U.S. patent application number 14/300410 was filed with the patent office on 2014-09-25 for method and system for calculating an intraday indicative value of leveraged bullish and bearish exchange traded funds.
The applicant listed for this patent is PROFUND ADVISORS LLC. Invention is credited to Taeyong LEE, William E. SEALE.
Application Number | 20140289095 14/300410 |
Document ID | / |
Family ID | 37074072 |
Filed Date | 2014-09-25 |
United States Patent
Application |
20140289095 |
Kind Code |
A1 |
SEALE; William E. ; et
al. |
September 25, 2014 |
METHOD AND SYSTEM FOR CALCULATING AN INTRADAY INDICATIVE VALUE OF
LEVERAGED BULLISH AND BEARISH EXCHANGE TRADED FUNDS
Abstract
A computer implemented method, system, and software for
calculating and using an intraday indicative value of a leveraged
Bullish or Bearish exchange traded fund ("ETF") for arbitrage
purposes, includes calculating an intraday current value of all the
equity securities in the ETF (applicable only to Bullish ETFs),
calculating mark to market gains or losses of at least one
derivative product, and retrieving an accumulated loss or gain of
the at least one derivative product and other cash equivalent
amounts. The intraday indicative value of the ETF is determined by
combining the calculated intraday current value of all the equity
securities (applicable only to Bullish ETFs), the accumulated loss
or gain, the mark to market gains of the at least one derivative
product and other cash equivalent amounts. The determined intraday
value of the ETF is used, by a party, for arbitrage purposes.
Inventors: |
SEALE; William E.;
(Annapolis, MD) ; LEE; Taeyong; (Seoul,
KR) |
|
Applicant: |
Name |
City |
State |
Country |
Type |
PROFUND ADVISORS LLC |
Bethesda |
MD |
US |
|
|
Family ID: |
37074072 |
Appl. No.: |
14/300410 |
Filed: |
June 10, 2014 |
Related U.S. Patent Documents
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Application
Number |
Filing Date |
Patent Number |
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14035403 |
Sep 24, 2013 |
8788403 |
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14300410 |
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13889678 |
May 8, 2013 |
8595129 |
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14035403 |
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13231707 |
Sep 13, 2011 |
8452692 |
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13889678 |
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11397902 |
Apr 5, 2006 |
8041625 |
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13231707 |
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60668601 |
Apr 6, 2005 |
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60719985 |
Sep 26, 2005 |
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Current U.S.
Class: |
705/37 |
Current CPC
Class: |
G06Q 40/04 20130101;
G06Q 40/00 20130101; G06Q 30/0201 20130101; G06Q 30/02
20130101 |
Class at
Publication: |
705/37 |
International
Class: |
G06Q 40/04 20120101
G06Q040/04 |
Claims
1. A computer implemented method of calculating and using an
intraday indicative value of a Bullish exchange traded fund ("ETF")
for arbitrage purposes, comprising the steps of: calculating or
having calculated an intraday current value of all the equity
securities in the ETF; calculating, or having calculated, mark to
market gains or losses of at least one derivative product;
retrieving, or having retrieved, an accumulated loss or gain of at
least one derivative product; determining, or having determined,
the intraday indicative value of the ETF by combining the
calculated intraday current value of all the equity securities, the
accumulated loss or gain and the mark to market gains of the at
least one derivative product; and using the determined intraday
value of the ETF, by a party, for performing an arbitrage
transaction, wherein one or more of the above steps are performed
on a computing system.
2.-23. (canceled)
Description
CROSS-REFERENCE TO RELATED APPLICATIONS
[0001] This application claims the benefit of priority under 35
U.S.C. .sctn.119(e) of provisional application Ser. No. 60/668,601
filed on Apr. 6, 2005, and provisional application Ser. No.
60/719,985 filed on Sep. 26, 2005, the disclosures of which are
incorporated herein in their entireties.
BACKGROUND OF THE INVENTION
[0002] The present invention relates generally to the field of
exchange traded funds. In particular, it relates to a method and
system for calculating an intraday indicative value for leveraged
bullish and/or bearish exchange traded funds ("ETF").
[0003] Shares of ETFs are traded intraday throughout the exchange
trading hours. Investors can buy or sell these shares anytime
during the trading hours and achieve the performance of a stock or
bond portfolio as a single security. Currently, all of the ETFs
listed on the U.S. Exchanges are "Index Funds or Trusts" that track
specific market indexes. However, leveraged bullish and bearish
ETFs (individually "Bullish ETFs" or "Bearish ETFs" and together
"Bullish and Bearish ETFs") have only been proposed recently.
SUMMARY OF THE INVENTION
[0004] In certain embodiments the present invention relates to a
computer implemented method of calculating and using an intraday
value of a Bullish ETF for arbitrage purposes, comprising the steps
of: calculating, or having calculated, an intraday current value of
all the equity securities in the ETF; calculating, or having
calculated, mark to market gains or losses of at least one
derivative product; retrieving, or having retrieved, an accumulated
loss or gain of the at least one derivative product; retrieving
other cash equivalent amounts; determining, or having determined,
the intraday value of the ETF by combining the calculated intraday
current value of all the equity securities, the accumulated loss or
gain and the mark to market gains or losses of the at least one
derivative product; and other cash equivalent amounts; and using
the determined intraday value of the ETF, by a party, for arbitrage
purposes.
[0005] In certain embodiments, the derivative product comprises one
or more of a swap contract, a forward contract, a futures contract,
an options contract or the like.
[0006] In certain embodiments, the step of determining the intraday
value is performed in near real time.
[0007] In certain embodiments, the method further comprises:
comparing, by the party, of the determined intraday value of the
ETF to a traded value of the ETF; and performing, by the party, an
arbitrage transaction if the difference between the determined
intraday value of the ETF differs from the traded value of the ETF
by a threshold value.
[0008] In certain embodiments, the method further comprises
calculating a balancing amount for purposes of fund share creation
or redemption that is composed largely of the gain or loss of at
least one derivative product.
