premium/discount when buying an ETF

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fctu
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premium/discount when buying an ETF

Post by fctu » Wed Mar 21, 2018 8:10 pm

Are you supposed to consider the premium/discount when deciding if you should purchase an etf?

What is considered an acceptable premium/discount when buying an ETF?

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Re: premium/discount when buying an ETF

Post by livesoft » Wed Mar 21, 2018 8:42 pm

I absolutely never do. For ETFs with reasonable volume that one should want to own, the premium/discount is just waste of time thinking about at all.
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Re: premium/discount when buying an ETF

Post by grok87 » Wed Mar 21, 2018 8:46 pm

fctu wrote:
Wed Mar 21, 2018 8:10 pm
Are you supposed to consider the premium/discount when deciding if you should purchase an etf?

What is considered an acceptable premium/discount when buying an ETF?
it is one of the things i consider. the others would be bid/ask spreads and commissions and of course the expense ratio.
I think it comes down to your holding period. I generally assume that just because i buy at a premium does not mean i would be able to sell a premium.

Let's say an etf has an expense ratio of 0.20% but trades at a premium of 1%, has a bid/ask spread of 0.5%, costs $5 commission to buy and sell.
If i have a 10 year holding period, then annualizing the expenses other than the expense ratio and commission would look like this:

premium-----> extra 0.1% a year = 1%/10
bid/ask spread--> extra 0.05% a year = 0.5%/10

so that would mean an effective annual expense ratio of 0.35% = 0.2% +0.1% +0.05% plus whatever the $10 roundtrip commission would cost as % of the dollar amount of the purchase. THat is probably getting a little high for my taste.

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Re: premium/discount when buying an ETF

Post by livesoft » Wed Mar 21, 2018 9:00 pm

I think grok87 example numbers are quite an exaggeration. So I leave it as an exercise to the OP to state what the average bid/ask spread is for VTI in term of percentage and what the premium/discount range and average is.

I would not be buying ETFs with the numbers that grok87 used as an example either.
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Re: premium/discount when buying an ETF

Post by triceratop » Wed Mar 21, 2018 9:16 pm

What ETFs are you buying, grok? Why do you suspect those numbers are at all accurate?
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Re: premium/discount when buying an ETF

Post by fctu » Wed Mar 21, 2018 9:35 pm

I was buying some international for my HSA today.

Wisdomtree small cap international (DLS) is at 0.24% premium.
SPDR Small Cap ETF (GWX) is at -0.2% premium. ( Negative should be good I think)

I thought these two were basically equally good before looking at the premiums and spreads, but then I bought GWX because of the better premiums. Good decision?

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Re: premium/discount when buying an ETF

Post by triceratop » Wed Mar 21, 2018 9:39 pm

fctu wrote:
Wed Mar 21, 2018 9:35 pm
I was buying some international for my HSA today.

Wisdomtree small cap international (DLS) is at 0.24% premium.
SPDR Small Cap ETF (GWX) is at -0.2% premium. ( Negative should be good I think)

I thought these two were basically equally good before looking at the premiums and spreads, but then I bought GWX because of the better premiums. Good decision?
How did you measure the premium? Are you aware of the limitations of the intraday indicative value? That it has nothing to do with the best estimate of value of the underlying?

(this is not well known so I wouldn't feel too bad; but IIV basically only does FX adjustments not modifications based on what securities in closed foreign markets would likely be trading at)
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Re: premium/discount when buying an ETF

Post by fctu » Wed Mar 21, 2018 9:47 pm

I just used the premium listed on the TD Ameritrade app.

