How to Trade ETFs

Presented by FA Magazine & IndexUniverse

November 5, 2013

Moderator Ray Fazzi Senior Editor Financial Advisor Magazine

Panelists

Matt Hougan President, ETF Analytics & Publications IndexUniverse

Dave Nadig Unknown, Unknown IndexUniverse

Ugo Egbunike Director, Business Development IndexUniverse

For internal use only

The Problem

“I can’t buy an ETF that trades less than 100,000 shares a day!”

“I don’t want to be more than 5% of daily volume!”

“I know I can get in, but what if I want to get out?”

For internal use only

For internal use only

Myth 1: You Can’t Trade an ETF with less than 100k shares of ADV

For internal use only

For internal use only

Myth 2: An ETF is As Liquid As Its Underlying

For internal use only

For internal use only

Trade

Elephants & Knotholes

For internal use only Source: Bloomberg,

For internal use only

Trade

Bulls & China Shops

For internal use only Source: Bloomberg,

For internal use only

Back to Basics: Bid/Ask Spread

Sell at Bid, Buy at Ask

For internal use only

Back to Basics: Bid/Ask Spread

Sell at Bid, Buy at Ask

Source: IndexUniverse, as of 2/16/13

For internal use only

Different Asset Classes, Different Spreads

0.00% 0.10% 0.20% 0.30% 0.40% 0.50% 0.60%

U.S. Equity

International Equity

U.S. Fixed Income

International Fixed Income

Commodities

Currency

Leveraged

Inverse

Asset Allocation

Alternatives

All ETFs:

Median Spread %

Source: Markit, as of 12/28/12

For internal use only

ETF Liquidity Explained:

Source: IndexUniverse, as of 2/16/13

Bid/Ask Spread

For internal use only

Market Order: Buy 1000 Shares

For internal use only

Market Order: Buy 1000 Shares

For internal use only

How Big Trades Happen in Little ETFs

Creation/Redemption Refresh

What Goes into an ETF Spread?

ETF Arbitrage Bands

Special Situations

For internal use only

ETFs, Inc.

?

How An ETF Works

For internal use only

CSCO

AAPL

CAT

MSFT

IBM

$2.5 million

100K @ $25 ETFs, Inc.

Authorized Participant

ETF Anatomy: Creation/Redemption

For internal use only

CSCO

AAPL

CAT

MSFT

IBM 100K @ $25 ETFs, Inc.

Authorized Participant

ETF Anatomy: Creation/Redemption

50K @ $25

For internal use only

What’s in an ETF Bid/Ask Spread?

Underlying NAV

Brokerage Fees

Market Maker P&L

Creation Costs

Forex Hedging Costs

Taxes

Bid Price

Ask Price

Market Maker P&L

Brokerage Fees

Taxes

Forex Hedging Costs

Redemption Fees

Underlying Bid/Ask

Sp

read

ETF Spread

Source: SSgA.

For internal use only

ETFs Should Trade Within Their Arbitrage Bands … Most of the Time

Source: Fox River Execution. Data as of 12/1/09. Source: Fox River Execution. Data as of 12/1/09.

For internal use only

ETF Trading: D

iffi

cult

y

Size of Order

It’s Hardest In The Middle

For internal use only

For internal use only

For internal use only

For internal use only

0.00%

0.10%

0.20%

0.30%

0.40%

0.50%

9:30AM

10:00AM

10:30AM

11:00AM

11:30AM

12:00PM

12:30PM

1:00PM

1:30PM

2:00PM

2:30PM

3:00PM

3:30PM

IGV Spread Weighted Avg. Spread of Underlying Holdings

Issue: When to Trade IGV vs. Underlying

Source: Bloomberg, as of 10/19/12

For internal use only

Ticker Fund Name Avg. Spread Median Volume

(40 Day)

