High-frequency traders and their beloved computer programs do not just focus on stocks. They like exchange traded funds, including some ETFs that are far from ordinary and leveraged exchange traded notes (ETNs).
Recent 13F filings by high-frequency trading shops with the Securities and Exchange Commission reveal the SPDR S&P 500 ETF (NYSEArca: SPY) is an ETF favored by HFT firms. That is not surprising considering that SPY is the world’s largest ETF and by far the most heavily traded security in U.S. markets. After moving past SPY, the filings reveal HFT firms have a flare for the exotic, risky and unusual when it comes to their favorite exchange traded products.
Citing 13F filings, Bloomberg reports that Virtu Financial, a major HFT firm, held stakes in the U.S. Oil Fund (NYSEArca: USO) and the PowerShares DB Crude Oil Double Short ETN (NYSEArca: DTO) at the end of the fourth quarter.
Virtu’s other ETF and ETN holdings include the CurrencyShares Euro Currency Trust (NYSEArca: FXE) and the ProShares Ultra VIX Short-Term Futures (NYSEArca: UVXY). UVXY, which tries to reflect two times or 200% the daily performance of the S&P VIX Short-Term Futures Index, was one of 2014’s worst performing leveraged exchange traded products. [Worst Leveraged ETFs of 2014]
Hudson River Trading, another HFT shop, owned shares of the First Trust ISE-Revere Natural Gas Index Fund (NYSEArca: FCG) and the First Trust NASDAQ Clean Edge Green Energy Index Fund (NasdaqGS: QCLN) at the end of the fourth quarter, according to Bloomberg. Thanks to last year’s energy sector route, FCG was one of the year’s worst-performing non-leveraged ETFs with a loss of 42%. QCLN rose to prominence for was previously one of the largest ETF weights to Elon Musk’s Tesla (NasdaqGS: TSLA). The ETF now allocates 6.5% to that stock.
Controversy surrounding HFTs has grown in recent years, reaching almost fevered pitch following the publication of Michael Lewis’s book “Flash Boys” last year. However, HFTs play an important role in the ETF market.
Arbitrageurs use high-frequency trading to keep markets in step with each other, which can help prevent the market price of an ETF from wildly deviating from its net asset value (NAV). Some industry observers have noted HFT has helped narrow ETF spreads, leading to reduced costs for investors while some industry analysts have gone so far as to say ETFs in their current state would not exist without HFT.
“Without HFTs, ETFs would act more like closed-end funds, which frequently move to wide premiums or discounts to their NAVs. That issue does occur with some ETFs, often following an issuer’s decision to limit or suspend creations of new shares.
Without the HFT, the price of the ETF might rise and be disconnected from the underlying value of the index it is trying to track. This is how closed-end funds work. Yet most ETFs are pretty good at following their respective index. That’s because once an investor starts to bid up the ETF, the HFT in, offering the inventory for sale that they have built up. HFT simultaneously make a market for up to thousands of stocks,” wrote Axel Merk in a Forbes piece published soon after the debut of “Flash Boys.”
SPDR S&P 500 ETF
Tom Lydon’s clients own share of SPY.