Trading Low Volume Exchange Traded Products   

Updated: Aug 21st, 2015 | Vance Harwood

Many of the 1600+ Exchange Traded Products (ETPs) on the market are low volume, low asset offerings that either implement failed strategies or have bigger, higher volume competitors.  However some low volume ETPs offer unique opportunities you won’t want to wait for.

I’ve organized the special handling required for low volume funds into these categories:

  • Alternatives
  • Before you buy
  • When you buy
  • While you’re holding
  • When you sell

The liquidity of low volume ETPs is a big topic of its own which I discuss in Determining the Liquidity of Low Volume ETPs


Choosing an ETP—are there alternatives?

Before you trade a low volume ETP you should search for alternatives.  The biggest fund in a given strategy segment will usually have the narrowest bid / ask spreads and the best ability to handle large trades without shifting significantly in value. When comparing bid/ask spreads between ETPs it’s useful to convert them into percentages of the trading price (e.g., a 7 cent spread for a $25 ETP is 0.28%).

Some people prefer Exchange Traded Funds (ETFs) over Exchange Traded Notes (ETN) for the equivalent strategy because the assets underlying the ETF are held directly by the fund.  Whereas ETNs just give you a promise from the issuer to make good on redemptions, much like a bond, and you typically have no visibility into how the issuer is hedging their positions.  Since ETN issuers are typically big banks with very good credit ratings I don’t put much weight in this distinction.  See “Credit Risk and Exchange Traded Notes” for more detail on this subject.

Two other possible selection criteria are availability of options on the fund, and tax considerations.  Some funds require a K-1 form to be submitted for taxable accounts rather than the typical 1099 treatment. That’s usually not a big deal, but something to be aware of.

Finally, fees are worth a look as a tie-breaker.  However if you’re interested in a low volume ETP you’re probably looking for gains that are large compared to the differences in in fees.


Before you buy

Once you’ve selected a low volume ETP you’re still not ready to trade.  Some due diligence on the day-to-day price behavior of the fund is called for.  There are three key factors:  bid /ask spreads, intraday value, and market depth.

The difference or spread between the price for you to sell (bid) and the price to buy (ask) for a low volume ETP is usually significantly more than the penny typical for high volume ETPs.  If you have trouble remembering if it is the bid or the ask that is pertinent for your trade just use the price that’s worse for you—that rule always works.   The spread is essentially another fee that you pay every time you go in and out of a fund; if the spread is wide its costs can be comparable to the annual fee.

Monitor the spreads over the course of a couple days and at different times.  Many low volume ETPs seem to need their morning cup of coffee before they reach their normal ranges, so give particular attention to the spreads soon after the market open.  Some authors suggest avoiding trades right before close, but I’ve not seen that be a problem. Get a feel for the normal spread of the ETP— that will be important when you are ready to make a trade.

The intraday value (IV) or intraday Net Asset Value (iNAV), detailed here, is the near real time calculation of the index that the fund tracks, typically updated every 15 seconds.  An IV value between the bid / ask prices gets a green light.  When outside that range it indicates one or more of the following:

  • Liquidity challenges with the underlying  (e.g., Junk Bonds)
  • Difficulties valuing securities on a real time basis (e.g., underlying markets are closed)
  • Extenuating circumstances (e.g., government restrictions / political crisis)
  • The fund might not be working well, see If you think your ETP is broken for details.

These factors aren’t necessarily show stoppers, but they warrant additional investigation.

It’s also a good idea to check the market depth of the fund.  You can do this by looking at the level 2 quotes.  Not only can you see how many shares are being offered at the current NBBO (National Best Bid and Offer) but you can also see how much public liquidity there is at prices inferior to the current best bids and offers.  This post gives more information on interpreting those quotes.  Remember these quotes only report public liquidity— for ETPs there are typically many more shares available near the bid / ask prices that are hidden from view.


When you buy—if today is the day

When you have decided to buy you need to make another decision—at what price?  Never use a market order with low volume ETPs, always use a limit order—otherwise you’re just asking to be ripped off.  With a limit order you need to pick a price you are willing to pay and no more, otherwise no trade.  You should only trade an ETP when it is behaving normally.  Put your trade on hold if there’s an abnormally wide spread, unusual IV quote compared to the bid/ask or unusually slim market depth.

