Calculation of Forward Price on ETFs

[matt_sb_101]

I am interested in taking long positions on ETF forwards, but would like some comfort from IG around how the forward prices are calculated.

I understand that forward prices are essentially equal to the CASH PRICE plus FINANCE COST minus DIVIDENDS (simplifying somewhat).

Accumulation ETFs

Accumulation ETFs take dividends out of the picture and so are easier to analyse. When I do so, the finance cost AER is coming out differently depending on whether I'm looking at March, June or September forward contracts. The AER is very slightly lower for Sept (~5.6%) versus June (~5.65%) versus March (~5.7%). How does IG calculate them? I understand that IG builds in something like a 0.5% pa premium as its cost of offering the spread bet facility, but what is that on top of?  Where could I look up the underlying interest rate?

Distributing ETFs

In the case of a distributing ETF, how can dividends be accurately factored in? Isn't this ultimately a guess as no one can be sure what will be distributed over the next X months? I would really like to be able to trade distributing ETF forwards because that opens up a much wider variety of ETFs however I don't feel confident that I understand the calculation and it means there's scope for hidden costs.

In my view IG should be as up-front about all of this as it is about overnight funding costs (which are illustrated with formulas / examples etc.)

Matt

[KoketsoIG]

10 hours ago, matt_sb_101 said:

I am interested in taking long positions on ETF forwards, but would like some comfort from IG around how the forward prices are calculated.

I understand that forward prices are essentially equal to the CASH PRICE plus FINANCE COST minus DIVIDENDS (simplifying somewhat).

Accumulation ETFs

Accumulation ETFs take dividends out of the picture and so are easier to analyse. When I do so, the finance cost AER is coming out differently depending on whether I'm looking at March, June or September forward contracts. The AER is very slightly lower for Sept (~5.6%) versus June (~5.65%) versus March (~5.7%). How does IG calculate them? I understand that IG builds in something like a 0.5% pa premium as its cost of offering the spread bet facility, but what is that on top of?  Where could I look up the underlying interest rate?

Distributing ETFs

In the case of a distributing ETF, how can dividends be accurately factored in? Isn't this ultimately a guess as no one can be sure what will be distributed over the next X months? I would really like to be able to trade distributing ETF forwards because that opens up a much wider variety of ETFs however I don't feel confident that I understand the calculation and it means there's scope for hidden costs.

In my view IG should be as up-front about all of this as it is about overnight funding costs (which are illustrated with formulas / examples etc.)

Matt

Hi @matt_sb_101,

Thank you for your post.

Please note that a forward price is available to allow clients to take a longer-term view of the price of a stock.

We offer this in quarterly contracts: the near, far and very far quarters until they reach expiry.

We use the underlying price for shares and adjust them to create a synthetic forward price. To create these synthetic prices we simply apply interest to the current share price for the difference between today and the expiry date of a market. The interest rate we use is SONIA (or SONIA equivalent) + 0.5% admin fee (annual).  We then wrap a wider dealing spread around this price. 

Our spreads are available on the website: Spread Bet Shares

All the best,

KoketsoIG

 

[matt_sb_101]

12 hours ago, KoketsoIG said:

Hi @matt_sb_101,

Thank you for your post.

Please note that a forward price is available to allow clients to take a longer-term view of the price of a stock.

We offer this in quarterly contracts: the near, far and very far quarters until they reach expiry.

We use the underlying price for shares and adjust them to create a synthetic forward price. To create these synthetic prices we simply apply interest to the current share price for the difference between today and the expiry date of a market. The interest rate we use is SONIA (or SONIA equivalent) + 0.5% admin fee (annual).  We then wrap a wider dealing spread around this price. 

Our spreads are available on the website: Spread Bet Shares

All the best,

KoketsoIG

 

Thank you but you've only answered half of my first question, not the full question.  March June and September forwards all seem to be using a slightly different effective interest rate so are you using SONIA forward curves to price and (if so) is there a public domain source I could use to verify the approach?  It's not just the overnight SONIA rate + 0.5%, I'm fairly sure.

And on the second question: I would really like to be able to use distributing ETFs because there's a much better selection of those BUT I won't do it unless I can be comfortable that I will get at or close to the full dividend value. How is this achieved? You give very full descriptions of how it works on DFB bets but all we have on forwards is: "Dividend adjustments are already factored into the pricing of futures and forwards."

How are they factored in? I would really like to understand in detail because otherwise I'm not sure how I can take out a long position on a distributing ETF forward and be confident I'm getting proper value.

[matt_sb_101]

@KoketsoIG are you able to help with a bit more detail?

Thanks,

Matt