario 2: ETF Shares trading higher than underlying; AP creates ETF shares until prices re‐align What’s in an ETF Bid/Ask Spread? Ask Price Market Maker P&L Creation Costs Forex Hedging Costs Taxes ETF Underlying NAV Spread Spread Brokerage Fees Underlying Bid/Ask Brokerage Fees Taxes Forex Hedging Costs Redemption Fees Bid Price Market Maker P&L Source: SSgA. Hurdles to Creations & Redemptions      Market Hours Overlap Turnover Fees Closures Illiquid Markets Market Hours Overlap London Market Hours Briefly Overlap with New York Sometimes international markets overlap: Tokyo Market Hours Never Overlap with New York Market Impact Ticker: SPY Market: US Large Caps Ticker: IWC Market: US Micro Caps Ticker: VNM Market: Vietnamese Equities Underlying Vol / Unit: 0.01% Underlying Vol / Unit: 0.30% Underlying Vol / Unit: 5.29% Conclusion: The underlying trading required to create 50K SPY shares is unlikely to impact underlying prices. Conclusion: The underlying trading required to create IWC will probably have a minor impact on prices Conclusion: The underlying trading required to create 50K VNM shares is likely to impact underlying prices. What is a Fair Price? Evaluating Fair Value: iNAV  iNAV = Indicative (or Intraday) Net Asset Value  IOPV = Indication of Portfolio Value  IV = Indicative Value (especially for ETNs) Yardstick for the current Bid/Ask How To Calculate Fair Value Evaluating Fair Value: SPY vs. iNAV Source: Bloomberg, as of 2/4/13 Fair Value Revisited: iNAVs Flaw For international securities, this price is stale. International securities priced in local currency, so must adjust for USD. To truly assess fair value, some desks use proxy securities for portions of the portfolio that have “stale” prices as a result of not trading during US market hours. Market Hours Overlap: GXC Source: Bloomberg, as of1/30/12 Situational Premiums and Discounts Egypt Exchange reopens March 23, 2011. Egyptian Stock Exchange closes January 27, 2011 Protests begin January 25, 2011. Mubarak resigns February 11, 2011. Premiums and Discounts in Fixed Income Do market prices lead NAV or does NAV lead market prices? When to Call in the Pros Difficulty Trading is Hardest in the Middle 1 Share Size of Order 1 Creation Unit How is my Strategy Affecting my Price?  2‐Sided Quotes are fine, but WHEN do you want to trade?  Immediately?  Layout the position over the next few hours?  Days? Weeks? Source: Goldman Sachs Securities Division, as of 1/31/13 Three Types of Trading for Advisors:    Entirely Self‐Directed Internally Assisted “Trade Away” Captive Desks  Wide range of service levels  Provide basic execution advice  Enforce “blacklists”  Source liquidity externally  “Work” larger trades  Pros: Little information leakage, liquidity access, expertise  Cons: Accountability and Best Execution not guaranteed “Trade Away” Types of Firms  Market Makers / Authorized Participants     Goldman Sachs KCG Susquehanna International Group Agency Brokerages   WallachBeth ConvergEx Every Issuer Can Facilitate Liquidity  Optimizing Baskets  Customized Baskets  Accepting Cash in Lieu  Tightening Up Onscreen Spreads  Recommending Where to Route Trades Thank you. Questions? Elisabeth Kashner, CFA ETFs 201: How to Trade ETFs Director of Research ETF.com Spencer Bogart ETF Specialist ETF.com