How Market Makers Profit on ETFs

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August 10, 2009 8:54am ETF BASIC NEWS

mm“While large institutional players who use these products generally hedge their bets, retail investors can be emotional when buying and selling leveraged securities. If someone is desperately trying to buy or


unload shares, he often doesn’t pay attention to the difference between price and underlying value. This gap is gold for market makers using high-frequency trading to instantly lock up the difference.” Says Don Dion writing for The Street.

“Investors should be aware that this situation applies to all ETFs, not just those of the leveraged variety. High-speed arbitrage traders can make tidy products in both highly liquid and illiquid products. The Financial Select Sector SPDR (XLF Quote) has an average daily trading volume of nearly 150 million shares. Since this ETF is so liquid, the spread — the difference between the bid and ask — is generally a penny. If a high-frequency trading firm is able to dominate the spread and lock in a penny a trade, the profits add up quick.” Says Don Dion writing for The Street.

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