Frequently Asked Questions
- What are the benefits to trading ETFs as stocks?
- Can ETFs be sold short?
- Can ETFs be purchased on margin?
- Do I get paid dividends and/or capital gains?
- Where do ETFs initially come from?
- Where can I find ETFs listed in the newspaper?
- Where can I get up-to-date price information?
- How are prices determined for ETFs?
Exchange Traded Funds (ETFs) can be traded as stocks. In this aspect, they differ from traditional mutual funds. The main advantages of ETFs over traditional funds are:
- ETFs can be bought and sold at any time during trading hours;
- Like stock, ETFs can be bought on margin. Margin requirements for stocks and ETFs are exactly the same;
- There are no high management and sponsoring fees and no sales loads, although brokerage commissions will apply;
- ETFs can be sold short and can be used as an investment vehicle in bear markets.
A short sale is initiated when a trader expects a drop in an ETF price and intends to obtain a profit from this price decline.
Like stocks, Exchange Traded Funds (ETFs) can be sold short. Because a trader "borrows" ETFs shares from a broker during a short sale, there could be margin requirements as with any short sale.
In addition to being able to be sold short, there is a wide family of inverse ETFs that track the inverse performance of regular ETFs and which can be purchased in Bear markets. QQQ and QID (both are traded on the NASDAQ) are examples of regular and inverse ETFs.
ETFs can be purchased on margin. As with buying common stock on margin, such action is subject to margin requirements.
As with common stocks, ETF holders are eligible to receive their portion of dividends. While a stock is eligible for dividends from one company, an ETF provides dividends from a portfolio of stocks, of course, if any dividends were accumulated and held in trust.
ETFs are maintained and managed by large investors and institutions. ETFs are "created" in block-sized units of shares (or multiples thereof) known as "Creation Units" of a respective ETF. A creation requires a deposit with the trustee for a specified number of shares (of a portfolio of stocks that closely approximate the composition of a specific index) and cash equal to the accumulated dividends in return for specific Index Shares. Similarly, block-sized units of ETFs can be redeemed for a portfolio of stocks approximating the index and a specified amount of cash. A unit of 50,000 shares (or multiples thereof) is required to create SDPRs, NASDAQ-100 Index Tracking Stock, Select Sector Funds and DIAMONDS, whereas a unit of 25,000 shares is required to create Mid Cap SPDRs.
The majority of U.S. Exchange, including SPY (S&P 500 ETF), DIA (Dow Jones Industrials ETF), and MDY (S&P 400 ETF), are traded on the American Stock Exchange (Amex). However, some of the ETFs, like QQQ, are listed and traded on the NASDAQ Stock Exchange.
The ETFs' price and volume quotes can be obtained from any data provider who distributes quotes directly from exchanges. The majority of online brokers provide stocks and ETFs quotes at no charge for clients who have brokerage accounts with them.
The price of the Exchange Traded Funds that track indexes is determined from the current price of their benchmark indexes. As an example, QQQ is designed to be 1/40 of the NASDAQ 100 index, SPY is designed to match 1/100 of the S&P 500 index, and MDY is designed to be 1/5 of the S&P 400 index, etc. Furthermore, when the NASDAQ 100 index is traded at $1,600, QQQ stock is traded at $40 per share and when NASDAQ 100 moves to $1,800, QQQ's price moves to $45. Similarly, when the S&P 500 index is at the $1,300 level, SPY stock is traded at $130 per share.
Price dependence on the benchmark index is the major difference between ETFs and stock pricing. If stock's price is driven by the stock's supply and demand, an ETF's price does not depend greatly on its supply and demand. Since an ETF tracks an index, an ETF's pricing depends on the supply of and demand for all stocks listed in the benchmark index. Furthermore, when it comes to timing of ETFs, technical analysis should be applied to a benchmark index rather than to its ETF.