[0009] In certain other embodiments, the present invention provides
a computer implemented method of using an intraday value of a
Bearish ETF for arbitrage purposes, comprising the steps of:
calculating, or having calculated, mark to market gains or losses
of at least one derivative product; retrieving, or having
retrieved, an accumulated loss or gain of the at least one
derivative product; retrieving, or having retrieved, other cash
equivalent amounts; determining, or having determined, the intraday
value of the ETF by combining the accumulated loss or gain, the
mark to market gains or losses of the at least one derivative
product; and other cash equivalent amounts; and using the
determined intraday value of the ETF, by a party, for arbitrage
purposes.
[0010] In certain embodiments, the above mentioned method further
comprises receiving an IIV File (as defined herein) comprising
values for: value of all the equity securities in the ETF (only
applicable for Bullish ETFs); notional value of at least one
derivative product; an accumulated loss or gain of the at least one
derivative product; and other cash equivalent amounts. The received
IIV File is used to determine an intraday value of the ETF by
combining the calculated intraday current value of all the equity
securities (only applicable for Bullish ETFs), the accumulated loss
or gain, the mark to market gains or losses of the at least one
derivative product; and other cash equivalent amounts, and the
determined intraday value of the ETF is used for arbitrage
purposes.
[0011] In certain other embodiments, the present invention provides
a computer implemented method of providing an IIV File for a
Bullish or Bearish ETF, comprising: (1) periodically creating an
IIV File comprising values for: value of all the equity securities
in the ETF (only applicable to Bullish ETFs); notional value of at
least one derivative product; an accumulated loss or gain of at
least one derivative product; and other cash equivalent amounts;
and (2) periodically sending the created IIV File to other
parties.
[0012] Certain embodiments provide a computer readable medium
having program code recorded thereon for calculating and using an
intraday indicative value of a bullish exchange traded fund ("ETF")
for arbitrage purposes when executed on a computing system, the
program code including: code for calculating an intraday current
value of all the equity securities in the ETF; code for calculating
mark to market gains or losses of at least one derivative product;
code for retrieving an accumulated loss or gain of at least one
derivative product; code for determining the intraday indicative
value of the ETF by combining the calculated intraday current value
of all the equity securities, the accumulated loss or gain and the
mark to market gains of the at least one derivative product; and
code for using the determined intraday value of the ETF, by a
party, for arbitrage purposes.
[0013] Certain other embodiments provide a computer readable medium
having program code recorded thereon for calculating and using an
intraday indicative value of a bearish exchange traded fund ("ETF")
for arbitrage purposes when executed on a computing system, the
program code including code for calculating mark to market gains or
losses of at least one derivative product; code for retrieving an
accumulated loss or gain of at least one derivative product; code
for determining the intraday indicative value of the ETF by
combining the accumulated loss or gain and the mark to market gains
of the at least one derivative product; and code for using the
determined intraday value of the ETF, by a party, for arbitrage
purposes.
[0014] Certain embodiments provide a system for calculating and
using an intraday indicative value of a bullish exchange traded
fund ("ETF") for arbitrage purposes, including: a communication
unit configured to receive an IIV file comprising a value of all
equity securities in the ETF, the notional value of at least one
derivative product. an accumulated gain or loss of the at least one
derivative product, and other cash equivalent amounts; and a
computing unit configured to calculate an intraday current value of
all the equity securities in the ETF, calculate mark to market
gains or losses of at least one derivative product, and determine
the intraday indicative value of the ETF by combining the intraday
current value of all the equity securities, the accumulated loss or
gain and the mark to market gains of the at least one derivative
product; and the computing unit configured to compare the intraday
indicative value of the ETF to a market value of the ETF on a per
share basis to make a determination for arbitrage purposes.
[0015] Certain other embodiments provide a system for calculating
and using an intraday indicative value ("IIV`) of a bearish
exchange traded fund ("ETF") for arbitrage purposes, including: a
communication unit configured to receive an IIV file comprising a
notional value of at least one derivative product, an accumulated
loss or gain of the least one derivative product, and other cash
equivalent amounts; a computing unit configured to calculate mark
to marked gains or losses of the at least one derivative product,
retrieve an accumulated loss or gain of the at least one derivative
product, and determine the IIV of the ETF by combining the
accumulated loss or gain and the mark to marked gains of the at
least one derivative product and the other cash equivalent amount,
and said computing unit configured to compare the IIV of the ETF to
a market value of the ETF on a per share basis to make a
determination for arbitrage purposes.
BRIEF DESCRIPTION OF THE DRAWINGS
[0016] The accompanying drawings, which are incorporated in and
constitute a part of the specification, illustrate embodiments of
the invention and together with the description, serve to explain
the principles of the invention.
[0017] FIGS. 1 and 2 show formats of an exemplary IIV File.
[0018] FIG. 3A is a flow diagram illustrating the general steps of
an IIV calculation.
[0019] FIG. 3B is a diagram that illustrates the steps of
calculating an IIV with exemplary data.
[0020] FIGS. 4 and 5 are diagrams that illustrate exemplary process
flows of creating and redeeming Bullish and Bearish ETFs.
[0021] FIG. 6 provides exemplary calculations of the balancing
amount for a Bullish ETF.
[0022] FIG. 7 illustrates the components of a generic computing
system connected to a general purpose electronic network.
DETAILED DESCRIPTION OF THE PREFERRED EMBODIMENTS
Introduction
[0023] In certain embodiments, the present invention relates to
Bullish and Bearish ETFs and systems and method for calculating and
transmitting values of the bullish and bearish ETFs that may be
used for arbitrage purposes so that efficient markets for these
ETFs are facilitated.
