August 9, 2006 ETF vs Cash Index hosted by Tom
Tom Preston: Good afternoon everybody!
Tom Preston: Today we're going to talk about why ETFs and cash indices
have different prices.
Tom Preston: I'll talk about it for a few minutes then open it up for question.
Tom Preston: One of the questions I get periodically is why the DJX isn’t
the same price as the DIA. Not only those two, but just about every pair of
cash index and ETF, like SPX and SPY, XEO and OEF, and RUT and IWM.
Some, like DJX and DIA, are pretty close, but others, like SPX and SPY are
quite different.
Tom Preston: If you can not hear the audio, please close and reopen the
software. Then you will see "Thinkorswim live broadcast" in the audio
feature.
Tom Preston: If you need assistance with this, please call tech support at 1
866-839-1100
Tom Preston: Let’s first define what the cash index and ETF (exchange
traded fund) are. A cash index, like DJX, XEO, and SPX are made up of
individual stocks. The prices of the indices are calculated off of the last price
of the component stocks, so, the current price of the index is simply the sum
(or weighted sum) of the last prices of the individual stocks. This also
impacts the index settlement prices at expiration, where the settlement prices
based on the opening prints of individual stocks can be very different from
the first prices you see for the index in the morning. If an individual stock
doesn’t trade for a while, the cash index will be calculated off that “old”
stock price. If that stock starts to trade again at a significantly different price,
you can see the cash index jump when it reflects that new price. Of course,
the index will move as much as the stock is weighted, which is why the
impact on the index is usually small.
Tom Preston: ETFs are actual shares of stock that represent the underlying
index. The are technically modified unit trusts or investment companies that
trade on a secondary market (like a closed end mutual fund). The ETF
represents ownership in a trust that actually holds all the component stocks
in the index. That’s the big distinction between and ETF and the cash index.
You can’t buy or sell the actual cash index, unless you buy or sell the
individual component stocks (2000 in the case of RUT). You can buy and
sell the index by buying and selling the ETF. So, instead of trading 2000
individual stocks, you can trade shares in IWM. Because they represent
ownership in a trust of the component stocks, the ETFs receive and
dividends that are paid on the individual stocks.
Tom Preston: So, if the cash index and ETF represent the same thing, why
do they have different prices? The DJX was 112.14 and the DIA was 112.16.
The SPX was 1279.95 and the SPY was 128.14 (1281.40 in SPX terms). As
you can see the differences are not that big.
The main reason is that there are supply and demand forces on the ETF that
push them up and down independent of the individual component stocks.
Yes, there is an arbitrage opportunity that very large institutions can do,
where they can try to buy the basket of component stocks and convert them
into shares of the ETF and simultaneously sell the ETF. That keeps the ETFs
from getting too far away from the cash index.
But the trading activity of the ETF will drive it higher and lower than the last
of the cash index, and for retail traders, there is no arbitrage opportunity.
Tom Preston: The dividends payable on an ETF are held by the trust and
paid out quarterly (monthly in the case of DIA). The ETF will drop on the
ex-dividend date by the dividend amount. You may see a divergence
between the cash index and the ETF as the individual stocks go ex-dividend
but the ETF doesn’t drop because the dividend owed on the stock is added to
the price of the ETF trust. When the ETF goes ex-dividend, the ETF’s price
drops closer to the cash index price. Keep in mind, though, that because the
dividend yields are quite low (2% annually or so for the S&P 500), such
divergence tends not to be too great. Because the ETFs go ex-dividend on
expiration Friday, you will see this convergence at expiration. So, you could
say that the ETF and cash index tend to converge at expiration. But
considering that the ETF and component stocks will presumably trade
indefinitely, there need not be any specific time when the ETF and cash
index are precisely the same. There isn’t necessarily any “settlement date”
for the ETF. So, you will always see some discrepancy between the cash and
ETF prices.
Tom Preston: The consequence for options is that they can be priced
differently because their underlying securities (cash index or ETF) are priced
differently. But more to the point, ETF options are American-style, while
most cash index options are European-style. Also, the ETF options have one
more day to trade than most of the European style cash index options (XEO
excluded). Those are the main reason for the difference in prices. But any
differences there are don’t mean there are any arbitrages, mainly because of
the differences of settlement at expiration, as well as commission and
slippage costs.
