As traders go in and out of markets during shifting environments, it is important to understand some key trading practices to best execute exchange traded fund orders.
For instance, traders who are trying to efficiently execute ETF trades should understand why premium/discounts occur, evaluate an ETF’s bid-ask price, wait a while after the market opens to trade, place international trades when foreign markets are open and consult ETF specialists for large orders, James Ross, Chairman of the Global SPDR Business for State Street Global Advisors, said in a note.
“Understanding the unique structure of ETFs and how they trade will allow you to transact more efficiently,” Ross said.
Specifically, when looking up an ETF, the ETF’s price may diverge from its intraday net asset value, or iNAV, which is typically updated every 15 seconds and should closely approximate the net asset value of an ETF throughout the day. Consequently, an ETF can trade above or below its iNAV, or also known as a premium or discount to its underlying portfolio’s value. If one is buying an ETF at a premium, an investor is essentially paying more than what the underlying basket is worth, or if one is buying at a discount, an investor is getting a deal over the NAV.
Unlike traditional open-end mutual funds, ETFs trade throughout the day, like a stock. Consequently, traders will be subject to a bid-ask spread. The bid is the highest advertised price a buyer gets from a seller, while the ask is the lowest advertised price a seller gets from a buyer. Ross advised investors to set a limit order at a price somewhere inside the bid-ask spread to optimize execution and to better control trades.[related_stories]
Since not all stocks open for trading at the exact second the markets open, ETF investors should wait five or ten minutes after the open to begin trading. ETFs track a basket of securities, and if the underlying securities are not trading, it becomes difficult to effectively calculate an ETF’s price.
“Placing your trade after all stocks have begun trading for the day can mean more accurate ETF pricing,” Ross said.
ETFs track a number of markets, including international stocks. However, these foreign markets may not be open during U.S. market hours. Consequently, ETF investors seeking international exposure will likely get their most accurate price to NAV trading when the foreign and U.S. market hours line up.
Lastly, large traders dealing in big block orders may consider consulting with a specialized liquidity provider whom benefits from an Authorized Participant contact to execute ETF trades. APs keep trades fluid by creating and redeeming ETF shares in the primary market and help limit a large investor’s impact on an ETF’s price.
“If you make these trades on your own, especially if it’s a large trade of a thinly-traded ETF, you could pay more for execution,” Ross added.
For more information on ETFs, visit our ETF 101 category.