Institutional Execution & Trading
Member FINRA/SIPC
Best Practice Trading Tips For ETFs
Elementary: Who Trades ETFs?
• To properly and effectively trade ETFs, you must first understand the uniquely
different “players” involved in the marketplace.
• Having a general understanding of their business models and their objectives will
make you a stronger and more efficient trader.
The Players
Retail and Institutional Customers
Those who purchase products with the goal of price appreciation and/or sell short with the goal of profiting from price decline
High Frequency Traders
Computer based trading programs generating a multitude of orders within split second time frames and designed to profit from incremental
arbitrage opportunities and rebates provided by electronic trading centers.
Algorithmic models are dependent on a very high ADV (Average Daily Volume)
APs - Market Makers - Liquidity Providers
Professional traders actively involved in arbitrage trading of ETFs
Strategies that involve hedging: futures, baskets, options, correlated products, etc.
Most hedges are tied to the creation and redemption process of an ETF, making perceived liquidity concerns immaterial.
Instantaneous hedging allows these participants to provide ongoing liquidity in the same product or similar products
“ADV Doesn’t Matter”… or Does it?
Issuers and sponsors will promote their ETFs suggest that ADV does NOT matter
When selecting an ETF, the liquidity of the underlying index or components is the best indication of its tradability.
Issuers and sponsors are correct when advising that low ADV should not be a deterrent to invest in a particular ETF
ADV DOES determine how you should trade the ETF
10 Million +
Shares →
Market will dictate
true value of the
product
Marketable limit
order safe
VWAP, TWAP,
Algos safe
MOC orders safe
High frequency
traders heavily
involved
Block trades not
always necessary
5 Million to
10 Million →
Underlying value
dictates true value
of the product
Marketable limit
order safe
VWAP, TWAP,
Algos safe as long
as percentage of
your order is
under 10% of
ADV
MOC orders can
have some risks
High frequency
traders minimal
involvement
Block trading can
be a better option
1 Million to
5 Million →
Underlying value
becomes harder to
determine
(premiums or
discounts can be
hidden)
Marketable limit
order becomes
less efficient
VWAP, TWAP,
Algos safe as long
as percentage of
your order is
under 10% of
ADV
Avoid MOC
orders
Nominal high
frequency trader
involvement
Block trading
usually the most
efficient option
Less than
1 Million →
Underlying value
becomes harder to
determine.
On screen spreads
are wider than
necessary
Marketable limit
order much less
efficient
VWAP, TWAP,
Algos not
recommended
Avoid MOC
orders
No high
frequency trader
involvement
Block trading the
most efficient
trading option
How To Use NAV & iNAV To
Your Trading Advantage
• NAV – the net asset value of the fund
– Very similar to NAV of a mutual fund
– Calculated end of day (after the close); published well after the close
– Often used as a benchmark, but otherwise has no trading value in ETFs
• iNAV – intraday net asset value of the fund
– Typically calculated every 15 sec. and published on Bloomberg; also available with a slight
time delay on other financial systems.
– Can be a useful tool in pricing the value of an ETF, discovering premiums and discounts and
using limit orders for your ETF trades.
When Is iNAV Useful?
iNAV is a useful tool when the underlying basket of securities is trading
during open market hours
Domestic
Equity-Based
Best asset class for using iNAV to find true value of ETF intraday
*The 15 second delay produces a slightly inaccurate “picture” on high
ADV products
iNAV can be useful in this asset class
Fixed Income
iNAV from Bloomberg is calculated differently for bonds vs. equities
*A majority of the calculations for fixed income products are priced on
the bid side of the product, causing minor price fluctuations
International
iNAV is not useful in the majority of international issues, as the
underlying securities are often closed and not trading during iNAV
calculation.
Block Trading Tips
• Experience
– Whether principal or agency, custodian or wire house, always make sure the broker
representing your order flow is fluent in the particular product and ETF trading overall.
• Transparency
– Make sure your block price and subsequent price improvement (if applicable) is supplied to you
immediately after the conclusion of your trade.
• Two-sided Quote
– Have your broker/market maker provide you with a bid and offer on the ETF you’re
attempting to trade*.
*This technique is subject to debate within the professional trading community, however, twosided quotes provide a more accurate reflection of the value of the ETF at trade time.
• Liquidity
– Use more than one source or request multiple “risk quotes” to ensure you’re getting a fair and
accurate representation of the best price available within the context of the prevailing market.