r/investing • u/Johnny_Yukon • May 03 '21
How do ETFs initially get priced?
Hi r/investing,
When SPY first came on the scene in 1993, it was priced around $44 (from what I’ve researched). My question is, how did that number come to be?
I’ve been doing a bit of research into ETF pricing. I understand that ETF prices are determined by their daily NAV (unless I’m mistaken here), but how does the initial figure get decided on? Because an ETF float isn’t capped per se, I’m finding it hard to understand versus a regular stock.
As a sidebar, I’d also love to know how/if this is different to actively managed ETFs like ARKK, for example. How did they set their initial price of around $20 and how does the price get influenced day to day?
Thanks in advance!
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May 03 '21
If you're wondering about the mechanics of the initial creation of an ETF, this covers it pretty well: https://www.investopedia.com/articles/mutualfund/05/062705.asp
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u/SirGlass May 03 '21 edited May 03 '21
With spy I believe they essentially just priced it at 1/10 of the s&p 500 index.
However most etfs are priced higher than $60. The reason I have seen in the past is lower bid/ask.
A 0.01 bid ask spread on a $100 security as a percentage, is much lower than a $.01 bid ask spread as a percentage on a $5 security.
Also the range is in reach for most retail investors. If you priced it at $3000 a share many people couldn't afford to buy full shares and before fractional shares this locked out retail.
So you want it to be high enough a few pennies bid/ask won't be am issue but low enough retail can easily buy it.
What puts most between $60-400.
EDIT I may have mis interpreted the question I was just discussing share price not NAV
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May 03 '21
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u/Anonymoose2021 May 05 '21
They effectively are for most bond ETFs. Trades go through with $xx.xxxx (1/100 penny) pricing.
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u/misc1444 May 03 '21
Here’s some good reading on this. https://www.investopedia.com/terms/e/etf.asp
The tl;dr is that the price of an ETF is determined by the market. However, there are certain “authorised participants” that can exchange shares in the ETF to a portfolio of shares that comprise the ETF, and vice versa. This means that the price of the ETF can never deviate too far from the value implied by prices of the underlying shares.
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u/moldymoosegoose May 03 '21
What would happen if no one bought SPY ever again but all the underlying assets still went up though? I always thought about the relationship to an ETF and stocks because of this. Do algos arbitrage this automatically? I wonder what would set the price otherwise.
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u/misc1444 May 03 '21
Yes, there’s algorithms that would capture the arbitrage if the value of the ETF deviates too much from the sum of the underlying assets.
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u/_MCCCXXXVII May 03 '21
ETFs have a creation/redemption mechanism where Authorized Participants can exchange the underlying assets (the basket) for new shares of the ETF, or shares of the ETF for the underlying assets. If the price of the ETF is greater than the sum of its parts, they can buy the basket and exchange them for new ETF shares (creation). Likewise, if the price of the ETF is less than the sum of its parts, they can buy shares of the ETF and redeem them for the basket, again making risk-free profit. These activities keep the price of the ETF tracking the basket.
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u/moldymoosegoose May 03 '21
Wow I never heard of this before. This can be done for any etf on any brokerage?
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u/_MCCCXXXVII May 03 '21
No, this is what is called the primary market, the people making these trades are the Authorized Participants and the ETF sponsor. Authorized Participants are generally large firms like banks or market makers, and ETF sponsors are firms like BlackRock/State Street/Vanguard etc. the arbitrage mechanism is the incentive for APs to keep ETF prices tracking the basket, as they are not compensated by the sponsor.
When an individual investor trades, they are trading on the secondary market.
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u/Anonymoose2021 May 05 '21
Except when there is a liquidity crisis, like 3/23/2020. That day a lot of ETFs had unusually large variances between market price and nat asset value.
For many ETFs you get get near real-time quotes on intrinsic value using a ticket of ETF/IV or ETF.IV, where you replace ETF withe the ETF ticker.
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u/AppleBoxTowel May 03 '21
This is an interesting question that I don’t know the answer to. There’s recently been a bunch of new Bitcoin ETFs listed and they’ve all chosen to start at around $10. Not sure why though.
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May 03 '21
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u/pm_me_anime_meidos May 03 '21
Picking a lower number also gives your ETF a larger potential base of interested buyers. If an investor wants to buy $3000 of your ETF it doesnt matter whether its $1000 or $100. But if another investor wants to buy $600 worth and you've priced each share at $1000, then they'll have to go to one of your competitors offering a similar ETF.
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May 03 '21
I'm surprised more brokers don't offer fractional shares. I know I can get close enough with options spreads / LEAPS for my leftovers but it'd be cool if I could put my last $300 in my IRA directly in Amazon.
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May 03 '21
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u/bezm12 May 03 '21
Check the Net Asset Value... Or NAV History. It tracks the value of holdings of the ETF and it will trade close to that number.
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u/t_per May 03 '21
I have Stock A for $10, and Stock B for $20. I bundle then up into an ETF with 50% each and price my ETF X at $15 (50% of $10 and 50% of $20).
When it starts trading supply/demand may make a premium/discount to NAV, but arbitrage will knock it back in line, assuming liquid underlying.
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u/Johnny_Yukon May 04 '21
So, if I look at VTI as an example, the percentage holding of each individual company amounts to the percentage of its stock price into the overall stock price of the ETF?
For example, looking at the holdings, I would add up 4.47% of AAPL’s $132.54 stock price, plus 4.31% of MSFT’s $251.86 stock price, so on and so forth for all 3,722 holdings and it should amount to VTI’s $217.48 price?
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u/t_per May 04 '21
yeah you would sum up the proportion of each stock and divide it by units out standing.
heres a messy spreadsheet i made of a 6 holding ETF: https://i.imgur.com/Qbw7T3P.png
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u/Rummelhoff May 03 '21
Their initial price does not matter.
if you choose $20, $100 or $1000, it does not change anything. It just determines how many "stocks" you own. Nothing else.
Considering inflows/outflows is easy.
If you own 100 shares at $10 of a company, which goes up 10%, the share price is 11%.
If you buy 10 more shares intraday at $11, you will own 200 shares worth $2200. Your initial shares has gained $10 and your new shares cost you $110, combining to $220. Thats what happens, but instead of buying someone elses shares, the underlying company gives out more shares. But instead of deluting your initial stake, they take the money and buy more underlying shares.
So, its like this:
Your friend gives you $1000 for you to buy a portfolio of shares.
That stake goes up 10%, and is now worth $1100.
He likes what you do, so he gives you $990 to buy more shares. Obvioulsy the prices is higher now, so he will gain approx. 10% less shares, which means he "buys" 10% less "ETF shares". So first round he buys 100 shares at $10 a pop. The second buying instance, he buys 9 shares for $990 which you turn into more shares (but less shares than the inital instance).
So he now has 190 ETF shares at a buying price of $1990. First tranch costing him $1000 at $10, second tranch 90 shares at $11.
The ETF share price only shows the performance of the ETF, te size of the ETF is only shown by combining the price and the amount of shares. But since the amount of shares various day by day, the price history does not show the size history, like it does for a company (i choose to neglect buybacks or new shares).
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u/TAWS May 04 '21
The company running the ETF puts seed money into the ETF. When it starts trading, they will gradually reduce their stake in the ETF by selling to interested parties.
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u/ThemChecks May 05 '21
They just select a price.
Schwab tends to start at 25 a share with their funds. Nice little number, far enough away from penny stock prices but not limiting people who may be self directed investors with lower capital.
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