How to Kill a Black Swan Remy Briand and David Owyong ...
How to Kill a Black Swan Remy Briand and David Owyong ...
How to Kill a Black Swan Remy Briand and David Owyong ...
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Figure 2<br />
Offer<br />
NAV Proxy<br />
Bid<br />
Using The Every-15-Second NAV Proxy<br />
To Determine Bids <strong>and</strong> Offers<br />
A B C D E<br />
15sec 15sec 15sec 15sec 15sec<br />
Time<br />
temporaneous with the futures markets. Since the change <strong>to</strong><br />
a formal close at 4:00 p.m., ETF volume between 4:00 p.m.<br />
<strong>and</strong> 4:15 p.m. has not changed materially. On May 15, 2009,<br />
the day before this article was prepared for submission, ETFs<br />
were four of the five most active issues in after-hours trading.<br />
One of that day’s most active after-hours ETFs is based<br />
on an index that does not have an active futures contract.<br />
ETF Intraday Net Asset Value Proxies<br />
When trading began in the first ETF introduced in the<br />
United States (the S&P 500 SPDR launched in 1993), the<br />
Securities & Exchange Commission (SEC) required that the<br />
sponsors of the SPDR arrange for dissemination of an intraday<br />
share value proxy for the SPDR at 15-second intervals. These<br />
proxies are usually called indicative optimized portfolio values<br />
(IOPVs). The requirement for publishing these values was<br />
extended <strong>to</strong> every domestic equity ETF launched since 1993<br />
<strong>and</strong>, with modifications, <strong>to</strong> ETFs holding foreign equities,<br />
fixed-income instruments <strong>and</strong> other financial instruments.<br />
In spite of improvements in trading data calculation<br />
technology <strong>and</strong> the introduction of ETF portfolios that hold<br />
infrequently traded securities, calculations of these intraday<br />
value proxies are still based on the most recent trade of each<br />
portfolio component. Matt Hougan discusses the inadequacy<br />
of last-sale value proxies in an article scheduled <strong>to</strong> appear<br />
in the July 2009 issue of ETFR. These intraday value proxy<br />
calculations are made <strong>and</strong>/or disseminated by the National<br />
Securities Clearing Corporation (NSCC) <strong>and</strong> other service<br />
providers <strong>to</strong> “support” intraday trading of ETFs.<br />
Professional ETF traders <strong>and</strong> market makers do not use<br />
the “official” every-15-second proxy value calculations <strong>to</strong> help<br />
them determine their ETF bids <strong>and</strong> offers. Professionals develop<br />
their own valuations or subscribe <strong>to</strong> real-time ETF value calculations<br />
based on contemporary bids <strong>and</strong> offers rather than<br />
last sales. The fact that they do not use the free IOPV does not<br />
mean that these professionals lack faith in the NSCC’s ability<br />
<strong>to</strong> calculate correct values. The simple facts are that the last<br />
sale is not a reliable indica<strong>to</strong>r of contemporary values in most<br />
Price<br />
market situations, <strong>and</strong> the 15-second interval between valuations<br />
is <strong>to</strong>o long for the values <strong>to</strong> be useful <strong>to</strong> a trader.<br />
Because an ETF is a derivative security, its current value<br />
changes every time the value of any component of the ETF<br />
portfolio changes. The ETF value proxies used by professional<br />
traders are calculated from the midpoint of the bid <strong>and</strong><br />
offer for each position in the ETF portfolio. Sometimes the<br />
value calculations made by <strong>and</strong> for professionals use the size<br />
of bids <strong>and</strong> offers <strong>and</strong> the pattern of “changes” <strong>to</strong> forecast<br />
short-term trends. Figure 2 illustrates how a naive inves<strong>to</strong>r<br />
might attempt <strong>to</strong> use the “free” intraday proxy information<br />
<strong>to</strong> develop a bid or offer for ETF shares.<br />
In Figure 2, the latest IOPV is represented by a dot at<br />
the beginning of each of the five 15-second intervals illustrated.<br />
Inves<strong>to</strong>rs might place limit orders at prices close <strong>to</strong><br />
the most recent per-share value proxy. Columns A through<br />
E illustrate how bids <strong>and</strong> offers entered at equal distances,<br />
respectively, below <strong>and</strong> above a sequence of these every-15-<br />
second net asset value (NAV) proxy calculations might become<br />
transactions—but not always the transaction that the inves<strong>to</strong>r<br />
entering the order hoped <strong>to</strong> achieve. An offer <strong>to</strong> sell the ETF’s<br />
shares slightly above the proxy value posted at the beginning<br />
of time interval A would probably be lifted as the fund portfolio<br />
value rose during intervals A <strong>and</strong> B. That offer was below<br />
the changing per-share proxy value by the time that value was<br />
updated at the beginning of interval C—less than 30 seconds<br />
after the order was entered. The offer was also below the<br />
likely bid in the market at that time. Of course, some of the<br />
last-sale prices used <strong>to</strong> calculate each 15-second proxy might<br />
be more than a few minutes old at the time the calculation<br />
was made. Using the free 15-second values can be costly, but<br />
even if inves<strong>to</strong>rs had access <strong>to</strong> proxy values based on every-<br />
15-second midpoints of bids <strong>and</strong> offers <strong>and</strong> could enter orders<br />
as soon as the value was published, a lot can change before or<br />
shortly after the next proxy value is published.<br />
In my experience, many inves<strong>to</strong>rs are aware of the existence<br />
of the every-15-second last-sale NAV proxy value, but<br />
few know how <strong>to</strong> find it for a particular ETF <strong>and</strong> even fewer<br />
think about how, if at all, <strong>to</strong> use it. It is probably a good thing<br />
that these proxies are not widely used. Any attempt <strong>to</strong> use<br />
them <strong>to</strong> manage an order is more likely <strong>to</strong> lead <strong>to</strong> disappointment<br />
than <strong>to</strong> a good execution. The information on share values,<br />
transaction prices, bids <strong>and</strong> offers summarized in Figure<br />
1 indicates that ETF bid <strong>and</strong> offer updates are published<br />
more frequently than every 15 seconds (every time portfolio<br />
component bids or offers change materially), making the ETF<br />
share bids <strong>and</strong> offers a much better indication of the current<br />
market for an actively traded ETF than the every-15-second<br />
last-sale proxy calculation could possibly be.<br />
The posted ETF bids <strong>and</strong> offers also have the advantage of<br />
being something you can trade with. You cannot trade with<br />
the every-15-second NAV proxy because it does not represent<br />
a bid or offer for the ETF shares. An inves<strong>to</strong>r can be confident<br />
that, even if his market data vendor is a bit slower <strong>and</strong> updates<br />
quotes less promptly than the best data vendors, he will not<br />
be seriously disadvantaged relative <strong>to</strong> other retail market participants.<br />
Bids <strong>and</strong> offers for the most actively traded ETFs tend<br />
both <strong>to</strong> be tighter <strong>and</strong> <strong>to</strong> change more frequently than s<strong>to</strong>ck<br />
26<br />
July/August 2009