If you’ve determined your ETP has good liquidity, and your order isn’t more than a few thousand shares you can be reasonably confident your order will complete at the current ask price.  Market makers will often only officially commit a small number of shares (e.g., 100s) for the current best asking price so unless your order is small you will likely see a series of partial fills that might even stall for a while before your order completes.  The initial action is very fast—clearly computer driven.

When you’ve exhausted the immediate liquidity at the limit price and your order has not been completely filled you will often see a significant pause before any more transactions occur.  I doubt there are any humans involved at this point, but experientially it feels like the other side is considering your order.  Perhaps there are automated queries going to various dark pools soliciting interest—or maybe the computers are just letting you sweat.

If your order doesn’t complete immediately you will see the ask price jump up, increasing the spread beyond its typical levels.   You’ve sucked up the public liquidity displayed at the old ask price; you’re now seeing  the new, higher price the market makers are asking for while they consider your order.

The market will not hold still during this time.  If it moves in your favor your order will complete, but Murphy would say that it will move against you.  If it moves enough, your order won’t complete and you’re left with an incomplete order.  This is not a disaster, you can replace your order (and pay another commission) with a new price that is more likely to complete.  You’re probably still better off than if you had used a market order.

If the market runs away from you when you’ve had a partial fill it’s very tempting to chase it, it’s very frustrating to be that close to a profitable purchase and miss out, but remember that markets fluctuate, and that it’s unlikely you’ve missed the last time the security will trade at that price.

You can try to shave a few pennies off the ask price by offering a price between the bid and ask.  If nothing happens you’ve lost nothing (unless the market moves against you), if you get a fill, or a partial fill you’ve saved some money.

If you order is large from a dollar amount standpoint you should get some help to move your order.  It’s not a good idea for you to break up your order into smaller pieces in hopes of not significantly moving the price.  High frequency traders are very good at sniffing out attempts to do this.  For specifics on getting professional help moving large orders see “How to Trade ETFs Without Getting Fleeced”.

An abnormally narrow spread suggests that someone other than a market maker is trying to beat the spread, offering a trade inside the bid / ask.  If you’re tempted to take this trade check the level 2 quotes to see if your order size is greater than or equal to the size of your trade.  If your order size exceed the listed liquidity you will likely experience a partial fill—not a big deal, but ultimately it might cost you some extra commissions.


While you’re holding

Unfortunately low volume ETPs are very susceptible to flash crashes.  One sloppy trader using a large market order can clean out the publically available liquidity in a few milliseconds, often dropping the bid price multiple percentage points.  A market order is required to execute immediately so most hidden sources of liquidity can’t come into play.

General market disruption, “fat finger” trades, and exchange software problems can also glitch ETP prices.

These crashes often are over before a human can even get involved.   The chart below shows how the VXX volatility ETN spiked from +4% to –3% over the course of 10 seconds.



Because of flash crashes it’s a bad idea to have any sort of standing sell orders or trailing stops in place.  A traditional stop loss order will convert into a market order as soon as the stop price is breached—automatically turning you into a sloppy trader.  Stop loss limit orders are better because they put a lower limit on the price you will sell at, however they will often execute on the recovery side of the flash crash, dumping you out of your position right before the security goes on to regain its pre-crash value.

Eschew automated orders.  Monitor things manually or setup email / text alerts to keep informed.


When you sell

 The process for selling is very similar to buying.  Make sure the ETP is trading normally with reasonable bid / ask prices located close to the IV price.  As always with low volume securities limit orders are a must.



Low volume ETPs can be very profitable, but must be treated with care.  I frequently see trades on these funds where the investors leave significant money on the table—or more accurately in the market maker’s pocket.   Pay attention and don’t be a chump.

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Evaluating Liquidity of Low Volume Exchange Traded Funds 

Updated: Aug 1st, 2015 | Vance Harwood

It’s disconcerting when the Exchange Traded Fund (ETF) you’re interested in has low trading volumes.  Days can go by with no volume at all.  If it was a small cap stock you wouldn’t consider buying it.  But low volume in itself shouldn’t prevent you from considering an ETF—some have the liquidity of a large-cap stock.