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Re: premium/discount when buying an ETF

Post by grok87 » Thu Mar 22, 2018 4:59 am

fctu wrote: Are you supposed to consider the premium/discount when deciding if you should purchase an etf?
livesoft wrote: think grok87 example numbers are quite an exaggeration
triceratop wrote:
Wed Mar 21, 2018 9:16 pm
What ETFs are you buying, grok? Why do you suspect those numbers are at all accurate?
here is an example of an ETF (BCD= ETFS Bloomberg All CmdtyLngrDtdStrtK-1Fr) that came up in a current thread on commodities.
viewtopic.php?f=10&t=243986&newpost=384 ... ead#unread
I have not bought this ETF yet but I am considering it.

According to morningstar it is currently trading at a 0.57% premium and for 2017 the range on the premium/discount was between -1% to +1%
http://www.morningstar.com/etfs/arcx/bcd/quote.html

I will check what the bid/ask spread is when it begins trading later today.

It obviously depends on the ETF. Some Bond/Commodity ETFs or ETNs can trade at fairly wide premium/discounts.

cheers,
grok
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Re: premium/discount when buying an ETF

Post by livesoft » Thu Mar 22, 2018 8:02 am

fctu wrote:
Wed Mar 21, 2018 9:35 pm
I thought these two were basically equally good before looking at the premiums and spreads, but then I bought GWX because of the better premiums. Good decision?
No, not a good decision if based on the premium.
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Re: premium/discount when buying an ETF

Post by jhfenton » Thu Mar 22, 2018 9:28 am

livesoft wrote:
Wed Mar 21, 2018 8:42 pm
I absolutely never do. For ETFs with reasonable volume that one should want to own, the premium/discount is just waste of time thinking about at all.
I disagree with respect to international ETFs. Several times a year I arbitrage between VSS and VSFVX (Vanguard FTSE ex-US Small Cap ETF and Investor Shares) based on discounts and premiums in VSS, making an average of 50 bp on every round trip.

It is harder to arbitrage Vanguard's other international ETFs, but I own both VWO and VEMAX (Vanguard Emerging Markets ETF and Admiral Shares), and I do choose which one to buy or sell based on discounts or premiums. Today, for instance, I would buy VWO if I needed to rebalance into emerging markets because it is currently trading at a substantial discount to reported IIV (intraday indicative value). Vanguard always closes the gap with fair value pricing, but not all the way (assuming the discount persists through the afternoon).

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Re: premium/discount when buying an ETF

Post by triceratop » Thu Mar 22, 2018 12:13 pm

jhfenton wrote:
Thu Mar 22, 2018 9:28 am
livesoft wrote:
Wed Mar 21, 2018 8:42 pm
I absolutely never do. For ETFs with reasonable volume that one should want to own, the premium/discount is just waste of time thinking about at all.
I disagree with respect to international ETFs. Several times a year I arbitrage between VSS and VSFVX (Vanguard FTSE ex-US Small Cap ETF and Investor Shares) based on discounts and premiums in VSS, making an average of 50 bp on every round trip.

It is harder to arbitrage Vanguard's other international ETFs, but I own both VWO and VEMAX (Vanguard Emerging Markets ETF and Admiral Shares), and I do choose which one to buy or sell based on discounts or premiums. Today, for instance, I would buy VWO if I needed to rebalance into emerging markets because it is currently trading at a substantial discount to reported IIV (intraday indicative value). Vanguard always closes the gap with fair value pricing, but not all the way (assuming the discount persists through the afternoon).
Why do you think IIV is accurate, and things are at a discount at all? I distrust IIV when foreign markets where the underlying are closed. To partially quote myself (follow the link quote for more context):
triceratop wrote:
Sat Apr 15, 2017 6:48 pm
I never assumed that iV necessarily had anything to do with fair value for a fund's assets. Some more research turned up a study by Interactive Data on fair value pricing and indicative value. Of note, as of 2011,
Current Industry Practice with IIV Calculations for Global Equity ETFs

ETF sponsors publish intraday indicative valuations (IIVs [or IOPV or iNAV]) every 15 seconds throughout the trading day to provide investors with a real-time estimate of the ETF's underlying basket value. For U.S. equity ETFs, the IIV calculation process is straightforward, as current market prices for the ETF constituents are readily available throughout the day. With respect to international equity ETFs, however, the current industry practice is to incorporate traded prices for the equities while available, and and then convert the last traded local market prices to USD based on real-time FX rate data.
(emphasis mine)

question: Did the industry standard for fair value pricing change in the time since the Interactive Data report was published? (I did some research on this point which was mostly not illuminating)

This, ahem, is not what Vanguard is talking about when it discusses fair value adjustments: it uses models based on primarily U.S. markets, Foreign futures markets, and FX rates.

