to Trade ETFs Spencer Bogart

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1 ETFs 201: How Elisabeth Kashner, CFA Director of Research ETF.com to Trade ETFs Spencer Bogart ETF Specialist ETF.com

2 Agenda The Special Case for ETFs On the Screen and Behind the Scenes What s a Fair Price? When to Call the Pros

3 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 of portfolio value and supply/demand for shares Trades all day Price Determined exclusively by supply & demand for shares

4 How Do You Trade a Platypus?

5 Market Order: Buy 1000 Shares

6 Market Order: Buy 1000 Shares

7 Bulls & China Shops

8 Elephants & Knotholes

9 Working with Liquidity

10 On Screen and Behind the Scenes

11 On Screen Trading Metrics

12 Average Volume Can Be Deceptive Median volume is more telling

13 Bid/Ask Spread Sell at Bid, Buy at Ask

14 Spreads A Moving Target Source: IndexUniverse, as of 2/16/13

15 What s Not on the Screen?

16 Hidden Liquidity

17 Creation/Redemption Mechanism Authorized Participant Stocks $2.5 million 100K Inc. $25 CSCO AAPL CAT MSFT IBM

18 Creation/Redemption Mechanism 1 CSCO AAPL CAT Stocks Authorized Participant MSFT IBM 3 ETFs, Inc. 2 ETF Shares ETF Shares

19 Incentives of Authorized Participants Sell High ETF Shares Underlying Securities ETF Shares Underlying Securities Buy Low Scenario 1: Prices are balanced, No action from AP Scenario 2: ETF Shares trading higher than underlying; AP creates ETF shares until prices re align

20 What s in an ETF Bid/Ask Spread? Ask Price Market Maker P&L Creation Costs Forex Hedging Costs Taxes Brokerage Fees ETF Spread Underlying NAV Spread Underlying Bid/Ask Brokerage Fees Taxes Forex Hedging Costs Redemption Fees Bid Price Market Maker P&L Source: SSgA.

21 Hurdles to Creations & Redemptions Market Hours Overlap Turnover Fees Closures Illiquid Markets

22 Market Hours Overlap London Market Hours Briefly Overlap with New York Sometimes international markets overlap: Tokyo Market Hours Never Overlap with New York

23 Market Impact Ticker: SPY Market: US Large Caps Underlying Vol / Unit: 0.01% Conclusion: The underlying trading required to create 50K SPY shares is unlikely to impact underlying prices. Ticker: IWC Market: US Micro Caps Underlying Vol / Unit: 0.30% Conclusion: The underlying trading required to create IWC will probably have a minor impact on prices Ticker: VNM Market: Vietnamese Equities Underlying Vol / Unit: 5.29% Conclusion: The underlying trading required to create 50K VNM shares is likely to impact underlying prices.

24 What is a Fair Price?

25 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

26 How To Calculate Fair Value

27 Evaluating Fair Value: SPY vs. inav Source: Bloomberg, as of 2/4/13

28 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.

29 Market Hours Overlap: GXC Source: Bloomberg, as of1/30/12

30 Situational Premiums and Discounts Egyptian Stock Exchange closes January 27, 2011 Egypt Exchange reopens March 23, Protests begin January 25, Mubarak resigns February 11, 2011.

31 Premiums and Discounts in Fixed Income Do market prices lead NAV or does NAV lead market prices?

32 When to Call in the Pros

33 Trading is Hardest in the Middle Difficulty 1 Share 1 Creation Unit Size of Order

34 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

35 Three Types of Trading for Advisors: Entirely Self Directed Internally Assisted Trade Away

36 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

37 Trade Away Types of Firms Market Makers / Authorized Participants Goldman Sachs KCG Susquehanna International Group Agency Brokerages WallachBeth ConvergEx

38 Every Issuer Can Facilitate Liquidity Optimizing Baskets Customized Baskets Accepting Cash in Lieu Tightening Up Onscreen Spreads Recommending Where to Route Trades

39 Thank you. Questions?

40 ETFs 201: How Elisabeth Kashner, CFA Director of Research ETF.com to Trade ETFs Spencer Bogart ETF Specialist ETF.com

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