ETF Liquidity

Unlike stocks, ETFs have two levels of liquidity.  The first level is the same as a stock—the pool of people / institutions that hold, or are short the security.  The second level of liquidity is the domain of institutions.  They monitor the difference between the ETF’s trading price and the price of the underlying securities.  If that gap gets big enough they will buy or sell the ETF as appropriate and trade an offsetting transaction in the underlying.

For example, let’s say there was a low volume ETF that tracks Apple, Amazon, and Google—I’ll call it AAG, which holds one third of its assets in each stock and rebalances at the end of each day.  During the day you’d expect AAG’s intraday value to be the market prices of AAPL, AMZN, and GOOG times the number shares it’s holding in each.

But what if AAG is trading lower than its asset value?   If you can buy AAG at 55.03, and it has 200,000 shares outstanding the market is valuing the fund at $11,006,000, but what if you could sell AAG’s stock holdings for $11,050,000 –a 0.5% premium?

The second tier liquidity providers know exactly what to do; they buy undervalued shares of AGG, and short the appropriate number of Apple, Amazon, and Google shares to lock in their profit.  At day’s end they go to AAG’s issuer and sell back (redeem) the AAG shares they bought in exchange for shares of AAPL, AMZN, and GOOG. These ratios are fixed for the day so they get exactly the number of shares they need to cover their short positions.  They’ve just made 0.5% on their invested capital with zero risk.  It doesn’t matter what happens to AAG, AAPL, AMZN, and GOOG’s prices after their trade executions—their position is perfectly hedged.  This is an example of riskless arbitrage.

So how do the transactions of the 2nd tier providers (called Authorized Participants, or APs) impact AAG’s price?  Well, if AAG is underpriced they are buying it, driving up the price, and if it is overpriced they are selling AAG—exactly the actions that are needed to bring AAG’s value closer to its ideal level.   Because these transactions are riskless to the APs they are happy to continue them until the price difference between the market and the ideal level becomes too small to be profitable given transaction costs, bid/ask spreads, etc.

In the case of AAG the liquidity provided by the APs makes AAG no riskier for the investor than owning Apple, Amazon, and Google.  You can buy or sell large quantities of AAG without impacting its price.

If the underlying securities of an ETF are liquid then the ETF itself will be liquid too.

On the other hand, the liquidity picture for an ETF that tracks small cap Chinese stocks (e.g., ECNS) is significantly different.  The underlying stocks aren’t even trading when the USA markets are open because there’s no overlap in trading hours with the Chinese exchanges.  Now instead of riskless arbitrage the 2nd tier liquidity providers take significant risks if they buy or sell ECNS shares.  They will do these transactions, but not without requiring a significant premium to sell you shares or a discount in buying shares from you.


What About Exchange Traded Notes?

 Although the term ETF is used generically to reference all exchange traded products, a subset of funds called Exchange Traded Notes (ETNs) handle things differently than the example above.  While ETFs explicitly hold the securities specified in the index they track, ETNs link to their index without revealing how they hedge their exposure to market moves.  In practice ETN issuers do hedge their positions, but usually with derivatives like swaps or options that are less expensive than the actual underlying securities.

When an ETN’s shares are redeemed issuers pay out cash according to the Net Asset Value (NAV) per share rather than exchanging securities.  If the AAG example above was an ETN the Authorized Participant would cover their short positions themselves by buying Apple, Amazon, and Google shares at day end rather than obtaining the offsetting securities from the issuer.  If the underlying securities are liquid the arbitrage transactions by 2nd tier liquidity providers are just as effective for ETNs as they are for ETFs.


Evaluating Market Depth

 As a liquidity cross-check for ETFs and ETNs you can look at their Level 2 market depth.  These reports tell you not only how many shares are being offered at the National Best Bid and Offer (NBBO) quotes, but also can give you an indication of how much additional liquidity is available if you are willing to pay a premium on a buy or accept a discount on a sale.