[0024] Examples of such Bullish and Bearish ETFs may be based on
various well-known indexes as listed below. It should be noted that
the indexes and the percentages listed below are exemplary only and
the principles of the present invention would apply to other
indexes and percentages as would be recognized by one skilled in
the art. The investment objective for a Bullish or Bearish ETF is
to track a percentage of the performance of the index, with the
percentage being any multiple greater than, equal to or less than
100% of the performance of the underlying index. The following are
some examples:
TABLE-US-00001 Name Investment Objective Bullish ETFs Ultra S&P
500 ProShares +200% of the performance of S&P500 Index on a
daily basis Ultra QQQ ProShares +200% of the performance of
Nasdaq100 Index on a daily basis Ultra Dow 30 ProShares +200% of
the performance of Dow Jones Industrial Average on a daily basis
Ultra Mid-Cap 400 +200% of the performance of ProShares
S&PMidCap400 Index on a daily basis Bearish ETFs Short S&P
500 ProShares -100% of the performance of S&P500 Index on a
daily basis Short QQQ ProShares -100% of the performance of
Nasdaq100 Index on a daily basis Short Dow 30 ProShares -100% of
the performance of Dow Jones Industrial Average on a daily basis
Short Mid-Cap 400 -100% of the performance of ProShares
S&PMidCap400 Index on a daily basis UltraShort S&P 500
-200% of the performance of S&P500 ProShares Index on a daily
basis UltraShort QQQ ProShares -200% of the performance of
Nasdaq100 Index on a daily basis UltraShort Dow 30 -200% of the
performance of Dow Jones ProShares Industrial Average on a daily
basis UltraShort Mid-Cap 400 -200% of the performance of ProShares
S&PMidCap400 Index on a daily basis
[0025] Operations and management of ETFs require various technical
processes to ensure the effectiveness of intended product design.
More specifically, as the shares of the ETFs are traded on an
Exchange, their trading prices are supposed to stay close to the
"fair value" of the shares throughout the trading hours. Various
processes need to be in place to achieve that result.
[0026] In order to achieve these features successfully, ETFs offer
the mechanisms that encourage effective arbitrage activities by the
institutional market participants, which are typically major
brokers-dealers and investment banks. Two of the important
mechanisms that allow effective arbitrage activities are: near
real-time Intraday Indicative Value ("IIV") calculation and
Continuous Creation/Redemption. Each of these two mechanisms is
discussed in detail in the two parts further herein.
[0027] As discussed in certain embodiments with respect to the
Bullish ETFs and Bearish ETFs, these mechanisms work differently
when compared to other existing ETFs. Certain embodiments of the
present invention provide unique computer implemented techniques
and processes to ensure at least equivalent accuracy and
effectiveness relative to processes that are currently available
with respect to other ETFs.
Part I. Indicative Intraday Value ("IIV") Calculation for Bullish
ETFs
[0028] A. Definition and Role of IIV
[0029] Exchange Traded Funds ("ETFs"), similar to the traditional
mutual funds, are required to calculate the "official closing" net
asset value ("NAV") per share, based on 4 pm (or at some fixed
time) closing prices and/or fair values of the securities held in
the fund once per day on every business day.
[0030] Unlike the traditional mutual funds, shares of ETFs trade on
the exchanges throughout the trading hours, and the "estimated
real-time value" of the ETF, in terms of value per single share is
calculated and disseminated by a third party (typically the Primary
Listing Exchange for the ETF). This estimated real-time value is
called "IIV", and is typically updated frequently, for example,
every 15 seconds during market hours (market makers are able to
calculate IIV on a real-time basis). It should be noted that, while
the IIV is also referred to as "Underlying Trading Value (UTV)"
among some market participants, in this application only the term
IIV is used.
[0031] Generally, IIV is calculated by valuing the sample subset of
the assets held in the ETF at current prices during the market
hours. This calculation methodology is similar to the basic concept
employed to calculate an official closing NAV (at the end of the
business day) required for both traditional mutual funds and
conventional ETFs. Therefore, IIV based on the 4 pm closing prices
should be almost equal to the official closing NAV of the ETF.
[0032] By comparing these IIV figures to the trading price of the
respective ETFs, one would know whether the current trading price
(or bid-ask price) of a particular ETF is at premium or discount
relative to its indicative real-time value. For example, if the IIV
of an ETF shows $100 compared to the quoted price of $102 at a
particular moment, it would indicate that the ETF shares are traded
at premium (i.e., at a higher price than the fair value of
$100.)
[0033] IIVs also play an important role for the institutional
market participants who are ready to engage in the arbitrage
activities when the opportunities arise. These institutional
participants include, for example, the exchange specialists, market
makers, and other arbitrageurs. One of the key institutional
participants are "Authorized Participants (APs)" who carry out the
important functions, including market making and arbitrage
activities, in the ETF market place. APs are the only entities that
can create (buy) or redeem (sell) the ETF shares directly with the
fund that issues the ETF. Part II, further herein, provides
additional information of the role of APs with respect to creation
and redemption of ETF shares directly with the fund. Being able to
calculate the accurate IIV is critical for these participants since
it allows them to actively engage in market making and arbitrage
activities, which in turn, keeps the trading price of the ETF
shares close to the real-time fair value. The success and value of
this mechanism becomes apparent when compared to the persistent and
significant premium/discount facing closed-end funds. Although the
shares of the closed-end funds also trade on the exchanges, the
"closed" structure does not provide the same effective arbitrage
mechanism that the "open-end" ETFs offer since the shares of the
closed end funds are typically fixed in absence of a share
offer.
[0034] B. IIV Calculation Methodology for Conventional Index-Based
ETFs
[0035] To facilitate the calculation of IIV for a share of a
conventional ETF, the ETF advisor, with the collaboration of the
Index Receipt Agent, prepares and transmits a specially formatted
file, known as the "Portfolio Composition File (PCF)", to the
National Securities Clearing Corporation ("NSCC") each business
day. PCF contains a complete data set with which a third party can
use to calculate the IIV of the ETF throughout the trading hours
since the fund holdings information in the data set (held by the
ETF) does not change during the course of the day.
[0036] The PCF is prepared to represent a single "Creation Unit"
which typically consists of 50,000 shares of the ETF. In certain
embodiments, a Creation Unit is the minimum size that APs can
create or redeem fund shares directly with the statutory trust
creating the units. Direct transactions with the ETF are typically
only permitted in a multiple of the Creation Units through an AP.
Part II, further herein, provides details of direct transactions
with ETFs for the creation or redemption of ETF shares (typically
in Creation Units). If the price of one share is $100, the value of
one Creation Unit, consisting of 50,000 shares, would be
$5,000,000. Other investors who do not have large number of shares
to trade and/or are not acting as APs can buy and sell the ETF
shares (in lot sizes different than a creation unit) on the
exchanges through their brokers.