Tom Preston: Let me open it up for questions.
apolloofgreece: I can understand why the ETF trades higher than the cash
index (dividends), but why would the ETF trade lower than the cash index?
my_utmost: Has there been any talk about allowing options on SPY, DIA,
IWM to fall under the 60/40 taxation rules?
JT: How do you know, at any given time, if the DIA or the DJX will get
better fills?
bearishbull: Is acting like a closed fund why there are so many new ETF's
popping up?
ngetline: what is dividend risk? ned
jarkis2: From a liquidity standpoint, bid ask spread which ETF's and cash
indices do you feel comfortable trading ?
jarkis2: It seems impossible trading some of the smaller ETf's as there is no
option open interest and liquidity
zolotoyM: How do I turn off this infernal message that keeps popping up in
my 'LIVE NEWS' on the main webpage?!!
RUF: What happens when a stock is substituted because of merger, etc?
JT: When the VIX was at 10.5, TOS trainers taught to trade DJX Iron
Condors. Now that VIX leves are much higher, Iron Condors don't work as
well. What would be a better strategy?
ggreiner9: Tom this is just a little off topic, but what happened to the
expected price feature on the trade screen?
bearishbull: Why does IWM trade later on expiration Friday then the others?
Is that off topic?
apolloofgreece: Can OTM calls sometimes be exercised if the dividend
amount is large enough?
bearishbull: Are there any indexes or ETF's that are worthwhile holding long
term?
gwptrader: ggreiner9 - Click on the oval SETUP button upper right on your
platform. Then look for "Show Expected Price" about 1/2 way down the
list. Use the blue drop down arrow to choose "Always" if you want
expected price feature to be shown.
gwptrader: apolloofgreece - check out Tom's past Wed. classes on when
early exercise is likely and how to evaluate whether your short options are at
risk
http://www.thinkorswim.com/tos/displayPage.tos;jsessionid=33AA2D2CD3∞
A8DBBF8C92A4C44FBF2B53.www2_tos0?webpage=onlineSeminar
jack0408: Is there a new highs and new lows screen for all stocks in the
market?
JT: Sorry for being a bit off topic... I would like to see a "stock screener"
where particular fundamental and technical criteria can be applied to search
for a small set of stocks that meet those criteria?
bearishbull: Maybe it was the otions on IWM that trade later...
GTIP: dividend should be priced in the stock
aa35360: Tom, off topic question: the Nymex mini energy futures (oil,
natural gas, etc) are electronically traded. When will TOS be offerring
those? And do you know if and when options will be offerred on the e-mini
index futures? Thanks.
MichFury: Is there any particular rational for institutions to react negative on
Small Caps indexes, because of the BP rumor???
Bernie: Why the expected price is not sufficiently accurate?
aa35360: Speaking of the Monkey brains blog, why did you go with IC with
70-80% win prob, rather than the usual 50% TOS style?
gwptrader: jack0408 - Until ToS platform has a stock screener, you can click
on the underlined number to open a list of symbols, etc. for today's new
highs/ new lows and more (for free)
http://stockcharts.com/def/servlet/SC.scan∞
MichFury: That improvement to TOS platform was GREAT! Thanks. You
can also customize your own index or selected stocks portfolio.!!!
RUF: Can we get the stock adj button to show 5C rather than a dime?
Bernie: Does the expected price work better for single?
poolman: is there a advantage to the holder ETF ?
MichFury: Thanks for your comments ...pretty good
MichFury: I am expecting to recover some losses on the emini Russell 2000
after 4:30pm EST. Do you think after hours would possibly move $4. up or
down.. or much less. I usually don't trade after hours.???
RUF: On the trade page
bearishbull: aren't holdrs way expensive?
RUF: I think you have to use theo px
gwptrader: HOLDRs website
http://www.holdrs.com/holdrs/main/index.asp?Action=FAQ∞
mike007: Tom, when you gonna join monday class presentations club?
Hopefully soon?
st: Holders come in 100 share quantities. So you can't do odd lots. Options
should be the same as any ETF.
GTIP: i expect er2 go down 10 points
DoubleD: Why don't after-hours trading prices show up on daily charts?
ZGP: any eta on cbot binary interest rate option symbols being carried by
TOS?
