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The funds in question are YCL/YCS. I was looking at the price fluctuations in these funds and noticed they are not priced accurately on an intraday basis. There is decent enough liquidity in these products and the options on them are marked accurately. That is, the option prices reflect the middle ground of the bid/ask spread.

Why is it that the underlying shares have such large deviations? Are the fund managers not under any obligation to mark these shares accurately until the end of the day? Is there something I glossed over in the prospectuses? It seems extremely shady from a liquidity perspective that the options on these funds are priced accurately but the shares themselves are not priced on the bid-ask spread.

For example, look at FXY, a similar fund (although not leveraged). Its shares are consistently priced on the bid-ask spread and the deviation is rarely >.2% of NAV.

Is this a product of market microstructure with respect to leveraged ETFs?

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  • Leveraged ETFs do not track their non leveraged ETFs linearly. The options are not related to the pricing of the ETF (your claim of inaccuracy) but to the price of the ETF. IOW, since both of these ETFs have nearly identical historical volatility as well as implied volatility, the respective options will reflect that, eg.. "There is decent enough liquidity in these products and the options on them are marked accurately. That is, the option prices reflect the middle ground of the bid/ask spread."
    – Bob Baerker
    Apr 5, 2018 at 23:51

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ETFs are different from mutual funds in that their price is not determined simply by calculating the NAV at the end of the day.

Instead, they are bought and sold at whatever price the market is willing to buy and sell them at, with the exception that they usually have a mechanism to convert ETF shares back to a basket of stocks or assets that they represent.

In the case of YCL, the prospectus states that 50,000 shares is a creation unit, and that authorised participants may redeem a creation unit for a basket of assets that the fund holds (or vice versa).

This mechanism creates an arbitrage opportunity where the authorised participants can buy and sell shares of the fund against the assets that the fund holds for a profit, which in turn results in the fund more closely following the basket of assets that the fund holds.

There are usually fees involved, and such operations require capital, which in turn limits the profitability of such trades. As a result, there may be small variations between the price of ETF and the value of the assets that it holds.

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  • So the deviation exists as a result of the exotic-ness of the underlying? Which in this case is FX swaps on the Yen.
    – HK47
    Apr 5, 2018 at 21:05
  • I would say it is more to do with the mechanics of arbitraging a basket against a creation unit. You could work through it manually - when you see a deviation, what would it cost to buy the basket and send it in to be turned into a creation unit while simultaneously selling a creation unit's worth of the ETF. My guess is there would be insufficient liquidity - i.e. the bid is not 50,000 shares.
    – xirt
    Apr 5, 2018 at 21:09
  • That makes sense. I will call my brokerage to price out the underlying trade. Thanks for the tip!
    – HK47
    Apr 5, 2018 at 21:27

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