Here's the really interesting bit from the Interactive Data report (they created a fair-value adjusted IV and tested it against a ETF's price history as well as IV ticker for a day):

Image

So it is possible for IV (at least at time of this report) to diverge significantly from price; but does this mean market participants are acting irrationally? If you believe the validity of this model, there was a honest to goodness reason for the actual fair value/price of the ETF to be below IV.
Are you saying that Vanguard does fair value adjustment relative to where IIV ends up at the end of the day? I rather thought they used algorithms much closer to what are described above, to estimate the fair value (not just including currency movements) of investments. In my opinion this point I quoted above is an underdiscussed thing on bogleheads.org and I'd like to get some more opinions, at the very least.
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Re: premium/discount when buying an ETF

Post by wshang » Thu Mar 22, 2018 12:18 pm

While I can't always get the data on tax loss carryforward, if a mutual fund has a large tax loss, this is a reason to favor two otherwise identical appearing funds. Of course this ihis is relatively uncommon in recent years, but can prevent a nasty surprise in the New Year.
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Re: premium/discount when buying an ETF

Post by jhfenton » Thu Mar 22, 2018 12:38 pm

triceratop wrote:
Thu Mar 22, 2018 12:13 pm
Why do you think IIV is accurate, and things are at a discount at all? I distrust IIV when foreign markets where the underlying are closed. To partially quote myself (follow the link quote for more context):

Are you saying that Vanguard does fair value adjustment relative to where IIV ends up at the end of the day? I rather thought they used algorithms much closer to what are described above, to estimate the fair value (not just including currency movements) of investments. In my opinion this point I quoted above is an underdiscussed thing on bogleheads.org and I'd like to get some more opinions, at the very least.
I've watched the behavior of VSS/VFSVX and VWO/VEMAX closely for two and a half years. I tracked and graphed the daily data for VSS for more than a year. I've seen where Vanguard's NAV for VSS and VWO end up in relation to IIV. I'm sure they have very sophisticated algorithms, but the reality is that the starting point for their algorithms has to be the closing prices overseas plus current currency prices.

As a practical matter, it's harder to arbitrage from the mutual fund to ETF. VWO will almost certainly close at a discount to Vanguard's reported NAV today, but it will be far less than the $46.96 < $47.45 I see at the moment. (The IIV is 15-minutes delayed. The quote is real-time.) Vanguard's algorithm seems more aggressive in adjusting fair value down than in adjusting fair value up. That is the reason that I almost always arbitrage from VSS->VFSVX when VSS is trading at a high premium late in the day. When VSS closes at a 60-100 bp premium to IIV, Vanguard will usually report it at a 40-60 bp premium to NAV. It's harder to profitably go in the other direction, so I seldom do. Right now, VSS shows a 20 bp discount to IIV. Vanguard will close most of that, making it an unprofitable swap today. For that reason, I actually do the VFSVX->VSS conversion more often than selling and buying. The typical premiums in VSS are larger and more profitable than the occasional discounts.

Note: VWO has already risen to $47.10 with an IIV of $47.49. And VSS is at $118.90 vs $119.05. (It's not arbitrage if you buy or sell the ETF earlier in the day and gamble on which way the market will move.)

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Re: premium/discount when buying an ETF

Post by jhfenton » Thu Mar 22, 2018 2:58 pm

Just for the record, at 3:55 PM, the market price of VSS was $118.00 with a reported IIV of $118.94. The market price of VWO was $46.56 and the IIV was $47.36.

