yeaterday several of my brokers sent me the WSJ article on the growing importance of the closing facility, somehow believing this to be news. One bright Bulb who can’t understand why I won’t trade with him even suggested I wait for the close to do much with my Delta hedging. That of course is a terrible idea, let me explain why…
First off the close has seen a near linear growth in relative market share over the past five years. The pundits will suggest growth is related to ETF growth, and overall growth in passive investing, but that is a simplistic view. Europe and Canada have seen similar increases in passive investing and ETFs without the same growth in close facility trading. The real driver is growth of inverted and leveraged ETFs that need to do internal rebalancing on a daily basis, often done at or around the close. Also important is the auction facility itself – the London in Toronto closing facilities are garbage….poorly designed mechanisms that inhibit confidence and disincent participation.
But why do I mock the sales guy telling me to hold off until the close? Well, unbeknownst to the guys running leveraged ETFs, Delta hedging typically has relatively high short term Alpha, particularly in a trending market. Any savings in terms of market impact are more than offset by the cost of delaying orders. This is why I laugh when I hear folks say just send it to IEX, the fills are better. The ITG and liquidnet guys have made similar arguments in years past. But for any quant fund trading off of common risk models (barra) and standard factors, you most likely have enough short term Alpha that any improvement in fill quality is a fraction of delay costs. Now if you are a fundamental guy trading off unique analysis – and not around roadshows, Earnings or broker recommendations – the short term Alpha maybe near zero and parking in a lone facility might be acceptable strategy. Of course the key is to regularly measure your Alpha, on both a strategy and geographic basis to determine the optimal urgency rate for each set of trades. Dispersion book hedging is all about optimizing frequency and urgency – understanding this is the only way to be profitable in a 12 handle VIX regime. (Ok basket optimization is the real key, but that I’m not explaining for free)
So yes, the close has become more important. But waiting for the close is mugs game unless you have benign orders. Trading smarter doesn’t mean gleaming a single piece of data and changing your trading around it without further thought investigation or measurement.
My 2 cents on rebal day