[0037] The PCF may be downloaded by all entities with a link to the
NSCC system (e.g. stock exchanges, APs). These entities are able to
download the PCF of an ETF from NSCC, upon the receipt and
processing of data by the NSCC from the particular ETF investment
advisor. Based on these PCFs, APs and exchanges are able to
calculate an accurate near real-time IIV during the trading
hours.
[0038] Conventional index-based ETFs, similar to traditional
index-based mutual funds, generally hold the same securities that
are contained in the Underlying Index that the fund tracks. Any
residual cash, if any, is typically invested in various
money-market or other short-term cash instruments. Therefore, the
data set shown in a PCF represents a proportional subset of the
ETF's entire asset structure, proportionately prepared in terms of
one Creation Unit.
[0039] IIV for the conventional ETFs are determined by the
following steps: (i) calculating the current value of the Deposit
List (list of the securities as provided in PCF) based on the last
sale prices, (ii) adding the amount calculated in (i) above to the
estimated cash/money market instruments (as provided in PCF) to
arrive at a cumulative value, and then (iii) dividing the
cumulative value by the number of shares per Creation Unit
Aggregation (which is the number of shares per creation unit) in
order to obtain the estimated current value on a per share
basis.
[0040] C. IIV Calculation Methodology for Bullish ETFs
[0041] In accordance with certain embodiments of the present
invention, this section discloses the IIV calculation methodology
for a Bullish ETF. For example, the investment objective of a
Bullish ETF may be to achieve 200% of the performance of an
underlying index on a daily basis. That is, the Bullish ETF seeks
to achieve a gain or loss that is 200% of the respective gain or
loss of the underlying index on a daily basis. Of course, one
skilled in the art would recognize that the percentage (200%) and
the time period (daily basis) may be varied without significantly
altering the principles of the present invention.
[0042] In order to achieve the targeted leverage (i.e., for example
200%), the proposed Bullish ETF utilizes various financial
instruments, including derivatives, in addition to equity
securities in managing the portfolio exposure and to capture a
movement proportional to the targeted leverage.
[0043] In contrast, conventional ETFs generally do not carry the
derivative products as part of their holdings. Therefore, the data
in the PCF (used by the conventional ETFs) is simply the list of
equity or debt securities. The current format of the PCF that is
compatible with the NSCC system is not designed to accommodate the
various derivative contracts that the present invention utilizes
for the management of the Bullish and Bearish ETFs.
[0044] As a result, in certain embodiments, the present invention
provides for a separate file, named "IIV File," to complement the
PCF as a way to provide an adequate data set for IIV calculation of
a Bullish ETF. The IIV File is designed to provide detailed
information about the derivatives positions in the Bullish ETF and
all other information that is necessary for the accurate near
real-time IIV calculation.
[0045] FIG. 1 shows an exemplary format of an IIV File 100 that may
be used in certain embodiments of the present invention and FIG. 2
provides examples of headers and symbols (in a table 200) that may
be used in the IIV File. It should be noted that FIGS. 1 and 2 are
exemplary only and one skilled in the art would recognize various
other modifications and alternatives all of which are considered as
a part of the present invention. As shown in FIG. 1, the exemplary
file format 100 is depicted with headers (which represent exemplary
data fields) and various symbols and values representing data
corresponding to each of the headers (which represent data fields).
FIG. 2 provides examples of how the headers and symbols may be
constructed in one embodiment of the computer implementation of the
present invention. For example, the table 200 (in FIG. 2)
illustrates the type of symbols that may be used in data fields
(corresponding to specific headers) and also specifies a
description of the meanings of the various symbols.
[0046] The daily IIV File may be provided via a secure website and
is prepared to show all the necessary information of the entire ETF
assets, as opposed to a subset of the proposed ETF assets (which is
contained in a conventional PCF file), to ensure the accuracy of
the IIV calculation. The PCF may still be prepared in terms of one
Creation Unit and be made available through NSCC. It should be
noted that the concept of an IIV File represents a formulaic or
logical file which is implemented in a data processing system using
techniques that are well known to those skilled in the art. One
skilled in the art would also recognize that streaming or other
evolving technologies may be used to transmit or access an IIV File
(using wireline, optical, or wireless communications) and all such
technologies are considered to be a part of the present
invention.
[0047] The exchange and APs (or other parties that need to
calculate, or have calculated, a near real-time IIV) require both
PCF and IV Files to calculate the IIV of Bullish ETFs.
Alternatively, as would be recognized by one skilled in the art,
the relevant information from the PCF file may be included in the
IIV file so that one logical file contains all the information
required to compute the IIV of the bullish ETF.
[0048] As shown in FIG. 3A, in certain embodiments, the IIV is
determined by the following steps. (i) In step 302, calculating the
estimated current value of equity securities held by the ETF by
calculating the percentage change in the value of the Deposit List
(that is the list of securities provided in the PCF) and applying
that percentage value to the total value of the equity securities
in the ETF as of the close of trading on the prior trading day (as
provided in IIV File). (ii) In step 304, calculating the
mark-to-market gains or losses from the ETF's total return equity
index swap exposure based on the percentage change of the
Underlying Index and the previous day's notional values of the swap
contracts, if any, held by such ETF (which previous day's notional
value is provided in the IIV File). It should be noted that the
same calculation is also applied to other similar forms of
over-the-counter derivative contracts such as forwards and
contracts for difference. (iii) In step 304, also calculating the
mark-to-market gains or losses from futures and/or options
positions by taking the difference between the current value of the
futures and/or options contracts held by the ETF, if any, and the
previous day's value of such positions (as provided in IIV File).
(iv) In step 306, adding the values from (i), (ii), and (iii) above
to an estimated cash amount (which cash amount includes the swap
costs) (as provided in IIV File) to arrive at a value, and (v) in
step 308, dividing that value by the total shares outstanding (as
provided in IIV File) to obtain the current IIV per share.