Bernie: Does the theoretical price give better prediction on the fill price?
gwptrader: per HOLDRs website, these ETFs are NOT re-balanced like
other ETFs are when a stock in the ETF makes a significant move that may
change the ratio of holdings within the ETF.
treefrog: Is that Monday class only the one that is held in your offices?
joyce: can we record monday training and put in web?
treefrog: You just answered that .... it's live
treefrog: I like Joyce's idea.
gwptrader: joyce - GREAT IDEA!!!
bearishbull: what Monday training are you referring to?
mdsilver: what about getting 200 day moving avg when looking at 2-3 day
15min chart
hollyerjb: one more time on how to get the after hours trade....you said it so
fast i could not get there. thanks.
MichFury: Thanks Tom.... If I leave the emini Russell 2000 active, will it go
to next day? versus Canceling at midnight and start a new day tomorrow.
You know when the paper loss realizes at midnight? Maybe I want to
continue to trade tomorrow todays entry on the emini Russell.
gwptrader: bb - at www.OptionPlanet.com you can see in-office classes.
These are classes held in the ToS offices on Monday nights.
coffeecup: On the Analyze page there is a print/export button...I can only get
a "no page to print" message??
treefrog: For those of us who are pretty far away....could you also record the
Wed classes. San Diego is a long hike.
bearishbull: there are a lot of podcasts on how to make podcasts.
gwptrader: mdsilver - use 5200 period moving average on your 15 minute
charts to see the equivalent of 200 day moving average. (26 fifteen minute
periods per day X 200 days = 5200 periods)
MichFury: Thanks.
RUF: Do you intend to have a booklet explaining all the features in the
platform?
rwilen: What are the exact hours TOS is closed for futures trading, and are
they the same for all the different contracts?
bearishbull: coffee cup, try a screenshot
treefrog: Thanks, Tom
bearishbull: i'd pay real money for a dvd
mdsilver: tos gwptrader will that wok with 50 day as well
MichFury: Tom... did you say Russell in TOS closes at 4:30pm Chicago
time?
livetrader: Wow Tom these Classes are rocking with your info and
Gwptrader helping absolutely AWESOME
Tom Preston:
http://www.thinkorswim.com/tos/displayPage.tos?webpage=servicesOrderT∞
ypes
mdsilver: goo to know thank you gwp
MichFury: Sorry…thanks.
GTIP: hire gwp to finish all the manuals
hollyerjb: thanks tom
Tom Preston: I have to wrap it up now
Tom Preston: If you have any questions or suggestions for the software,
tpreston at thinkorswim.com
Tom Preston: Good afternoon everybody!
Tom Preston: Today we're going to talk about why ETFs and cash indices
have different prices.
Tom Preston: I'll talk about it for a few minutes then open it up for question.
Tom Preston: One of the questions I get periodically is why the DJX isn’t
the same price as the DIA. Not only those two, but just about every pair of
cash index and ETF, like SPX and SPY, XEO and OEF, and RUT and IWM.
Some, like DJX and DIA, are pretty close, but others, like SPX and SPY are
quite different.
Tom Preston: If you can not hear the audio, please close and reopen the
software. Then you will see "Thinkorswim live broadcast" in the audio
feature.
Tom Preston: If you need assistance with this, please call tech support at 1
866-839-1100
Tom Preston: Let’s first define what the cash index and ETF (exchange
traded fund) are. A cash index, like DJX, XEO, and SPX are made up of
individual stocks. The prices of the indices are calculated off of the last price
of the component stocks, so, the current price of the index is simply the sum
(or weighted sum) of the last prices of the individual stocks. This also
impacts the index settlement prices at expiration, where the settlement prices
based on the opening prints of individual stocks can be very different from
the first prices you see for the index in the morning. If an individual stock
doesn’t trade for a while, the cash index will be calculated off that “old”
stock price. If that stock starts to trade again at a significantly different price,
you can see the cash index jump when it reflects that new price. Of course,
the index will move as much as the stock is weighted, which is why the
impact on the index is usually small.
Tom Preston: ETFs are actual shares of stock that represent the underlying
index. The are technically modified unit trusts or investment companies that
trade on a secondary market (like a closed end mutual fund). The ETF
represents ownership in a trust that actually holds all the component stocks
in the index. That’s the big distinction between and ETF and the cash index.
You can’t buy or sell the actual cash index, unless you buy or sell the
individual component stocks (2000 in the case of RUT). You can buy and
sell the index by buying and selling the ETF. So, instead of trading 2000
individual stocks, you can trade shares in IWM. Because they represent
ownership in a trust of the component stocks, the ETFs receive and
dividends that are paid on the individual stocks.
Tom Preston: So, if the cash index and ETF represent the same thing, why
do they have different prices? The DJX was 112.14 and the DIA was 112.16.
