- Markets & Risk Newsletter
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- ETF Volatility In their endless quest for investing opportunities that are both highly complex and easy to trade, investors are finding exchange-traded funds (ETFs) to be increasingly attractive. These vehicles resemble mutual funds in that they consist of bundled securities or other assets. The assets may be correlated or uncorrelated. Each ETF portfolio is designed to track an index international stock, broad stock or bond market, or stock industry sector while trading like a single stock.
Unlike mutual funds, whose shares may be traded only at the close of the trading day, ETF shares can be traded on the secondary market anytime during the day. Because the valuation of an ETF is continuous during trading hours, investors are able to obtain real-time share prices. In addition, ETF shares are initially sold in blocks on the primary market as "creation units," which can be redeemed by the original institutional investors in kind. This means that ETF share prices tend to deviate less from their net asset value (NAV). With ETFs, investors can buy or sell shares in the overall performance of a portfolio as if it were a single security. To the traditional benefits of index fund investing, exchange-traded funds add the ease, flexibility, and liquidity of stock trading.
ETF Options In their endless inventiveness, investors have adopted ETF options as a way of defending against volatility. Without selling the position and triggering taxes, investors can choose from over 60 ETF options to secure profits from rises in an ETF or to buy insurance against a drop in a volatile market. The attraction of ETF options is convenience while many large stocks offer options, trying to manage many at once becomes a Gordian knot of tracking, expense, and paperwork. ETFs make defensive options easy to manage. The ETF market now provides a large number of products specializing in commodities, bonds, and even inverses. None of these include assets that are impossible or exceptionally difficult to trade, but today there are hundreds of ETFs and CEFs that provide easy access to these holdings.
Sources of Risk -Market Risk. Due to many factors including global events, economic conditions, investor sentiment, and security-specific factors, market prices for ETFs and their underlying securities fluctuate daily. While the VIX has settled down closer to its historic average in the 20s, analysts believe there may be plenty of volatility ahead. -Pricing Risk. The market price for ETF shares is based on the forces of supply and demand. While ETF creation units are redeemable for securities, there is still the possibility of pricing variances between the NAV and the exchange price. -Correlated Focus Risk. The risk associated with a particular ETF corresponds to the risk of the asset class the fund is tracking. For example, a mid-cap technology stock ETF would be more volatile and pose higher risk than a long-term government bond ETF. -Volume Risk. Some ETFs are less frequently traded than others. In a market downturn this could make them difficult to sell at the desired price, or to sell short. -Truth in Labeling Risk. Investors need to scrutinize the assets held by a prospective ETF because the title of the fund may not accurately reflect the type of underlying assets.
For information on powerful risk-management tools that allow you to track and measure the risk of global exchange traded funds, options, and broader equity markets, contact PortfolioScience today. |
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