[0049] These four steps are also illustrated as steps 310-340 in
FIG. 3B which shows the application of these steps to an exemplary
calculation of an IIV. In step 310, a current value of the equities
is calculated from a current value of the securities included in
the PCF by accounting for the percentage change (1% in the
illustrated example) in value of the deposit list of securities in
the PCF, with the percentage change applied to the previous day's
value of total securities in the IIV File. In step 320, the current
gains or losses from the swaps and futures are calculated to derive
a mark-to-market gain or loss for the swaps and the futures. In
step 330, the current total net assets are calculated by adding the
total values of the equities, the gains or losses from the
derivatives (swaps, futures, etc.) and net other assets (including
cash). In step 340, the total net assets are divided by the total
number of shares outstanding to arrive at the IIV per share.
[0050] D. IIV Calculation Methodology for Bearish ETFs
[0051] The investment objective of a Bearish ETF funds is to
achieve, for example, (-100%) of the performance of the underlying
index on a daily basis. That is, if the underlying index decreases
by a certain percentage on a certain day, the objective of the
Bearish ETF would be to increase by the same percentage on that day
and vice versa.
[0052] In order to achieve the targeted leverage, the present
invention utilizes various financial instruments, including futures
and swaps, in managing the portfolio exposure. In other words, a
total of (-100%) portfolio exposure is achieved through various
financial instruments, mostly derivative products. As these Bearish
ETFs do not invest in equity securities, leftover cash is invested
in the money market instruments, including repurchase
agreements.
[0053] As the current format of the PCF (used with conventional
ETFs) that is compatible with the NSCC system is not designed to
accommodate the various derivative contracts that are used with the
present invention, certain embodiments of the present invention
provide a separate file, named "IIV File," that contain the
detailed information about the derivatives positions in the fund
and all the other information that are necessary for an accurate
IIV calculation. Structure of the IIV File for Bearish ETFs is
substantially similar to the one prepared for the Bullish ETFs as
shown in FIGS. 1-2 except that the fields and data related to the
equities is missing or not used.
[0054] The daily IIV File may be provided via a secured website and
is prepared to show all the necessary information of the entire ETF
assets in order to ensure the accuracy of IlV calculation. As
Bearish ETFs do not intend to invest in equities, there is no need
for a PCF to be prepared for the Bearish ETFs.
[0055] The Exchanges and APs (or other third parties), using the
IIV File, can calculate IIV using the following step: (i)
Calculating, or having calculated, the mark-to-market gains or
losses from the ETF's total return equity index swap exposure based
on the percentage change to the Underlying Index and the previous
day's notional values of the swap contracts, if any, held by such
ETF (which previous day's notional value is provided in IIV File).
It should be noted that the same calculation is also applied to
other similar forms of over-the-counter derivative contracts such
as forwards and contracts for difference. (ii) Calculating, or
having calculated, the mark-to-market gains or losses from futures
and/or options positions by taking the difference between the
current value of the futures and/or options contracts held by the
ETF, if any, and the previous day's value of such positions (as
provided in IIV File). (iii) Adding the values from (i) and (ii)
above to an estimated cash amount (which cash amount includes the
swap costs) (as provided in IIV File) to arrive at a value, and
(iv) dividing that value by the total shares outstanding (as
provided in IIV File) to obtain the current IIV per share. See FIG.
3B for steps and an exemplary calculation of an IIV with the only
change being that there would be no step 310 for the IIV
calculation of a Bearish ETF since there are no equity positions
held in a Bearish ETF.
Unique Features of the Present Invention
[0056] For both Bullish and Bearish ETFs, the present invention
provides a unique IIV File. For Bullish ETFs, the provided IIV File
supplements the standard PCF file which is the only data set used
in conventional ETFs (or alternatively the IIV file contains all
the information in the PCF file and contains additional information
related to the derivative positions and swap contracts). In the
case of Bearish ETFs, IIV File represents, in certain embodiments,
the whole data set that enables the IIV calculation since no PCF is
needed because the Bearish ETFs do not hold any equity positions.
FIGS. 4-6 discussed further herein disclose the process of using
the IIV File in the creation and redemption process of the Bullish
and Bearish ETFs.
[0057] It should be noted that when calculating the daily NAV for
the mutual funds and ETFs that contain derivatives positions, gains
or losses from derivatives are reflected in NAV on an "accumulated"
basis, assuming the derivatives positions are established and
remain open over a period of time. That is, the periodic (for
example, daily) gains or losses from the derivatives are carried
forward and accumulated over the period of time during which the
respective derivative positions are open. Therefore, in calculating
IIV for Bullish and Bearish ETFs, the information regarding the
"accumulated" gains or losses from all derivatives positions, as of
end of the previous business day, needs to be delivered to the APs
and an Exchange (or any party that calculates the IIV on an
intraday basis). Therefore, the IIV File provides the mechanism by
which these accumulated gains or losses are provided, for example,
in the fields corresponding to the "net other assets" or NOA
disclosed in the IIV File format shown in FIGS. 1 and 3B. It should
be noted that the calculation of "mark-to-market" gains or losses
for derivatives, described above as part of the IIV calculation
methodologies for Bullish ETFs and Bearish ETFs (for example as
shown in FIG. 3B), provides gain/loss figures only for the period
between last night's closing to current time. Therefore, the
accumulated gains or losses as they exist for the derivatives in
the Bullish and Bearish ETFs are not available to the party
performing the calculation except by being provided by the
particular IIV file as provided by certain embodiments of the
present invention. Accordingly, the information from the IIV File
provided by the present invention can be used to accurately
calculate the IIV for the Bullish and Bearish ETFs since the
accumulated losses and gains of the derivatives are provided in the
IIV File and this information is not otherwise available to a third
party from any other source.
Part II. Creation and Redemption of Bullish and Bearish ETFs
[0058] FIGS. 4 and 5 are diagrams that illustrate exemplary process
flows for creating and redeeming Bullish and Bearish ETF shares
with the statutory trust that issues the particular ETF shares. In
practice, Bullish ETFs settle through NSCC as illustrated in FIG. 4
while Bearish ETFs do not use the NSCC facility as illustrated in
FIG. 5. One skilled in the art would recognize that the particular
entities described here in the creation and redemption process are
exemplary only and other such entities (or combinations thereof)
could perform the functions disclosed herein in the creation and
redemption process for the ETFs.
