Exchange Traded Funds (ETF)

[winston]

Long article. Link below ...

Are ETFs Really Safe? by David Galland

Dr.Andrew Bogan is a managing member of Bogan Associates, LLC in Boston, Massachusetts.


DG: Jumping right to the point, has there ever been a problem with an ETF?

AB: ETFs have operated pretty well historically, but the mechanics of share issuance and redemption also creates some unique differences that we believe may lead to unintended consequences.

There already have been a few problems with ETFs, some more significant than others. The Flash Crash on May 6 of last year showed some structural issues with ETFs and perhaps with our whole market system for equities as well.

It's hard to decide where to draw the line, but a lot of securities departed from their perceived value during the Flash Crash by very large amounts. The reasons are still not completely understood, although the SEC has made a reasonable effort to understand what happened.

Another incident occurred in September 2008, when the Lehman and AIG mess was upon us. The commodity ETFs run by ETF Securities, Ltd., in London halted trading when AIG's solvency came into question.

The funds were investing in derivative contracts, including swap agreements, some of which were with AIG. It was only the Federal Reserve pumping in tens of billions of dollars that prevented those products from going. Bailing out AIG averted a disaster for the funds, and they continued to trade the next day.


DG: In the case of the Flash Crash, your research paper pointed out that even though ETFs represent only 11% of the listedsecurities in the U.S., 70% of the canceled trades during the Flash Crash involved ETFs. Is there an explanation for that?

AB: Some clarity is starting to emerge from work done by the SEC and others. But from our perspective, those statistics are quite alarming. There's no good reason 70% of canceled trades would be in ETFs while only 11% of listed securities are ETFs. And even though ETFs trade more actively, they don't represent 70% of all trading volume. So any way you look at it, they were badly overrepresented among the canceled trades, i.e., overrepresented among the most extremely off-priced trades.

People have been short-selling ETFs up to shocking levels, like 100% short, 500% short, sometimes over 1,000% short. That's in a world where stocks like Apple are 1% short, or IBM is 1.4% short, or General Electric is 0.5% short. You really don’t see traditional stocks with short positions anything like this, so clearly something is fundamentally different.

The difference is that ETF short-sellers – including hedge funds, dealers and arbitragers – are confident they can always create the shares needed to cover, so they see less risk of being squeezed.


DG: But in a traditional short-selling situation, you typically have to borrow the shares before you can short them.

AB: Yes, and that's true here too. But if you look at the Securities Settlement Failure data, ETFs are very oddly overrepresented, so it does look like there is some short-selling that happens before the shares are borrowed. But that's a small matter. The problem is that there is no limit to the amount of short-selling you can theoretically do while still having borrowed the shares. It simply requires the same share to have been borrowed, short-sold, borrowed from the new owner and short-sold again down a daisy chain. That's how you get these arbitrarily large short interest figures.

The short-selling involves new buyers coming in without the shares being created at all, and that's the fundamental asymmetry in the short-selling that we're most concerned about.

DG: So, where is the potential for the ETFs to get into trouble?

AB: The trouble could come from a number of different angles.

One concern is that the huge short interest building up essentially leaves the ETF as a fractionally reserved stock ownership system. If you have a fund, for example, that is 500% net short, then for every one holder of an actual share there are five other investors who own IOUs for the shares.


DG: So it seems that it's not so much the fund that might have a problem. The fund is only liable for the shares it has issued. The risk seems to lie in the counterparties – the brokers or the investors that brokers lent shares to.


DG: Let’s stick with this potential problem of a huge bunch of redemptions. People say, "Oh my god, I've got to get out of my ETFs," and there is a wholesale run on the funds. Because of the way ETFs are structured, it would seem that if they post net redemptions for a day, that the broker that had lent fund shares to short-sellers would just force the borrowers to buy back and cover their obligations.


DG: Right. Is there anything else that would make this whole "house of cards" collapse? Suppose a highly visible ETF stumbles and is unable to meet redemptions, or they just have to postpone redemptions. That might be the sort of trigger that could really send people off.

