Mispriced ETFs and a market warning

From the “Why I rarely use stop-loss orders and never with ETFs” department…

There were several (many?) ETFs (Exchange Traded Funds) that were badly mispriced during this market crash day. These are sold as being roughly the equivalent of a ‘basket of stocks’ like a mutual fund, but one that you can trade during the day.

The problem is, they are not.

Somewhere there is a market maker who has a computer look at the underlying ‘basket’ and then make a synthetic of it for you. Sometimes via buying the stocks, sometimes with options, sometimes just via a contract / promise. When, due to data delays, glitches, computer AwShits; they can’t get the prices of the underlying, they just make a price that is guaranteed to get them out OK (you, not so much).

Now mix that with the toxic soup of HFT (High Frequency Traders) who have very special very high speed data connections and very special very high speed robot computer trading systems, and they can move the underlying faster than the ETF market maker can respond… So we had a “flash crash” of sorts down 1000+ DOW points in a few minutes at the open, and the folks with “safe” ETFs in things like financials with dividends who put a ‘prudent’ 10% stop loss order behind it to be able to sleep well got sold out dirt cheap. How cheap?

SDY is an S&P 500 “dividend” ETF. You know, retired folks and orphans need lunch money kind of story.

First up, a 5 day 5 minute chart, then we will zoom in on the day of the long knives…

After being down 5%, when the market took another 7% or so down, this ETF priced at -40%. Yes, 40 Percent DOWN and at least 30% DOWN FROM REALITY. I’ve got the S&P 500 as a gold line on this chart for comparison.

SDY 5 day 5 minute mispriced 26 Aug 2015

SDY 5 day 5 minute mispriced 26 Aug 2015

Here is a close up on that day with 1 minute tick marks. It looks to me like there are gaps, discontinuities between those early price bars, not evidenced in the later prices (but I’m just eyeballing it, so who knows). IMHO that shows the Market Maker manually setting prices as they struggle with the lack of a proper underlaying price, so just ‘making stuff up’ (that just accidentally assures they get richer and the poor folks selling got fleeced).

SDY 2 day 1 minute misprice chart 24 Aug 2015

SDY 2 day 1 minute misprice chart 24 Aug 2015

You can also see that the ‘error’ went on for about an hour… PLENTY of time, IMHO, for the Market Maker to have just looked at the S&P 500 ticker on the big board and known they were waaaayyyy underpriced on the offer.

On the Talking Heads financial shows, they are banging on about how, tsk tsk, that’s too bad and wrong, but the orders will not be cancelled.

IMHO this is exactly the kind of trade that needs to be reversed and ‘set right’. THIS is where the “regulator” needs to be “regulating”. They aren’t, near as I can tell.

So was it just this one? Nope. Here’s another (more or less at random – I don’t have a complete list):

XLF 5 day 5 minute mispriced 26 Aug 2015

XLF 5 day 5 minute mispriced 26 Aug 2015

Gee, “only” down 25% ….

The gold line in this graph is the Broker / Dealers index as a proxy for ‘financials’. Not an exact match, but the same sector. Here’s the close up:

XLF 2 day 1 minute mispriced 24 Aug 2015

XLF 2 day 1 minute mispriced 24 Aug 2015

Handled better, over in just a few minutes instead of an hour, and “only” about an extra 16% scalping instead of 30%.

So who made the money in those cases? Well, anyone buying that ETF (which will have been almost entirely the market maker during those crash moments, but a few folks with ‘buy if touched’ orders – though it would take a very very close look at the order book for those minutes to hour to sort it out. Oh, and a very close look at the ‘bid ask spreads’ since the Market Maker might have had a bid of, say, 40% off and an offer of only 10% off and still cleaned out the buyers…)

The Market Maker will have been buying those ETF sells (that is required) but doing it at rip off prices (they do get to set the price) and then “later” noticing that the sell of the underlying they did to offset just ‘happened’ to occur at much better prices…. Nice work if you can get it.

Welcome to the world of automated ripping off of “widows and orphans”…

In Conclusion

And that, boys and girls, is why a ‘stop loss’ order is often more of a ‘loss lock in’ order and why you ought to be particularly careful about using them with ETFs.

Much more often than not, markets make wide ‘excursions’ and then return to nearer normal ranges. It has been my experience that if you miss the ‘sell now!’ on a crash, you get a better price later in the session, or if the crash accelerates, a few days later on the rebound.

But in all cases you don’t get fleeced for an extra 40% off…

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About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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2 Responses to Mispriced ETFs and a market warning

  1. Paul Hanlon says:

    Hi Chiefio,
    This has been a very nice series of financial posts, thanks.

    I have a small spreadbetting account over here, I believe they’re banned in America. Spreadbetting is basically futures for the small guy. And because the spreadbetting company makes the market, you can trade a share price like a future, only having to put up a small margin each bet. The company makes money not just on the spread, but also by trading in their own right, based on what they’ve learned from the way people are betting.

    Quite a few times I’ve noticed, particularly when I put tight stops on a bet, that the price will all of a sudden start gravitating towards my stop loss, take it out, and then gravitate back to the point where the underlying market is. I’m not saying this is done deliberately, although it’s a possibility, and anyway, I am trading too small to be someone of interest. It’s probable that I’m setting my stops where a lot of other people are too, and we’re all getting taken out.

    When you set a stop loss, you’re giving away an awful lot of information to the market maker, information that can then be used against you if needed. By seeing where most people are putting their stops, they can take them out if they are close enough to the price (It is possible to move the market for a few minutes with a large trade, and that’s all they need), or if they want to trade themselves, make sure that their stop isn’t taken out by setting it beyond where most other people are. Nice work if you can get it.

  2. p.g.sharrow says:

    The house ALWAYS wins. They call it gambling 8-0!..pg

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