The SPX was 1279.95 and the SPY was 128.14 (1281.40 in SPX terms). As
you can see the differences are not that big.
The main reason is that there are supply and demand forces on the ETF that
push them up and down independent of the individual component stocks.
Yes, there is an arbitrage opportunity that very large institutions can do,
where they can try to buy the basket of component stocks and convert them
into shares of the ETF and simultaneously sell the ETF. That keeps the ETFs
from getting too far away from the cash index.
But the trading activity of the ETF will drive it higher and lower than the last
of the cash index, and for retail traders, there is no arbitrage opportunity.
Tom Preston: The dividends payable on an ETF are held by the trust and
paid out quarterly (monthly in the case of DIA). The ETF will drop on the
ex-dividend date by the dividend amount. You may see a divergence
between the cash index and the ETF as the individual stocks go ex-dividend
but the ETF doesn’t drop because the dividend owed on the stock is added to
the price of the ETF trust. When the ETF goes ex-dividend, the ETF’s price
drops closer to the cash index price. Keep in mind, though, that because the
dividend yields are quite low (2% annually or so for the S&P 500), such
divergence tends not to be too great. Because the ETFs go ex-dividend on
expiration Friday, you will see this convergence at expiration. So, you could
say that the ETF and cash index tend to converge at expiration. But
considering that the ETF and component stocks will presumably trade
indefinitely, there need not be any specific time when the ETF and cash
index are precisely the same. There isn’t necessarily any “settlement date”
for the ETF. So, you will always see some discrepancy between the cash and
ETF prices.
Tom Preston: The consequence for options is that they can be priced
differently because their underlying securities (cash index or ETF) are priced
differently. But more to the point, ETF options are American-style, while
most cash index options are European-style. Also, the ETF options have one
more day to trade than most of the European style cash index options (XEO
excluded). Those are the main reason for the difference in prices. But any
differences there are don’t mean there are any arbitrages, mainly because of
the differences of settlement at expiration, as well as commission and
slippage costs.
Tom Preston: Let me open it up for questions.
apolloofgreece: I can understand why the ETF trades higher than the cash
index (dividends), but why would the ETF trade lower than the cash index?
my_utmost: Has there been any talk about allowing options on SPY, DIA,
IWM to fall under the 60/40 taxation rules?
JT: How do you know, at any given time, if the DIA or the DJX will get
better fills?
bearishbull: Is acting like a closed fund why there are so many new ETF's
popping up?
ngetline: what is dividend risk? ned
jarkis2: From a liquidity standpoint, bid ask spread which ETF's and cash
indices do you feel comfortable trading ?
jarkis2: It seems impossible trading some of the smaller ETf's as there is no
option open interest and liquidity
zolotoyM: How do I turn off this infernal message that keeps popping up in
my 'LIVE NEWS' on the main webpage?!!
RUF: What happens when a stock is substituted because of merger, etc?
JT: When the VIX was at 10.5, TOS trainers taught to trade DJX Iron
Condors. Now that VIX leves are much higher, Iron Condors don't work as
well. What would be a better strategy?
ggreiner9: Tom this is just a little off topic, but what happened to the
expected price feature on the trade screen?
bearishbull: Why does IWM trade later on expiration Friday then the others?
Is that off topic?
apolloofgreece: Can OTM calls sometimes be exercised if the dividend
amount is large enough?
bearishbull: Are there any indexes or ETF's that are worthwhile holding long
term?
gwptrader: ggreiner9 - Click on the oval SETUP button upper right on your
platform. Then look for "Show Expected Price" about 1/2 way down the
list. Use the blue drop down arrow to choose "Always" if you want
expected price feature to be shown.
gwptrader: apolloofgreece - check out Tom's past Wed. classes on when
early exercise is likely and how to evaluate whether your short options are at
risk
http://www.thinkorswim.com/tos/displayPage.tos;jsessionid=33AA2D2CD3∞
A8DBBF8C92A4C44FBF2B53.www2_tos0?webpage=onlineSeminar
jack0408: Is there a new highs and new lows screen for all stocks in the
market?
JT: Sorry for being a bit off topic... I would like to see a "stock screener"
where particular fundamental and technical criteria can be applied to search
for a small set of stocks that meet those criteria?
bearishbull: Maybe it was the otions on IWM that trade later...