The Level 2 Schwab StreetSmart Pro screen shot below of market depth is for Direxion’s Lightly Leveraged  Daily S&P 500® Bull 1.25x Shares (LLSP), an ETF with low daily volume.  Its underlying is the S&P 500— probably the most liquid security in the world.


The numbers on the far right indicate the number of shares various market participants are willing to sell at the prices listed in the middle.  The share amounts shown are minimum amounts—other players like High Frequency Traders (HFT) and dark pools will likely jump in with additional liquidity if a buyer appears.   The top two depth lines are essentially a duplicate, showing that the quote provided by the “arca” exchange is the current overall best bid.

A market order to sell 1000 shares would likely sell 600 shares at 26.64 and the remaining 400 at 26.63—a mere 0.04% less than the initial bid value.

A limit order to sell 1000 shares would probably fill entirely at 26.64 within a few minutes.

The next screenshot shows the level 2 quotes for another low volume ETF— iShares’ MSCI China Small-Cap (ECNS).  It does not have good liquidity even though it holds more than 20X the assets of LLSP.

bid ECNS-liq

A market order (not recommended!) to sell 1000 shares of ECNS would likely clear the book down to the 47.45 level—a big 2.3% drop from the starting bid price of 48.57.  A limit order at 48.57 would enable you to sell at least 300 shares at that price, but there is a good chance the rest of order would not fill because the next official bids are 0.5% lower.  The illiquidity of the underlying stocks makes it unprofitable for the tier 2 liquidity providers to offer better prices.


Some Investigation Required

Unlike a small cap stock you can’t judge the liquidity of an ETF or ETN by its daily volume or assets under management.  A quick look at the securities underlying the fund will spell out the real liquidity story—it’s dumb to use small cap rules of thumb.

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VQTS: A Large Cap Investment That Protects Itself

Updated: Nov 9th, 2015 | Vance Harwood

VQTS is an exchange-traded product that that attempts to solve the essential conundrum of the stock market: how to run with the bulls without getting mauled by the bears.

The algorithms in VQTS are tuned to outperform the other hybrid volatility funds like Barclays’ VQT and VelocityShares’ SPXH during good times and to be competitive during the bad times.

We don’t have much trade data since UBS only introduced VQTS on December 3rd, 2014.  It stumbled in its first month of trading, but then recovered during the first half of 2015—but after 8 months it is only lagging SPX by 0.5% since its inception.

Hybrid-since-VQTS incept


All of the hybrid volatility funds dynamically allocate assets into the S&P 500 (SPX), VIX futures, and cash depending on market conditions.  VQTS is the first fund of this type that invests essentially all of its assets into the S&P 500 when the market’s overall volatility is low.  This avoids the costs of hedging when the market is least likely to go down—during the long upward stretches of bull markets.  In comparison, two similar funds, Barclays’ VQT and PowerShares’ PHDG both have at least 2.5% of their assets allocated to long volatility—and that small amount significantly drags down their returns during bull markets.

The chart below compares the simulated performance of VQTS compared to SPX, VQT, and SPXH from early 2006.



VQTS defines low volatility as being historical volatility less than 10% using the higher of two exponentially weighted moving averages on volatility.  Before shifting allocations VQTS requires that its historical volatility metric move by more than 10% from the target volatility used at its last rebalancing.  Once the target volatility climbs above 10% VQTS starts holding cash and volatility securities (2/3rds cash, 1/3rd volatility) in addition to the large cap S&P 500.  The table below shows the range of asset allocations as realized volatility increases.


VQTS Asset Allocations

Realized Volatility
(exponentially weighted)
Equity % Volatility % Cash %
0% to 10% 100% 0% 0%
10% to 20% 100% to 50% 0% to 16.7% 0% to 33.3%
20% to 30% 50% to 33.33% 16.7% to 22.22% 33.3% to 44.44%
30% to 40% 33.33% to 25% 22.22% to 25% 44.44% to 50%
40% to 50% 25% to 20% 25% to 26.67% 50% to 53.33%
50% to 60% 20% to 16.67% 26.67% to 27.78% 53.33% to 55.56%
60% to 70% 16.67% to 14.29% 27.78% to 28.57% 55.56% to 57.14%
70% to 80% 14.29% to 12.5% 28.57% to 29.17% 57.14% to 58.33%
80% to 90% 12.5% to 11.11% 29.17% to 29.63% 58.33% to 59.26%