[0059] A. Creation/Redemption Mechanism for Conventional
Index-Based ETFs
[0060] Purchases (creations) and sales (redemptions) "directly"
with the Exchange Traded Fund (ETF) can be done only in a multiple
of a "Creation Unit", which typically consists of 50,000 Shares. In
addition, these direct creations and redemptions can only be
initiated by APs who have executed a Participant Agreement with the
ETF. The dollar value of a single Creation Unit generally exceeds
$1 million dollars. For example, an ETF with a $100 NAV per Share
would have a Creation Unit value of $5,000,000 ($100.times.50,000
Shares).
[0061] Other investors (for example, retail investors) buy and sell
the Fund Shares in the secondary markets through their brokers.
Trades executed in the secondary market (e.g. the primary listing
exchange, ECN) do not have any direct impact on the operation of
the ETF.
[0062] The continuous ability of an AP to create or redeem ETF
shares allows APs to engage in the market making and arbitrage
activities and thereby effectively and efficiently keep the price
of the ETF Shares traded on the exchange close to the real-time
value (IIV) of the ETF during the trading hours.
[0063] Generally, creations and redemptions are transacted on an
"in-kind" basis. When APs create ETF shares (in creation units),
APs receive the ETF shares from the statutory trust and deliver the
securities as specified in PCF (which represent the securities held
by the ETF). When APs redeem the ETF shares (in creation units),
the opposite occurs, that is, the APs exchange the ETF shares for
the securities held by the ETF. If the values of the two (ETF
shares vs. securities) do not match, cash is paid or received to
equalize the difference. The cash to equalize the values of the two
sides is called "Balancing Amount."
[0064] Typically, conventional index funds maintain "fully
invested" positions in the securities that make up the underlying
index. As a result, almost the entire portion of the assets in the
conventional index-based ETFs comprises the equity or fixed-income
securities. Therefore, any cash amount as Balancing Amount that has
to be paid or received is generally small in the creations or
redemptions of the conventional ETFs. In other words, the
difference between the value of one Creation Unit and the value of
the securities listed in PCF corresponding to one creation is
generally quite small.
[0065] B. Creation/Redemption Mechanism for Bullish ETFs
[0066] The Bullish ETFs seek to provide daily investment results,
before fees and expenses, that, for example, double (200%) the
daily performance of the applicable index. That is, the percentage
change of the estimated real-time value (or IIV) of these ETFs is
expected to be approximately twice the percentage change of the
underlying index at any given moment throughout the trading hours.
The "percentage change" in this context is calculated by comparing
the current market value to the previous day's closing value (4 pm
official closing NAV for the Fund and 4 pm closing price for the
index). For example, assuming previous day's NAV of the ETF is $100
and the underlying index that the Bullish ETF tracks increased 1%
from previous day's close at a particular moment during the trading
hours, the IIV of the ETF at that moment is expected to be at $102,
indicating that the ETF's value is up 2% (($102-$100)/$100), which
is twice the percentage change of the index.
[0067] Bullish ETFs utilize various derivative products to obtain
the necessary leverage and target exposure as would be recognized
by those skilled in the art. The value of each derivative contract
is "marked-to-market" each day, following the change in the value
of the underlying securities or index. As a result, unlike the
conventional index ETFs, value of the securities in the PCF (i.e.,
the securities held by the ETF on a Creation Unit basis) may be
significantly different from the value of one Creation Unit, since
the gains or losses from the derivatives are reflected in
calculating the value of Creation Unit. It should be noted that the
PCF does not include any derivatives information. In other words,
the difference between the value of the Securities from PCF and the
value of the shares in the Creation Unit may be much greater than
in the case of conventional ETFs due to the extensive use of
derivatives in the Bullish and Bearish ETFs. For example, the
difference may be greater than 10% of the value of the Creation
Unit and could even be 50% or higher.
[0068] In order to resolve this discrepancy, certain embodiments of
the present invention expand the concept of Balancing Amount to
include the portion that makes up the leverage. In the conventional
ETFs, Balancing Amount reflects daily accruals and is generally
small. In contrast, in the Bullish ETFs, the present invention uses
the Balancing Amount as a way to reconcile the difference caused by
the extensive derivatives positions. In other words, in order to
equalize the value of the equity securities and value of the Units
being created/redeemed, the Balancing Amount in IIV files for the
Bullish ETFs includes the accumulated gains/losses from the
derivatives positions. Therefore, Balancing Amount in the IIV file
for Bullish ETFs is generally much greater than the balancing
amount value in the IIV file for conventional ETFs.
[0069] FIG. 4 discloses an exemplary process flow in the creation
and redemption of an ETF creation unit (as defined herein, a
creation unit is the minimum aggregation of lot size of ETF shares
that are created or redeemed by a fund creation and redemption
entity 500. In certain embodiments, each of the blocks shown in
FIG. 4 comprise a computing system or node while the arrows
connected there between disclose network data flows between the
computing nodes. The flow of information in FIG. 4 is discussed
first with respect to steps (4) and (5) and is then followed by a
discussion of steps (1), (2), and (3).
[0070] As shown in steps (4) and (5) of FIG. 4, the creation or
redemption order is initiated by an authorized participant 500 and
the order passes through a distributor 510 to an index receipt
agent 520 acting on behalf of the ETF issuing Trust. In certain
embodiments, each of the blocks represent a server or other
computing system and the lines represent network or other data
connections between the servers or computing systems. It should be
recognized that each of the blocks need not be on different
computing systems since two or more blocks could reside on one
computing system. The creation and redemption order is then
forwarded, in a continuation of step (4), to a clearing house 530
to initiate the settlement process. As shown in step (6), the
creation and redemption transaction is completed by exchanging the
ETF shares with the securities and a Balancing Amount
(corresponding to the difference in value between the ETF shares
and the securities). When creating units, the authorized
participant 500 receives ETF shares in exchange for the securities.