GTIP: dividend should be priced in the stock
aa35360: Tom, off topic question: the Nymex mini energy futures (oil,
natural gas, etc) are electronically traded. When will TOS be offerring
those? And do you know if and when options will be offerred on the e-mini
index futures? Thanks.
MichFury: Is there any particular rational for institutions to react negative on
Small Caps indexes, because of the BP rumor???
Bernie: Why the expected price is not sufficiently accurate?
aa35360: Speaking of the Monkey brains blog, why did you go with IC with
70-80% win prob, rather than the usual 50% TOS style?
gwptrader: jack0408 - Until ToS platform has a stock screener, you can click
on the underlined number to open a list of symbols, etc. for today's new
highs/ new lows and more (for free)
http://stockcharts.com/def/servlet/SC.scan∞
MichFury: That improvement to TOS platform was GREAT! Thanks. You
can also customize your own index or selected stocks portfolio.!!!
RUF: Can we get the stock adj button to show 5C rather than a dime?
Bernie: Does the expected price work better for single?
poolman: is there a advantage to the holder ETF ?
MichFury: Thanks for your comments ...pretty good
MichFury: I am expecting to recover some losses on the emini Russell 2000
after 4:30pm EST. Do you think after hours would possibly move $4. up or
down.. or much less. I usually don't trade after hours.???
RUF: On the trade page
bearishbull: aren't holdrs way expensive?
RUF: I think you have to use theo px
gwptrader: HOLDRs website
http://www.holdrs.com/holdrs/main/index.asp?Action=FAQ∞
mike007: Tom, when you gonna join monday class presentations club?
Hopefully soon?
st: Holders come in 100 share quantities. So you can't do odd lots. Options
should be the same as any ETF.
GTIP: i expect er2 go down 10 points
DoubleD: Why don't after-hours trading prices show up on daily charts?
ZGP: any eta on cbot binary interest rate option symbols being carried by
TOS?
Bernie: Does the theoretical price give better prediction on the fill price?
gwptrader: per HOLDRs website, these ETFs are NOT re-balanced like
other ETFs are when a stock in the ETF makes a significant move that may
change the ratio of holdings within the ETF.
treefrog: Is that Monday class only the one that is held in your offices?
joyce: can we record monday training and put in web?
treefrog: You just answered that .... it's live
treefrog: I like Joyce's idea.
gwptrader: joyce - GREAT IDEA!!!
bearishbull: what Monday training are you referring to?
mdsilver: what about getting 200 day moving avg when looking at 2-3 day
15min chart
hollyerjb: one more time on how to get the after hours trade....you said it so
fast i could not get there. thanks.
MichFury: Thanks Tom.... If I leave the emini Russell 2000 active, will it go
to next day? versus Canceling at midnight and start a new day tomorrow.
You know when the paper loss realizes at midnight? Maybe I want to
continue to trade tomorrow todays entry on the emini Russell.
gwptrader: bb - at www.OptionPlanet.com you can see in-office classes.
These are classes held in the ToS offices on Monday nights.
coffeecup: On the Analyze page there is a print/export button...I can only get
a "no page to print" message??
treefrog: For those of us who are pretty far away....could you also record the
Wed classes. San Diego is a long hike.
bearishbull: there are a lot of podcasts on how to make podcasts.
gwptrader: mdsilver - use 5200 period moving average on your 15 minute
charts to see the equivalent of 200 day moving average. (26 fifteen minute
periods per day X 200 days = 5200 periods)
MichFury: Thanks.
RUF: Do you intend to have a booklet explaining all the features in the
platform?
rwilen: What are the exact hours TOS is closed for futures trading, and are
they the same for all the different contracts?
bearishbull: coffee cup, try a screenshot
treefrog: Thanks, Tom
bearishbull: i'd pay real money for a dvd
mdsilver: tos gwptrader will that wok with 50 day as well
MichFury: Tom... did you say Russell in TOS closes at 4:30pm Chicago
time?
livetrader: Wow Tom these Classes are rocking with your info and
Gwptrader helping absolutely AWESOME
Tom Preston:
http://www.thinkorswim.com/tos/displayPage.tos?webpage=servicesOrderT∞
ypes
mdsilver: goo to know thank you gwp
MichFury: Sorry…thanks.
GTIP: hire gwp to finish all the manuals
hollyerjb: thanks tom
Tom Preston: I have to wrap it up now
Tom Preston: If you have any questions or suggestions for the software,
tpreston at thinkorswim.com