In October 2008 the realized volatility as computed by VQTS’ algorithms peaked at 82%


When not fully allocated to equities VQTS takes a long or short position in VIX futures depending on the curvature of the futures’ term structure.  The term structure is the curve that’s formed if you plot VIX futures’ price vs time to expiration.  The decision to go long or short is determined by the comparison between the slope of the two nearest to expiration futures (1st and 2nd) and the slope of the 4th and 7th month futures.  I’ve marked up the chart below from to illustrate the calculation.



VQTS’ curvature calculation is similar, but not identical to the more familiar designations of contango and backwardation for futures’ term structures.  In general VQTS will go long volatility if the term structure is in backwardation (futures prices less than spot), and short volatility if the curve is in contango.  This approach would have worked well in the past, profiting from the fast rise of volatility as a crash / big correction develops, and then switching to be short volatility as volatility mean reverts.  The chart below shows the simulated performance of VQTS during the 2008/2009 crash.


VQTS experienced around a 20% drawdown in the fall of 2008 before rallying to a year end gain of +13%.

Many strategies that backtest well on historical data do not perform well once they go live.  As I noted at the beginning of this post VQTS has already shown that it can approximate the S&P 500 during periods of low volatility—the condition the market is in 75% of the time.  VQTS’ drawdowns during crashes and corrections are likely to be significant, but VQTS’ strategy of going long volatility during panicky periods and short volatility during the recovery should continue to work well as a way to power through severe downturns.  The real challenge for it will be choppy markets with fast declines and V-shaped recoveries.

UBS did think about Black Swan events when constructing this fund.  If VQTS was allocated to short volatility when a major disaster (e.g., terrorist attack) occurred the fund could experience very heavy losses.  If VQTS is down 60% or more intra-day from the previous close or the indicative value drops below $5 the fund is terminated.  This is called an acceleration.  The shareholder receives a payout that is equal to the liquidated assets of the fund—which may be higher or lower than the acceleration threshold levels.

VQTS is still a small fund with only $25 million in assets, so investors are hesitant to invest in it, but since the S&P 500 and VIX futures are its underlying securities its liquidity is excellent.  Bid/ask spreads have been reasonable—in the 6 to 7 cent range (0.3%).

Everyone knows this bull market will end, the tough part is guessing when. With VQTS you can ride the bull and be prepared for the inevitable bad ending—the primary question being how well it handles the inevitable corrections that happen inbetween.

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How Does VXUP / VXDN’s Corrective Distribution Work?

Updated: Jun 26th, 2015 | Vance Harwood

It’s now clear that the VXUP/VXDN naysayers were right—the actual behavior of these funds is nowhere close to Accushares’ claim that “VXUP and VXDN are the first securities to offer direct “spot” exposure to the CBOE Volatility Index® (VIX).

Accushares has said nothing publicly about the poor behavior of the funds.  Their only response has been to move up the “go live” date of their Corrective Distribution process.

This is a desperation move.  Apparently not understanding what has happened to them they are rushing to use the last weapon at their disposal to fix their horrible tracking error (as high as 18%) relative to the VIX®.   This move will reduce their tracking problem for less than a day and add yet another complexity to these already complicated and broken funds.

Accushares’ Corrective Distribution (CD) is intended to reduce any ongoing differences between VXUP / VXDN’s Net Asset Value (NAV) and its market price.   I don’t know what specific scenarios they were targeted with this process, but I’m guessing they were worried about a slow, progressive creep in the market prices versus the NAV.

The CD is triggered if there are 3 consecutive days where the tracking error (difference between NAV and closing price) is 10% or greater.  To be a valid closing price the last trade must occur within 30 minutes of market close.   When the CD is triggered it doesn’t occur immediately, it’s scheduled to accompany the next monthly Regular Distribution or a Special Distribution if that occurs first.  A Special Distribution is triggered by a greater than 75% rise in the VIX compared to the reference VIX value established at the beginning of the monthly cycle.