AB: You know, one of the big risks, by the way, that no one has really discussed much, is if an ETF were to have a big redemption run in panicky market conditions and halted redemptions. Halting redemptions is a complicated decision, because it breaks the symmetry that allows the arbitragers to go long or short both the basket of stocks and the ETF shares to move price toward NAV.


http://www.caseyresearch.com/editorial. ... 231ED0411A

[winston]

5 PowerRatings ETFs for the Next 5 Days (as of Friday, April 8, 2011)

ETF / Symbol / PowerRating
1) iShares Dow Jones Transportation Average Index Fund ETF IYT 9
2) Guggenheim Solar ETF TAN 9
3) Vanguard REIT ETF VNQ 9
4) Consumer Discretionary Select Sector SPDRS ETF XLY 9
5) Vanguard Growth ETF VUG 9


Source: Trading Markets

[winston]

High Probability ETFs for the Next 5 Days (as of 4/13/2011)

Name / Symbol / RSI(2)
1) Industrial Select Sector SPDRS ETF XLI 1.10
2) iShares Dow Jones U.S. Real Estate Index Fund ETF IYR 1.54
3) SPDR S&P 500 Trust ETF SPY 2.51
4) Financial Select Sector SPDRS ETF XLF 3.67
5) iShares MSCI Brazil Index Fund ETF EWZ 5.16


Source: Trading Markets

[winston]

5 PowerRatings ETFs for the Next 5 Days (as of Friday, April 15, 2011)

ETF / Symbol / PowerRating
1) iShares MSCI Spain Index Fund ETF EWP 10
2) Financial Select Sector SPDRS ETF XLF 10
3) SPDR S&P Metals and Mining ETF XME 9
4) iShares S&P 100 Index Fund ETF OEF 9
5) iShares Dow Jones U.S. Technology Sector Index Fund ETF IYW 9


Source: Trading Markets

[winston]

High Probability ETFs for the Next 5 Days (as of 4/20/2011)

Name / Symbol / RSI(2)
1) SPDR KBW Bank ETF KBE 2.32
2) B2B Internet HOLDRS ETF BHH 20.99
3) SPDR KBW Regional Banking ETF KRE 30.95
4) ELEMENTS / Rogers Intl. Commodity Index - Agriculture RJA 46.10
5) Financial Select Sector SPDRS ETF XLF 48.77


Source: Trading Markets

[winston]

5 PowerRatings ETFs for the Next 5 Days (as of Friday, April 22, 2011)

ETF / Symbol / PowerRating
1) Regional Bank HOLDRS RKH 10
2) Guggenheim Solar ETF TAN 9
3) SPDR KBW Regional Banking ETF KRE 9
4) ProShares UltraShort Semiconductors ETF SSG 8
5) Direxion Energy Bear 3x Shares ERY 8


Source: Trading Markets

[winston]

High Probability ETFs for the Next 5 Days (as of 4/27/2011)

Name / Symbol / RSI(2)
1) PowerShares DB Base Metals Fund DBB 9.75
2) ELEMENTS/Rogers International Commodity Idx - Ag Total Return RJA 11.08
3) iShares MSCI Hong Kong Index Fund ETF EWH 15.09
4) iShares FTSE/Xinhua China 25 Index Fund ETF FXI 24.87
5) iShares MSCI Brazil Index Fund ETF EWZ 32.83

Source: Trading Markets

[winston]

5 PowerRatings ETFs for the Next 5 Days (as of Friday, April 29, 2011)

ETF / Symbol / PowerRating
1) Direxion Technology Bear 3x Shares TYP 10
2) ProShares UltraShort Gold ETF GLL 9
3) iShares FTSE/Xinhua China 25 ETF FXI 9
4) iPath MSCI India Index ETN INP 8
5) Guggenheim China Small Cap ETF HAO 8

Source: Trading Markets

[winston]

High Probability ETFs for the Next 5 Days (as of 5/4/2011)


Name / Symbol / RSI(2)
1) iShares MSCI Pacific ex-Japan Index Fund ETF EPP 0.71
2) Market Vectors Russia ETF RSX 2.69
3) Vanguard Emerging Markets ETF VWO 3.62
4) Technology Select Sector SPDRS ETF XLK 13.12
5) DIAMONDS Trust Series DIA 16.35


Source: Trading Markets

[winston]

5 PowerRatings ETFs for the Next 5 Days (as of Friday, May 6, 2011)

ETF / Symbol / PowerRating
1) ProShares Ultra Oil & Gas DIG 10
2) Market Vectors Gold Miners ETF GDX 10
3) ProShares Ultra Basic Materials ETF UYM 10
4) iShares MSCI Canada Index Fund ETF EWC 9
5) iShares Russell 2000 Index Fund ETF IWM 9

Source: Trading Markets