Apr

30

Here's a technical question for experts on the operation of the NYSE and Amex markets.

For listed stocks with large volume, there is a daily "open" and "close" print at which a large number of shares usually trade. Ideally one can trade with a market-on-open and market-on-close order and avoid paying the bid/ask spread.
However, it seems to me that the open and close crosses have much smaller volumes for ETFs.

I'll compare Newmont Mining (NEM) and a gold stock ETF (GLD). Both are listed on NYSE. Both average about 5 or 6 million shares traded per day.

This morning 101,000 shares of NEM traded at the opening print, and 130,000 traded at yesterday's closing print. GLD, however, had a lot of volume this morning, including pre-market, but there was no obvious opening print. The largest single trade between 9:30am and 9:40am was only a few thousand shares, and that was by no means the first trade.

Are there different rules for ETFs in terms of the open and closing crosses? Is there a way to participate in some kind of crossing trade for ETFs?

David Wren-Hardin explains:

The short answer is, yes, there are opening crosses. The issue as to why a lot of them aren't seemingly efficient as stock crosses is that a lot of ETFs are traded as an arb. If there's a large buy imbalance in the QQQQs, the marketmakers and specialist will simply skew the market to where they can get their futures off to offset the trade and lock in their profit.

Unlike a stock, where the open and closing imbalance can be seen as the market's arriving at a conclusion as to the value of the stock, with an ETF, either the market knows what the value is because of an electronically traded future, or it doesn't, because the value is determined by a basket of stocks. In the first case, someone sending resting opening orders knows he will get a fill away from true value almost by definition. In the second case, the marketmakers and specialists can't figure out what something is worth until the basket of stocks is open, which all have their own opening imbalance games going on.

So in the case of something like GLD, which includes illiquid names with all sorts of late opens, the marketmakers would be fools to lay any sort of tight market. Anyone who traded against them would be doing so because he had a much better idea of where the underlying stocks are going to open.

Charles Pennington responds:

I don't understand the argument. The GLD ETF, as you note, would be the second of your two scenarios. That means there is much uncertainty about where it should open. I add that that's also the case for a regular stock. So what's the difference between an ETF and a stock in this regard?

David Wren-Hardin clarifies:

I was thinking of something like OIH. If there are 500,000 shares to go on the open, how are the marketmakers going to get their hedges off? Typically, they will wait until all the stocks are open, so they know what the value is. Of course, by this point, the world knows what the value is, and there's no longer need for price-discovery, and the customer will get arb'ed against. So if a customer is willing to do that, then he is essentially saying he know more about the opening or the post-opening than is obvious, and the trade will only be a loser for the marketmakers. Maybe he is leaning on the open prints in the underlyings in order to pick off the marketmakers.

The difference is who trades stocks, versus ETFs, or the perception of who trades them. ETFs are driven to a large degree by speculation. People trying to get in and out, people trying to capture an arb. They are often seen by marketmakers as smart money. Stocks, on the other hand, can often be driven by a different type of customer, such as a mutual fund. Their opening or closing order is just seen as a block of stock moving at some easy to mark price where the mutual fund is assured of some level of price-discovery giving them a fair price. Therefore, marketmakers, or even other customers, are more willing to step up and offset the balance.

Charles Pennington replies:

OIH is another example of a very liquid ETF which has very little volume on its open and close. Both OIH (the ETF) and SLB (Schlumberger) trade on average about 10 million in volume per day.

This morning, SLB traded 69,000 on the open, and OIH traded only 10,500. Yesterday SLB traded 36,500 on the close. My source of time and sales doesn't show any obvious large closing trade for OIH.

So there seems to be a big systematic difference.

Another Spec asked me what I meant by "closing cross". Here's my understanding:

One type of order that can be entered for NYSE stocks is a "limit on close". (There are also "market on close" orders.) These orders must be entered before 3:40pm EST, 20 minutes before the closing bell.