Let's see where they end up after this evening.

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Re: premium/discount when buying an ETF

Post by lahob » Tue Mar 27, 2018 7:49 am

jhfenton wrote:
Thu Mar 22, 2018 2:58 pm
Let's see where they end up after this evening.
Where did they end up?

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Re: premium/discount when buying an ETF

Post by jhfenton » Tue Mar 27, 2018 8:06 am

lahob wrote:
Tue Mar 27, 2018 7:49 am
jhfenton wrote:
Thu Mar 22, 2018 2:58 pm
Let's see where they end up after this evening.
Where did they end up?
Sorry about that. I forgot to report back.

VWO ended up about where I would have expected, with a reported closing NAV of $46.85. So VWO was trading a modest discount at the closing price of $46.46.

For VSS, on the other hand, Vanguard erased the entire discount and then some. The closing NAV was reported as $117.86, slightly below the closing market price of $117.90.

That is why I usually only arbitrage VSS/VFSVX in one direction (i.e., sell VSS at a premium, buy VFSVX at NAV). Large premiums are reduced by fair-value adjustments, they aren't eliminated. (Writing up NAV to reduce a premium in the ETF would reward sellers of the mutual fund.)

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Re: premium/discount when buying an ETF

Post by lazyday » Tue Mar 27, 2018 11:12 am

What sources are people using for real time IIV?

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Re: premium/discount when buying an ETF

Post by jhfenton » Thu Mar 29, 2018 6:26 pm

Today was a decent day for the VSS->VFSVX arbitrage.

I sold 1,xxx shares of VSS @ $119.26 (in two accounts), netting $1yy,yyy.yy after the SEC fee.
I purchased VFSVX with all it, which will net me z,zzz.zzz shares of VFSVX worth $1yy,yyy.yy.
When I call to convert those shares back to VSS, those shares will yield approximately (1,xxx+0.47%) shares of VSS. (That's what it would be if converted today with VSS at an NAV of $118.70. It might vary by a few thousandths depending on the NAV rounding for VSS and VFSVX on the day I convert.)

That is a relatively risk-free profit of 47 bp, or about $xxx (high 3 figures) at today's close ($119.24).

That is why I don't ignore premiums and discounts.

lazyday wrote:
Tue Mar 27, 2018 11:12 am
What sources are people using for real time IIV?
I check Yahoo! Finance, TD Ameritrade, and M* to make sure they all agree. I check the previous day's premium/discount on Vanguard to see where we are in relation to the day before. VSS was at decent premium yesterday, and was trading at an even higher premium today, so I was confident that yesterday's premium would persist, at a minimum.

I do not believe any of the IIV numbers are real-time. Unlike the other quotes, I believe they are 15 minutes delayed everywhere. At least they are on Yahoo!.

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Re: premium/discount when buying an ETF

Post by lazyday » Wed Apr 04, 2018 11:38 pm

jhfenton wrote:
Thu Mar 29, 2018 6:26 pm
I check Yahoo! Finance, TD Ameritrade, and M* to make sure they all agree.
Thanks. Here's another, with a chart: http://quotes.ino.com/charting/index.ht ... =l&a=2&w=1

I haven't used it often enough to guess how reliable it is.

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Re: premium/discount when buying an ETF

Post by Rick Ferri » Thu Apr 05, 2018 9:05 am

IIV is useless for trading ETFs and shouldn’t even exist. Premiums and discounts to NAV at the close are also useless. These values are old and stale. An IIV could be 10 to 15 seconds behind, which is an eternity in the market. In contrast, market makers calculate fair value several times a second.

If you want to understand why these numbers are meaningless, read “Flash Boys” by Michael Lewis. Any price that is more than 1/10 of a second old is out of date in today’s high speed market.