The flow is reversed from the flow discussed earlier for
redemptions. In addition, the Balancing Amount is used to equalize
the difference between the value of the ETF shares and securities
as explained further herein with respect to the examples shown in
FIG. 6.
[0071] FIG. 4 also shows the flow of the PCF file and the IIV File.
The PCF file is transmitted, as shown in step (2), by the Index
Receipt Agent to the clearing house 530 on each business day after
receiving the information on the securities in step (1) from the
Fund Manager. Once the PCF has been processed by the clearing house
530, it is available to all NSCC members such as the Authorized
Participants 500. The IIV File on the other hand is created (also
shown as step (3)) by the Fund Manager also on each business day,
in collaboration with Fund Accountant, and is made available to the
requesting parties, such as the Authorized Participants 500, so
that they can, for example, perform arbitrage transactions based on
the difference between the IIV of an ETF share and the market price
of the ETF share as traded on an exchange.
[0072] FIG. 6 provides exemplary calculations of the balancing
amount for a Bullish ETF that returns 200% of the return of the
underlying index on a daily basis. The fund information from the
previous closing is shown in table 725. As shown in table 725, the
number of shares on one Creation Unit is 50,000 while the closing
NAV per share was 100. Based on these values the value of one
Creation Unit is $5,000,000. Furthermore, the value of the deposit
securities in the PCF is also $5,000,000 and, therefore, the
estimated cash amount is zero. Block 705 shows the calculation of
the balancing amount for creation of a creation unit of the ETF
shares for the situation in which the underlying index has
increased by 10%. Since the index is up 10%, the NAV per share is
up by twice that amount (20%) from the previous close so that the
value of 1 Creation Unit is $6,000,000. However, the value of
deposit securities is up by 10% (since it tracks the index) to
$5,500,000. Accordingly, the balancing amount has a value of
$500,000 since that value-balances the difference between the value
of the ETF shares and the securities held by the fund (on a
Creation Unit) basis. Accordingly, in the creation process, the
party (for example, an AP) that creates Creation Unit of ETF
shares, receives the ETF shares corresponding to one Creation Unit
and delivers equities (worth $5,500,000) and cash (worth
$500,000).
[0073] Block 710 discloses the calculation for the redemption
process when the index is up by 10%. In this case, the AP would
deliver the ETF shares (corresponding to one Creation Unit) and
would in return receives the securities (worth $5,500,000) and a
cash balancing amount (worth $500,000).
[0074] Block 715 shows the calculation of the balancing amount for
the creation of a creation unit of the ETF shares when the
underlying index has decreased by 10%. In this case, the NAV per
share has declined by 20% (200% of the decline of the underlying
index) to a value of 80. Therefore, the value of the one Creation
Unit is $4,000,000 while the securities held by the ETF are worth
$4,500,000 (as they declined by 10% corresponding to the decline in
the index). Accordingly, when creating 1 Creation Unit of ETF
shares, the Authorized Party delivers the securities (worth
$4,500,000) and receives the ETF shares corresponding to 1 Creation
Unit (worth $4,000,000) and a cash or cash equivalent balancing
amount of $500,000.
[0075] Block 720 shows the calculation of the balancing amount for
the redemption of a creation unit of the ETF shares when the
underlying index has decreased by 10%. In this case, the Authorized
Party delivers the ETF shares corresponding to one Creation Unit
(worth $4,000,000) and a cash or cash equivalent balancing amount
of $500,000 while receiving the securities worth $4,500,000
(corresponding to the securities held by the ETF for one Creation
Unit).
[0076] Gains or losses from the derivatives positions are settled
in cash and/or securities as part of Balancing Amount in
creations/redemptions. Unlike the equity securities in the fund,
the derivative contracts such as futures and swaps can not easily
be transferred "in-kind." If such a mechanism is found to settle
the derivatives "in-kind", it may be possible to handle the
Balancing Amount by in-kinding the derivatives.
[0077] C. Creation/Redemption Mechanism for Bearish ETFs
[0078] The Bearish ETF Funds seek to provide daily investment
results, before fees and expenses, that match a certain percentage
(e.g. 100% or 200%) of the inverse (opposite) of the daily
performance of the applicable underlying index.
[0079] The percentage change of the estimated real-time value (or
IIV) of these Funds is expected to be the inverse of the percentage
change of the underlying index at any moment throughout the trading
hours. The "percentage change" in this context is calculated by
comparing the current market value to the previous day's closing
value (4 pm NAV for the Fund and 4 pm closing price for the index).
For example, assuming previous day's NAV per ETF Share being $100,
if the underlying index that the Bearish ETF, with the investment
objective of -100% daily, tracks is down 1% from previous day's
close at a particular moment during the trading hours, IIV of the
Bearish ETF at that moment is expected to be at $101, indicating
that the ETF's value is up 1%, which is 100% (or -1) times the
percentage change of the index.
[0080] Bearish ETFs utilize various derivative products to obtain
the target exposures, and the value of each derivative contract is
"marked-to-market" following the change in the value of the
underlying securities or index. Consequently, the value of Bearish
ETFs are determined mainly by the change in the value of those
derivative contracts.
[0081] Bearish ETFs do not intend to carry any stocks and
therefore, no securities are transferred "in-kind" between APs and
the statutory trust for the creations or redemptions unless an
efficient and feasible way to in-kind derivative positions is
developed in the future. To resolve this issue, in certain
embodiments, the present invention performs the
creations/redemptions for Bearish ETFs as "All-Cash" transactions.
After determining the NAV of the share, total cash amount for
creations or redemptions can simply be calculated by multiplying
that NAV to the number of shares being created or redeemed.
[0082] FIG. 5 is an operation flowchart that illustrates the
process of redemption and creation of the Bearish ETF shares. In
certain embodiments, each of the blocks represent a server or other
computing system and the lines represent network or other data
connections between the servers or computing systems. It should be
recognized that each of the blocks need not be on different
computing systems since two or more blocks could reside on one
computing system. The processing steps shown in FIG. 5 are very
similar to the corresponding steps in FIG. 4 with the exception
that the creation and redemption process exchanges the ETF shares
with a cash amount (a balancing amount) with no securities as shown
in step (4). As shown in the Figure, there is also no PCF file
created while the IIV File is created on each business day and made
available to the Authorized Participants 500 so that they can
perform arbitrage transactions based on the difference between the
IIV of the ETF and its market price on the exchange. It should be
noted that creation and redemption transactions will occur outside
the NSCC.