Accushares did not expect frequent CDs to be required, in the prospectus they state: “The Sponsor expects that Corrective Distributions will be infrequent, and may never occur.”

It’s likely they will occur on a near monthly basis.    When there is a significant gap between the VIX’s value and VIX futures prices (which is most of the time) the VXUP/VXDN tracking error will be large.  See this post for a near real time accounting of these errors.

With a combined Regular Distribution and Corrective Distribution three things occur:

  1. The NAV of the higher valued fund is set to equal the NAV of the lower valued fund.
  2. A dividend is issued that compensates the holders of the higher valued fund for the drop in NAV value. The dividend is either in cash or an equal number of VXUP/DN shares with a net value equal to the cash dividend.
  3. Accushares issues a new complementary share to every shareholder. If you have VXUP you will get VXDN shares and vice versa.  This is the Corrective Distribution mechanism.

Since Accushares can’t create assets out of thin air they must compensate for the newly doubled number of shares outstanding by dropping their value by half (or do a 2:1 reverse stock split).

The effect of the Corrective Distribution is not obvious.  Working through an example is a good way to understand it.   Imagine that a CD has been triggered and that a Regular Distribution is about to occur.  You own 1000 shares of VXUP.  Let’s assume that the market price of VXUP is $27.5, the VXUP NAV is $25, and that the VXDN NAV is $22 at market close right before the distribution.

You would receive a dividend of $3/share due to the resetting of VXUP’s $25 NAV value down to VXDN’s ending cycle value of $22.   You would also receive 1000 shares of VXDN.  The new NAV value would be $22/2 = $11 / share because Accushares doubled the number of shares outstanding.

Before the CD the VXUP shares in your account were worth $27.5 X 1000 = $27.5K.   After the Regular / Corrective Distribution your account has:

Your net account value drops to $25K—your $2.5K premium over NAV has disappeared.   Any premium over the closing NAV value is wiped out by the CD.  The next day VXUP will likely trade at a multiple percentage points over NAV, but your VXDN shares will like be trading at a symmetrical discount from NAV, so the net value of your shares will remain at around $22K.   Accushares has essentially cashed out your account at the NAV price—no premium for you…

No diligent shareholder will willingly take this sort of loss, nor short seller pass up this opportunity for profit; the market will ensure the value of these funds converges near to NAV the eve of the distribution.

From an entertainment value perspective there will be a couple of things to watch once the CD mechanism becomes effective:

  1. Will traders attempt to prevent CD’s from happening? Imagine a scenario where some groups are trying to prevent a CD from happening by selling, or short selling shares, while others hoping to profit from a CD are buying shares hoping to keep the tracking error above 10%.
  2. How low will the tracking errors go before the CD date? Short sellers would tend to drive the tracking errors to zero, but the about to expire VIX futures values will be decaying rapidly at that point, so significant intra-day profits might still be available to arbitrageurs on the last days of trading.

The net effect of the CD will be to complicate and disrupt an already difficult situation.   It won’t fix the funds.  What Accushares should do is eliminate the Corrective Distribution.

Once broken is better than twice broken.

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Did Accushares Create a Product That is Linearizing the VIX Futures Term Structure?

Updated: Nov 14th, 2015 | Vance Harwood

Eli Mintz, the publisher of, has published an analysis that shows the arbitrage relationship between Accushares’ VXUP shares and VIX Futures.  It shows that investors can use VXUP shares to lock in a low risk position for any VIX Future expiration month.

What struck me about this analysis was the incentive to sell VIX futures that had a higher daily roll yield, regardless of what month expiration they are.    This would tend to linearize the term structure of VIX Futures, and with a whopping 3 days of VXUP trading under our belts, this seems to be happening.   Normally I would expect very heavy contango between the first and second month futures as we bump up against all time highs in the S&P, but instead the contango has decreased from last week.


This might just be an effect from the May futures expiration that occurred during this transition, but I think  contango normally stays pretty consistent across expiration boundaries.

It could be that Accushares has unintentionally created a VIX futures term structure linearizer…

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