How to Kill a Black Swan Remy Briand and David Owyong ...

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How To Minimize Your Cost Of Trading ETFs The case for NAV-based trading By Gary Gastineau 24 July/August 2009
One of the features that long-term investors like most about exchange-traded funds is that each shareholder usually pays only the cost of his or her own fund share transactions and is protected by the ETF structure from the cost of other investors’ purchases and sales of fund shares. In spite of this feature, there is a great deal of misinformation in circulation about the cost of trading ETFs and how to trade them efficiently. This article tries to help you evaluate the quality of ETF markets and keep your ETF share trading costs low. Trading ETFs Is Different Than Trading Stocks A natural reaction to the title of this article is, “Why bother to write about trading ETFs? They trade “just like a stock.” In fact, the reason for writing this article is that ETFs don’t trade like stocks. ETF markets behave differently than stock markets, and ETF shares trade differently than stocks in a number of ways. Figure 1 lists some of the similarities and differences. To illustrate one difference, ETF investors have learned that ETF bids and offers usually change much more frequently than stock bids and offers. These more frequent changes can make ETF investors uneasy, as they suggest that individuals do not have as much information as professional traders have about what the ETF price should be or what the ETF bid or offer will do next. Even if your only interest is in day-trading one of the several dozen major benchmark index ETFs that trade more than 10 million shares on an average day, the market in ETFs is different than the market in common stocks in ways that can affect your trading results. If you trade ETFs that are not based on major benchmark indexes or that trade fewer than 10 million shares a day, ignoring the significant differences between ETF and stock trading can be very costly. This article will help investors find level stretches of the ETF playing field where professional and amateur traders have equal footing—and avoid the slippery slopes. Once you understand how the ETF market works, and how trading ETFs differs from trading stocks, you will be able to trade ETF shares confidently and efficiently. In fact, with the introduction of net-asset-value-based trading in ETFs, trading ETFs can be much simpler and less stressful than trading stocks. 1 While the focus of these comments is on U.S.-listed ETFs holding U.S. common stocks, many of the observations apply to European and Asian ETF markets and to U.S. ETFs with other portfolio holdings. The entry in Figure 1 that generates the most questions from investors is the trading hours for ETFs. Trading after 4:00 p.m. presents both opportunities and hazards to ETF traders. Trading in ETFs is active until well after 4:00 p.m., partly because the major benchmark index ETFs (such as the S&P 500 SPDRs, the iShares Russell 2000 Index Fund and ETFs tracking a number of other popular benchmark indexes) are part of major arbitrage complexes. These arbitrage complexes typically consist of an index that serves as a template for index mutual funds and other indexed portfolios and for a variety of index derivative financial instruments, including index futures contracts, index options and, of course, index ETFs. The arbitrage complexes also include derivatives on these derivatives, such as options on futures, options on ETFs and securities futures products (single “stock” futures) on ETFs. There are also exchange-traded and over-thecounter structured products and risk management contracts linked to many of these indexes. Until the NYSE acquired the Amex in 2008, ETFs—like most of the other tradable components of the index arbitrage complexes—traded in a regular session that lasted until 4:15 p.m. to provide a structured ETF market that was fully con- Figure 1 Some Key Differences Between Stock Trading And ETF Trading Stocks ETFs Trading Hours 9:30 am − 4:00 p.m. 9:30 am − 4:00 p.m. With substantial post-close trading until 4:15 p.m. Net Asset Value Determined − 4:00 p.m. Closing Price Determined 4:00 p.m. 4:00 p.m. Market-on-Close (MOC) Rules to Offset Order Imbalances Yes Yes Volume Concentrated First Half Hour, Last Hour First Half Hour, Last Hour (More Extreme) Share Value Determined Stock Market Stock Market Share Price Determined Stock Market ETF Market Share Value Published Every Stock Trade Every 15 Seconds Share Price Published Every Stock Trade Every ETF Trade Share Bids/Offers Published Every Time Quote Changes Every Time Quote Changes Frequency of Quote Changes Loosely Linked to Trading Activity Derivative Auto Quoting Loosely Linked to Trading Activity, Volatility and Number of Issues in the ETF Portfolio www.journalofindexes.com July/August 2009 25
Page 1 and 2: How to Kill a Black Swan Remy Brian
Page 3 and 4: www.journalofindexes.com Vol. 12 No
Page 6 and 7: FREE subscRiption oFFER! The Journa
Page 8 and 9: David Smith Publisher dsmith@fa-mag
Page 10 and 11: Editor’s Note Got Risk? Jim Wiand
Page 12 and 13: How To Kill A Black Swan Risk and a
Page 14 and 15: Figure 2 Comparison Of Asset Return
Page 16 and 17: Figure 5 Historical Real Returns Fo
Page 18 and 19: Figure 8 Subset Of A Multi-Asset Cl
Page 20 and 21: Benchmarking Policy Portfolios How
Page 22 and 23: investor has decided to benchmark 8
Page 24 and 25: An Interview With Susan Mangiero By
Page 28 and 29: Figure 2 Offer NAV Proxy Bid Using
Page 30 and 31: ETF Trading Volume Is Huge, Growing
Page 32 and 33: Figure 5 Hypothetical ETF Limit Ord
Page 34 and 35: Gastineau continued from page 31 th
Page 36 and 37: Portable alpha approaches—which e
Page 38 and 39: to write the book “Portable Alpha
Page 40 and 41: sitated more routine adjustment in
Page 42 and 43: Bogle’s Corner The Fiduciary Prin
Page 44 and 45: at the direct expense of the invest
Page 46 and 47: Talking Indexes Managing The Risks
Page 48 and 49: News CVC To Buy iShares … Or Mayb
Page 50 and 51: S&P Introduces Risk-Controlled Inde
Page 52 and 53: News New SPDR Offers Twist On Mortg
Page 54 and 55: Global Index Data Selected Major In
Page 56 and 57: Morningstar U.S. Style Overview: U.
Page 58 and 59: Exchange-Traded Funds Corner Larges
Page 60: “For a strong foundation in my cl

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