[0083] D. Unique Features Related to Creation and Redemption of
Bullish and Bearish ETFs
[0084] In certain embodiments, the present invention provides a
unique mechanism for the creation/redemption process for the
Bullish and Bearish ETFs by efficiently dealing with the values of
derivatives used to achieve the investment objectives of the
Bullish and Bearish ETFs. For the Bullish ETFs, the present
invention expands the Balancing Amount concept to include the
"leverage make-up portion" that represents the market value of
derivatives. In the case of Bearish ETFs, in certain embodiments,
the present invention uses "All-Cash Payment" procedures to account
for the value of the derivatives. Because the Bullish and Bearish
ETFs are the only domestic ETFs which provide leverage or short
exposures through the use of derivatives, the creation and
redemption process for units of the Bullish and Bearish ETFs employ
a unique technique not used with conventional ETFs. That is, the
Balancing Amount or All-Cash Payment in the Bullish and Bearish
ETFs include the accumulated gains/losses from the derivative
positions. This feature provides the advantage that it facilitates
the orderly creations and redemptions in the ETF marketplace.
[0085] FIG. 7 illustrates the components of a generic computing
system connected to a general purpose electronic network 10, such
as a computer network. The computer network can be a virtual
private network or a public network, such as the Internet. As shown
in FIG. 7, the computer system 12 includes a central processing
unit (CPU) 14 connected to a system memory 18. The system memory 18
typically contains an operating system 16, a BIOS driver 22, and
application programs 20. In addition, the computer system 12
contains input devices 24 such as a mouse or a keyboard 32, and
output devices such as a printer 30 and a display monitor 28, and a
permanent data store, such as a database 21. The computer system
generally includes a communications interface 26, such as an
Ethernet card, to communicate to the electronic network 10. Other
computer systems 13 and 13A also connect to the electronic network
10 which can be implemented as a Wide Area Network (WAN) or as an
internetwork, such as the Internet. In certain embodiments, such a
computer system 12 can be used to implement the third party
processing system discussed herein including programmed code that
implements the logic discussed herein with respect to FIGS. 1-6.
One skilled in the art would recognize that such a computing system
maybe logically configured and programmed to perform the steps to
calculate the IIV as detailed in FIG. 4, implement the IIV file
format as disclosed in FIGS. 1-6, perform the functions at each of
the nodes (authorized participant 500, distributor 510, or fund
creation/redemption entity 540) shown in FIGS. 4 and 5, and perform
the exemplary balancing amount calculations shown in FIG. 6 at the
fund creation/redemption entity 540.
[0086] One skilled in the art would recognize that the foregoing
describes a typical computer system 12 connected to an electronic
network 10. It should be appreciated that many other similar
configurations are within the abilities of one skilled in the art
and it is contemplated that all of these configurations could be
used with the methods and systems of the present invention.
Furthermore, it should be appreciated that it is within the
abilities of one skilled in the art to program and configure a
networked computer system to implement the method steps of certain
embodiments of the present invention, discussed herein.
[0087] As noted above, embodiments within the scope of the present
invention include program products comprising computer-readable
media for carrying or having computer-executable instructions or
data structures stored thereon. Such computer-readable media can be
any available media which can be accessed by a general purpose or
special purpose computer. By way of example, such computer-readable
media can comprise RAM, ROM, EPROM, EEPROM, CD-ROM or other optical
disk storage, magnetic disk storage or other magnetic storage
devices, or any other medium which can be used to carry or store
desired program code in the form of computer-executable
instructions or data structures and which can be accessed by a
general purpose or special purpose computer. When information is
transferred or provided over a network or another communications
connection (either hardwired, wireless, or a combination of
hardwired or wireless) to a computer, the computer properly views
the connection as a computer-readable medium. Thus, any such a
connection is properly termed a computer-readable medium.
Combinations of the above are also included within the scope of
computer-readable media. Computer-executable instructions comprise,
for example, instructions and data which cause a general purpose
computer, special purpose computer, or special purpose processing
device to perform a certain function or group of functions.
[0088] The invention is described in the general context of method
steps which may be implemented in one embodiment by a program
product including computer-executable instructions, such as program
code, executed by computers in networked environments. Generally,
program code include routines, programs, objects, components, data
structures, etc. that perform particular tasks or implement
particular abstract data types. Computer-executable instructions,
associated data structures, and program modules represent examples
of program code for executing steps of the methods disclosed
herein. The particular sequence of such executable instructions or
associated data structures represent examples of corresponding acts
for implementing the functions described in such steps.
[0089] The present invention in some embodiments, may be operated
in a networked environment using logical connections to one or more
remote computers having processors. Logical connections may include
a local area network (LAN) and a wide area network (WAN) that are
presented here by way of example and not limitation. Such
networking environments are commonplace in office-wide or
enterprise-wide computer networks, intranets and the Internet.
Those skilled in the art will appreciate that such network
computing environments will typically encompass many types of
computer system configurations, including personal computers,
hand-held devices, multi-processor systems, microprocessor-based or
programmable consumer electronics, network PCs, minicomputers,
mainframe computers, and the like. The invention may also be
practiced in distributed computing environments where tasks are
performed by local and remote processing devices that are linked
(either by hardwired links, wireless links, or by a combination of
hardwired or wireless links) through a communications network. In a
distributed computing environment, program modules may be located
in both local and remote memory storage devices.
[0090] Other embodiments of the invention will be apparent to those
skilled in the art from a consideration of the specification and
the practice of the invention disclosed herein. It is intended that
the specification be considered as exemplary only, with such other
embodiments also being considered as a part of the invention in
light of the specification and the features of the invention
disclosed herein. Furthermore, it should be recognized that the
present invention includes the methods disclosed herein together
with the software and systems used to implement the methods
disclosed here.
* * * * *