I will also add that the only way you know you are receiving fair value trading is to buy mutual funds rather than ETFs.
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Re: premium/discount when buying an ETF

Post by lazyday » Thu Apr 05, 2018 10:46 am

Rick Ferri wrote:
Thu Apr 05, 2018 9:05 am
IIV is useless for trading ETFs and shouldn’t even exist. Premiums and discounts to NAV at the close are also useless. These values are old and stale. An IIV could be 10 to 15 seconds behind, which is an eternity in the market. In contrast, market makers calculate fair value several times a second.
Let’s say that I want to buy a fund that mostly holds securities that are currently trading as I buy the ETF. For example, developed markets fund FNDF before 11am Eastern.

I wait until a morning when world markets are calm, with prices nearly flat. For the day, the S&P, FTSE, etc are nearly unchanged. For example, on a good enough but not-ideal day, they are down from the prior day by about .2%. I check the stale IIV, and see that it is .3% lower than the current bid-ask midpoint of the ETF. In the last 15 minutes, the FTSE is down about .1%. If I buy the ETF now, I’m likely paying a premium to NAV of about .4%, right? Rounding down from .3 + .1 + a portion of .2. The portion of .2% is for shares not trading this morning such as Japan, if those markets didn't fall overnight.

If I don’t want to pay that premium, I can try again tomorrow if markets are calm again. After a few tries, I see that the stale IIV is .1% higher than the ETF price, with the FTSE and S&P flat both over the last 15 mins and for the day. So I buy, saving myself maybe .5% by waiting a few days.

Is that reasonable?

This is more or less what I try to do when making large transactions, though for an EM fund (FNDE) it’s more complicated. For small transactions, I might quickly check IIV to be sure it isn’t very far off, but will mostly ignore premium/discount.

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Re: premium/discount when buying an ETF

Post by Rick Ferri » Thu Apr 05, 2018 11:56 am

There’s no obvious free money sitting around in the markets waiting for small retail investors who have no access to real prices and real market depth in millliseconds. It may appear that way, but it doesn’t work that way. Neither you nor I nor any retail investor who is using retail data knows where the market is really trading.
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Re: premium/discount when buying an ETF

Post by lazyday » Thu Apr 05, 2018 1:53 pm

Rick Ferri wrote:
Thu Apr 05, 2018 11:56 am
There’s no obvious free money sitting around in the markets waiting for small retail investors who have no access to real prices and real market depth in millliseconds. It may appear that way, but it doesn’t work that way. Neither you nor I nor any retail investor who is using retail data knows where the market is really trading.
If there are many who want to buy an ETF, then arbs will create and supply new shares. They must be compensated for their costs and risks. Isn’t this just the way ETFs work?

So if I buy on a day when others wish to buy, I may pay a significant premium to the underlying asset value. But if I am patient, I may be able to buy at a smaller premium or even at a slight discount. Or I might just choose a less popular ETF.

For funds with liquid holdings, like an S&P 500 fund, the premium will be so tiny it won’t matter. But for something less liquid like EM, international small, microcap, etc, it seems to me that the premium or discount can be significant.

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Re: premium/discount when buying an ETF

Post by Rick Ferri » Thu Apr 05, 2018 2:38 pm

OK. Let me try one more time.

There is no such thing as a free lunch on Wall Street, but there are many people who make a great living spreading that myth.
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Re: premium/discount when buying an ETF

Post by lazyday » Thu Apr 05, 2018 5:05 pm

Rick Ferri wrote:
Thu Apr 05, 2018 2:38 pm
There is no such thing as a free lunch on Wall Street, but there are many people who make a great living spreading that myth.
I'm not really trying to get a free lunch, I'm trying to avoid paying $1.004 for a lunch that's only worth $1.

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Re: premium/discount when buying an ETF

Post by Rick Ferri » Thu Apr 05, 2018 5:38 pm

I know. However, it has been my long experience that when you pay $1.0000 for an ETF share through one of the exchanges that sell order flow (like Charles Schwab), you get only $0.9999 worth of the ETF, and that’s before commission. You don’t complain because you don’t know what the true NAV was at the time of the trade, and you never will.

