ETF Basics
Research for Online Investors

by John Dalt

06/01/2009

I talked with one of our subscribers this weekend and realized that the letter on Friday may have assumed some market experience that all may not have.

We are all familiar with buying stocks.   We study a company and decide that we would like to be an owner.   We used to call our broker and discuss it with him then place an order to buy the stock.   Our broker helped us with money management, sector diversity, asset allocation, stop losses.      

Today, most of us have an online brokerage account.   These can be with one of the major stockbrokers, or may be with a discount online brokerage company.   There are advantages to each, as the major brokerage houses have more research available. 

Exchange Traded Funds (ETF’s) are relatively new, having been introduced in the mid 1990’s.   The first widely accepted ETF was SPY, which tracks the S&P 500.   SPY owns every stock in the index.   As a small investor, you can buy one share of SPY, and own an undivided interest in every stock included in the SP500!   The stock holdings are weighted and are public knowledge. 

This is how the SPY maintains pricing parity to the stocks it represents. 

1.    If the price of SPY is less than “Net Asset Value”, large institutions can buy SPY shares on the open market then exchange these shares with the ETF creator for underlying index shares; this causes the SPY share price to go up, as supply is reduced. 

2.    If retail buyers bid up SPY shares above “Net Asset Value”, large institutions can exchange a bundle of the index stocks to the ETF operator in exchange for SPY shares. The institution would then sell these new SPY shares on the market driving down the price, as the supply is increased. 

3.    These two forms of arbitrage by large institutions keep the ETF priced very close to parity with the value of the underlying stocks. 

4.    Pricing action is publicly disclosed throughout the day so institutions can evaluate a profit opportunity to either buy SPY shares in the open market to reduce supply, or exchange stocks for “creation” shares to increase supply. 

All ETF’s follow similar public disclosure, and arbitrage to outside market makers.   SPY is the original index fund; it actually owns the shares of the companies in the index.   There are ETF’s that track sector indexes, ie: transportation, industrials, technology, consumer goods, utilities, health care, and financials.   There are ETF’s that track the Russell 1000, or Russell 2000, or the Dow. 

Today we have learned a little about index ETF’s, and how they work.   Tomorrow, we will look at Ultra’s, Inverses, Triples, and Back flips.   I just made up that last one, but if some of the jokers on Wall Street get a bright idea, we may see it in the coming months. 

The market rallied today, GM is in bankruptcy. Oil, natural gas, and interest rates jumped. Gold and silver took a breather.  We closed a losing position in the SwingTrader, and opened another making almost as much as the loser in one day!  Whether you want to swing for the fences, or invest for the long-term, we want to help you.  We want to be of service, helping you realize your goals in investing.  Both services are inexpensive (cheap), and are designed for busy investors.

An interesting news item from Pravda, the Communist Parties Newspaper, featured an opinion article this weekend. You can read the article at Pravda.    A short quote that may wake some Americans Up, especially those in Blue States.

“It must be said, that like the breaking of a great dam, the American descent into Marxism is happening with breath taking speed, against the back drop of a passive, hapless sheeple, excuse me dear reader, I meant people.” 

   Evidently the article is popular, Pravda’s server is down.   Pravda means “Truth” in Russian.  

My family reminds me to talk about stocks in this newsletter; I wonder what the Russian people talked about in 1918, just before they were enslaved for over seventy years? If you have kids, you better get angry, and involved. 

Thought for the Day sent in by subscriber S.V.:
I called my stockbroker today and asked, "What are you buying?"
He said, "Canned goods and ammunition."

Will your children visit this headstone?

Will they tell family stories, handed down through generations?

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future

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