All such orders are held until the close. Then the specialist determines at what price the maximum number of orders can be crossed. If I have a limit order to buy at 50, and someone else has a limit order to sell at 49, then our orders might be "crossed" at 49.50. The specialist determines the price at which the cross can take place. Ideally there will be a price such that the buys and sells balance each other, and the specialist doesn't have to get involved in buying/selling. If not, then there is an "order imbalance".

However, NASDAQ over the past few years has added a closing and opening cross for its stocks, and they call it the "closing cross". I've been very satisfied when I've used it.

J.T. Holley notes:

From the AMEX webpage,

Rule 131A-AEMI. Market on Close Policy and Expiration Procedures. The following procedures apply to stocks and closed end funds and do not apply to options or to any security the pricing of which is based on another security or an index (e.g., Exchange Traded Funds or Trust Issued Receipts, securities listed under Section 107 of the Exchange Company Guide, warrants and convertible securities).

Looks like ETFs don't have the applicable MOC trade.

And it seems that they trade till 4:15pm in "broad index" cases.

David Wren-Hardin remarks:

That might be the case for products still listed on the AMEX, but doesn't help you if you're worried about things like the iShares.

There's an informal 4:00 closing price in the SPY for brokers/customers who want to mark their SPY against the 4:00 broad market close, then a formal closing rotation at 4:15.

Kevin Depew adds:

From the iShares Web site:

iShares ETFs are traded like stocks on an exchange where investors buy and sell them just as they would any other publicly traded security. And because iShares ETFs trade like a stock, investors can benefit from features like intraday pricing and trading, the ability to place stop and/or limit orders, and the opportunity to sell iShares ETFs short.

Like other exchange-traded securities, iShares ETFs will trade subject to a bid-ask spread. Spreads may fluctuate in response to supply and demand forces, overall market volatility, and other factors ? in other words, the same factors that influence the prices and spreads of stocks. But unlike stocks, the ETF's creation and redemption process not only helps to minimize the bid-ask spreads, but may also reduce the premiums and discounts that can develop between the iShares ETF market price and the Net Asset Value (NAV).

ETFs are very different from closed-end funds. A closed-end fund's shares are fixed, which is why they frequently trade at a premium or discount to NAV. Although they both trade on an exchange, the ETF shares can be created and redeemed throughout the day.

Also, it's important to get a handle on the composition of ETFs. The Biotech HLDR, with fewer than 20 members, is two-thirds weighted in AMGN and DNA. On the other hand, IBB, with more than 150 members, is only about 12% weighted in AMGN, has no exposure to DNA. That's a significant difference for two funds labeled Biotech.

David Wren-Hardin replies:

Kevin makes a great point. HOLDRS were invented by Merrill Lynch, and unlike other ETFs from the Spyder family (SPY, DIA, XLE, et al.), they never rebalance, and their composition does not change unless a company is taken over or goes bankrupt. That's why AMGN and DNA have taken over the BBH, as opposed to IBB, which is rebalanced from time to time.

In addition, it's more costly to create/redeem out of a HOLDR than a SPY, It costs $10.00 per 100 HOLDRS to create or redeem, That works out to a dime a HOLDR share, a pretty hefty premium. SPY, on the other hand, is a flat $3000.00 charge. The minimum creation unit is 50,000 shares, so that's only six cents, 40% cheaper already. But its $3000,00 for 50,000 or 5,000,000, and at that level the fee becomes a much smaller cost.

Also, HOLDRs pay their dividends straight through. If INTC goes ex-dividend, the owner of the SMH gets the dividend the same day as a regular INTC owner, minus a touch since fees are taken out of the dividend stream. Spyder products and their ilk accumulate the dividends over time, and pay it out quarterly. 

Art Cooper remarks:

An excellent resource is Russell Wild's Exchange Traded Funds for Dummies.  


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1 Comment so far

  1. David Bast on June 21, 2007 8:22 pm

    Is there any way to find out opening and closing imbalance in etf’s on the Amex and NYSE?

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