If you want to ensure your getting fair value when buying or selling funds, then use mutual funds that trade at NAV, not ETFs where lots of people have their fingers in the pie.
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Re: premium/discount when buying an ETF

Post by grabiner » Thu Apr 05, 2018 9:03 pm

lazyday wrote:
Thu Apr 05, 2018 5:05 pm
Rick Ferri wrote:
Thu Apr 05, 2018 2:38 pm
There is no such thing as a free lunch on Wall Street, but there are many people who make a great living spreading that myth.
I'm not really trying to get a free lunch, I'm trying to avoid paying $1.004 for a lunch that's only worth $1.
But I would worry more about spreads than premiums when trading ETFs. If there is an open order to buy an ETF at $49.98, and one to sell the same ETF at $50.02, then the market makers believe that the fair price is within that range. I don't know as much as they do, but I do know that if I place an order to buy 1000 shares at $50.02, I have lost somewhere between $0 and $40 to the fair value; $40 isn't significant in my $50,020 investment. In contrast, if I see a spread of $49.98-$50.48, there is $500 at stake, and I will wait for that spread to narrow before buying. (I often trade ETFs in the morning, and see impatient buyers on the wrong end of these 1% spreads, with one buying at $50.48 and then another selling at $49.98 a minute later.)
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Re: premium/discount when buying an ETF

Post by lazyday » Fri Apr 06, 2018 5:23 am

Rick Ferri wrote:
Thu Apr 05, 2018 5:38 pm
If you want to ensure your getting fair value when buying or selling funds, then use mutual funds that trade at NAV, not ETFs where lots of people have their fingers in the pie.
That makes sense, especially for someone who tends to buy and sell when others do. Of course not all funds have traditional mutual fund shares.

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Re: premium/discount when buying an ETF

Post by lazyday » Fri Apr 06, 2018 5:31 am

grabiner wrote:
Thu Apr 05, 2018 9:03 pm
But I would worry more about spreads than premiums when trading ETFs.
Though it’s very easy to see the spread compared to estimating a premium.

For funds I’ve bought lately, I think the typical premium is larger than the spread (at ~9:45 to 11am Eastern). FNDF for example might trade with a spread of .1%, and with a market order I might pay a little more than half of that. ETF.com reports the median premium as .3%, though it is probably a touch lower if we adjust for stale prices, if the market is generally up over their measurement period.
If there is an open order to buy an ETF at $49.98, and one to sell the same ETF at $50.02, then the market makers believe that the fair price is within that range.
Assuming “fair price” includes accounting for demand for the ETF itself, not just the underlying value of the securities.
Last edited by lazyday on Fri Apr 06, 2018 5:33 am, edited 1 time in total.

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Re: premium/discount when buying an ETF

Post by livesoft » Fri Apr 06, 2018 5:33 am

Rick Ferri wrote:
Thu Apr 05, 2018 9:05 am
I will also add that the only way you know you are receiving fair value trading is to buy mutual funds rather than ETFs.
Throughout this thread, there seems to be the assumption that "fair value trading" is actually at fair value. Ha!

Fair value pricing probably has many problems of its own.
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Re: premium/discount when buying an ETF

Post by Rick Ferri » Fri Apr 06, 2018 7:11 am

Mutual fund companies have a legal obligation to determine NAV at the end of the day to ensure both buyer and seller receive a fair NAV price (and the same NAV price) regardless of the quantity traded.

Spreads to trade ETFs are smaller at certain times during the day, but they always exist, and that is an uncontrollable cost. You can’t trade at the price and quantity you want.

Many ETFs show only 100 shares on the bid and ask. As soon as you put your larger order in at that price, high frequency trader algorithms kick in, the 100 shares disappears - and you didn’t get any filled.
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