Underlying Volume/Creation

Unit

FDM First Trust Dow Jones

Select MicroCap Index Fund

0.21% 4,260 0.33%

WMCR Guggenheim Wilshire

Micro-Cap ETF 0.71% 1,395 1.94%

IWC iShares Russell

Microcap 0.07% 66,708 0.38%

PZI PowerShares Zacks Micro Cap Portfolio

0.24% 5,925 0.19%

Issue: Market Impact

Source: IndexUniverse, as of 2/16/13

For internal use only

For internal use only

For internal use only

Issue: Fair Value - SPY vs. iNAV

$149.00

$149.50

$150.00

$150.50

$151.00

$151.50

1/30/2013 9:30 2/4/2013 16:00

Last Price iNAV

Source: Bloomberg, as of 2/4/13

For internal use only

Issue: Fair Value - GXC

$67.00

$67.50

$68.00

$68.50

$69.00

$69.50

$70.00

$70.50

1/18/12 8:00 AM 1/30/12 4:27 PM

GXC Price

GXC iNAV

Source: Bloomberg, as of1/30/12

For internal use only

Protests begin January 25, 2011.

Egyptian Stock Exchange closes January 27, 2011

Mubarak resigns February 11, 2011.

Exchange reopens March 23, 2011.

Issue: Premiums/Discounts - EGPT

Source: Bloomberg, as of 03/31/11

For internal use only

7:42pmEST: Credit Suisse issues

press release announcing re-opening of the ETN

February 22, 2012 March 20, 2012

Credit Suisse halted creations on the VelocityShares Daily 2X VIX Short ETN, TVIX

ETN placed on “threshold list”

11:10amEST: TVIX premium reaches

almost 100%

0

5

10

15

20

Price NAV

Issue: Premiums/Discounts - TVIX

Source: Bloomberg, as of 03/31/12

For internal use only

Issue: Premiums/Discounts - TLT

-0.80%

-0.60%

-0.40%

-0.20%

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

12/30/2011 12/31/2012

% P

rem

ium

/Dis

cou

nt

Source: Bloomberg, as of 12/31/2012

For internal use only

110

120

130

140

150

160

170

180

190

-3.00%

-2.00%

-1.00%

0.00%

1.00%

2.00%

3.00%

11/14/2011 11/13/2012

Shar

es

Ou

tsta

nd

ing

(Th

ou

san

ds)

% P

rem

ium

/Dis

cou

nt

%Premium Shares Out

Issue: Premiums/Discounts - HYG

Source: Bloomberg, as of 11/14/12

For internal use only

Executing Trades: Practical Strategies

For internal use only

Reality: Trading is Complicated

Three Types of Trading for Advisors:

Entirely Self-Directed

Internally Assisted

“Trade Away”

For internal use only

Self Directed: Level 2

Source: Bloomberg, as of 2/19/13 For internal use only

For internal use only

Internally Assisted

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

For internal use only

“Trading Away”

Types of Firms

Market Makers / Authorized Participants Knight Capital Group Susquehanna International Group

Agency Brokerages WallachBeth ConvergEx

For internal use only

AP/Market Maker Trade Date: January 30, 2013. For illustrative purposes only

Source: Goldman Sachs, as of 1/20/13

For internal use only

Agency Brokerage

“Give me your best bid and

offer!”

For internal use only

Executing Brokers – Sample APs

Largest ETF trader in the world Handles all ETFs Heavily focused on trading

technology

Institutional liquidity provider now targeting advisors

Heavy focus on fixed income Willing to work with captive customers

White-glove service Support of full firm’s resources Ability to trade on risk or in multiple

manners

For internal use only

Specializes in derivatives, European equity ETFs

Excellent technology and hedging capabilities

Focusing on advisors Heavy focus on fixed income Strong liquidity provider outside of

market hours

Doesn’t have customers A market maker’s market maker

Executing Brokers – Sample APs

For internal use only

Executing Brokers – Agency Brokers

Lead the charge of agency brokers Growing quickly and covers all ETFs Doesn’t do business with Knight

Subsidiary of Wolverine Broker neutral Technology driven

Bank of New York company Willing to support any ETF Growing technological platform

For internal use only

Every Issuer Can Facilitate Liquidity

Optimizing Baskets

Customized Baskets

Accepting Cash in Lieu

Tightening Up Onscreen Spreads

Recommending Where to Route Trades

For internal use only

Thank You.

Questions?