Would you hesitate to make an ETF trade that was significantly larger than the average daily volume? Here’s an example of how ETF liquidity works and what really matters.
During the first quarter of 2017, 1.1 million shares of NOBL (ProShares S&P 500 Dividend Aristocrats ETF) were bought in one block trade.
otional is notable for its This trade of $60 million notional is notable for its size and the quality of the execution. It is also a good example of some of the fundamental principles of ETF trading that are worth reviewing:
ETF volume is not an indicator of ETF liquidity
At the time of the trade, NOBL’s average 30-day volume was approximately 360,000 shares. The above-referenced trade was approximately three times the average daily volume. The ability for market makers to access the underlying liquidity of the ETF’s components, or basket, created a secondary level of liquidity that far exceeded the average daily volume of the ETF. As noted in the graph below, 1.1 million shares were sold at 11:07 am on the offer at $54.15 when only 8,400 shares were publicly offered at that price, which made no noticeable impact on the bid-ask spread.
Liquid underlying constituents means liquid ETFs
The underlying constituents of NOBL are 51 U.S. large cap equities that are equally weighted. These large cap securities are some of the most widely held U.S. equities with deep liquid markets. For the $60 million notional trade noted here, the approximate 2% weighting in NOBL yields approximately $1.2 million in notional to buy in each security. Viewed this way, the transaction is a relatively small trade across 51 securities. As result, the 1.1-million-share trade had little effect on the secondary trading of the ETF following the trade.
Accessing liquidity providers is the key to great execution
ETF liquidity providers have the unique ability to create and redeem new shares of the fund. As a result, they can look past low screen volume in an ETF to the underlying components. In addition, when the underlying components do not have the same liquidity as those in NOBL, in the case of small cap ETFs for example, a liquidity provider could use a liquid proxy hedge like small cap futures to provide immediate liquidity in the ETF and over time buy the underlying components. In either case, the liquidity provider needs only to deliver the underlying basket of securities to create new ETF shares.*
Intraday value can be a guide to execution quality
The intraday value provides a good estimate of the underlying value of the ETF compared with the trading prices of the underlying basket. The intraday value for NOBL is published by the NYSE every 15 seconds. At the time the trade was executed, the intraday value was approximately $54.1286. In other words, the trade was only $0.0214 (approximately 4 basis points) over the intraday value.
This article can be found at Proshares website here