etf fee arbitrage

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JackInTheGreen
Posts: 11
Joined: Sun May 20, 2018 2:40 pm

etf fee arbitrage

Post by JackInTheGreen » Sun May 20, 2018 3:03 pm

Naive, purely theoretical question, but one I'm curious about. Let's say I find an ETF with a relatively short constituent list. I then buy all the individual stocks at the same weights in a commission-free brokerage like Robinhood, and short the ETF for an equal dollar amount. Could I essentially collect the expense ratio as arbitrage profits?

rantk81
Posts: 88
Joined: Tue Apr 18, 2017 8:12 am

Re: etf fee arbitrage

Post by rantk81 » Sun May 20, 2018 4:24 pm

You’ll pay a borrowing fee for borrowing and shorting the shares, much more than the etf’s expense ratio.
Also, you won’t always know or be able to replicate the precise ratio of holdings in the fund either.
I don’t recommend trying this. Far easier to just buy a money market fund for a “guaranteed” small rate of return.

Edit: Another reason not to do this is, short positions can be closed outside your control if the original owner of the shares wants to sell their position.

drk
Posts: 690
Joined: Mon Jul 24, 2017 10:33 pm
Location: Seattle

Re: etf fee arbitrage

Post by drk » Sun May 20, 2018 5:03 pm

rantk81 wrote:
Sun May 20, 2018 4:24 pm
You’ll pay a borrowing fee for borrowing and shorting the shares, much more than the etf’s expense ratio.
Don't be so mild. That borrowing fee will likely be two orders of magnitude higher than the ER.

JackInTheGreen
Posts: 11
Joined: Sun May 20, 2018 2:40 pm

Re: etf fee arbitrage

Post by JackInTheGreen » Sun May 20, 2018 9:21 pm

Rest assured I had no intent of actually doing this, just wanted to know what the pitfall was. Thanks for the responses.

I didn't realize all stocks had borrowing fees - I thought it was only "hard to borrow" stocks. What's a typical fee?

TravelerMSY
Posts: 197
Joined: Sun Mar 03, 2013 5:40 pm

Re: etf fee arbitra

Post by TravelerMSY » Mon May 28, 2018 6:01 pm

You’d have to lookup the borrow fee first, or find a broker that doesn’t charge it for GC shorts. This would only be attractive in absolute dollars levered up, and I’m assuming there are still hidden risks we haven’t thought of yet.

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