Single Stock Exchange Traded Funds Investing 101

Single stock exchange traded funds (ETFs) allow you to invest in a single stock, just like buying individual shares, but through a fund that pools money from multiple investors.

These funds offer diversification benefits, as they can hold a large number of stocks, reducing risk.

You can invest in a single stock ETF by buying shares through a brokerage account, just like buying individual stocks.

The fees associated with single stock ETFs are often lower than buying individual stocks, making them a more cost-effective option.

Single stock ETFs can be a great way to gain exposure to a specific stock or industry, but it's essential to understand the underlying holdings and fees before investing.

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ETFs are investment funds that hold assets like stocks, commodities, bonds, or foreign currency.

They're traded like stocks throughout the trading day at fluctuating prices.

ETFs often track indexes, such as the Nasdaq, the S&P 500, the Dow Jones, and the Russell 2000.

Investors in these funds don't directly own the underlying investments, but instead have an indirect claim.

They're entitled to a portion of the profits and residual value in case of fund liquidation.

Ownership shares or interest in ETFs can be readily bought and sold in the secondary market.

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ETFs are inherently diversified, which means if one underlying security underperforms, the others may buffer its performance.

Holding a single stock is typically a riskier investment choice, although it may outperform an ETF with that stock in its holdings.

ETFs expose you to many securities with only one purchase, while you would need to make multiple stock purchases to diversify your portfolio.

In fact, if your brokerage charges commissions, each purchase may cost you a fee, making ETFs a more cost-effective option in the long run.

ETFs have significantly lower expense ratios than comparable mutual funds, which can save you money in the long run.

They also provide transparency, disclosing their daily portfolios, which helps you maintain better awareness of exactly how your money is being invested.

ETFs are more liquid than mutual funds, allowing you to buy or sell them throughout the day, rather than just at the end-of-day closing price.

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The AXS TSLA Bear Daily ETF, with the ticker symbol TSLQ, is a great example of a single-stock ETF. It seeks to return -1× the daily performance of Tesla (TSLA) shares.

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This means that if TSLA drops 5% over the course of a trading day, the TSLQ Bear ETF should gain 5% on the same day.

On Nov. 27, 2023, the daily returns of TSLQ provided a close mirror image to the intraday returns of TSLA.

However, the daily returns were not identically inverse, with TSLA gaining 1.08% at the close of that day, while the single-stock ETF TSLQ lost 1.03%.

This small difference in returns may not seem significant for a single day, but it could compound over time, especially if the price swings up and down repeatedly.

The TSLQ Bear ETF returns slightly lower profits over time due to management expenses and other costs.

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The ETF creation and redemption process is a continuous mechanism that's essential to how ETFs operate. It's what sets them apart from traditional stocks and allows them to maintain their fair market value.

Only large institutional investors, known as Authorized Participants (APs), can create or redeem new shares of an ETF. They're essentially market makers with a lot of clout.

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The APs create new shares by transacting with the ETF manager, who communicates which shares it wants to own in the fund. This is known as the creation basket, and it's the same as the redemption basket unless the ETF manager is trying to get rid of specific securities.

The creation basket is disclosed at the beginning of the day, and it's available to all market participants. This means the arbitrage gap, which is the difference between the ETF's price and its fair market value, can vary according to the liquidity of the securities and implied costs.

The creation process occurs in large blocks called creation units, which usually equal 50,000 shares of the ETF. This is a one-to-one rate, meaning one basket of underlying stocks is exchanged for one basket of ETF shares.

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If you buy ETFs in a standard brokerage account, you'll need to consider the tax implications. Any gains you make from selling an ETF will be taxed according to capital gains tax rules.

Dividend income from ETFs is also taxable, which means you'll need to factor in the tax impact on your investments. In contrast, investing in ETFs through an IRA can provide tax benefits.

In a traditional IRA, money in the account is only considered taxable income after it's withdrawn. This means you won't have to worry about capital gains or dividend taxes until you take the money out.

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Single-stock ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds which can only be traded at the end of the trading day.

Investors can execute the same types of trades that they can with a stock, such as limit orders, stop-loss orders, margin buying, and hedging strategies, without a minimum investment requirement.

The most popular single-stock ETFs trade tens of millions of shares per day and have strong market liquidity, making it relatively easy to buy and sell them.

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Some stockbrokers, however, may not allow for automatic recurring investments or trading fractional shares of single-stock ETFs.

Single-stock ETFs are allowed to trade under Rule 6c-11 under the Investment Company Act of 1940, which created a framework that allows ETFs meeting certain criteria to come directly to market without explicit permission.

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ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds which can only be traded at the end of the trading day.

Trading ETFs allows for more flexibility, as investors can execute the same types of trades they can with a stock, including limit orders, stop-loss orders, margin buying, and hedging strategies.

There is no minimum investment requirement for ETFs, which is a significant advantage over mutual funds.

ETFs can be traded frequently to hedge risk or implement market timing investment strategies, whereas many mutual funds have restrictions on frequent trading.

Options, including put options and call options, can be written or purchased on most ETFs, but not on mutual funds.

Many mutual funds must be held in an account at the issuing firm, while ETFs can be traded via any stockbroker.

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Single-stock exchange-traded funds (ETFs) are allowed to trade in the United States, despite being labeled as extremely risky by regulators and market commentators.

In 2022, the US listed single-stock ETFs for the first time, paving the way for this new type of investment product.

Single-stock ETFs appear to fall under Rule 6c-11 under the Investment Company Act of 1940, which created a framework for these ETFs to come directly to market.

The rule, combined with changes to listing standards at stock exchanges, allows ETFs meeting certain criteria to trade without needing explicit permission from the SEC.

This new framework is made possible through exemptive orders from the US Securities and Exchange Commission (SEC), which enables ETFs to bypass traditional approval processes.

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Single-stock futures and single-stock ETFs are not the same thing. Single-stock futures are futures contracts with an individual stock as the underlying security, each controlling 100 shares of stock.

The reception for single-stock futures was positive when they launched in the U.S. However, activity has faded over time.

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Single-stock ETFs can be a high-risk investment. They naturally exhibit time decay and tend to lose value over medium and long holding periods.

The construction of leveraged and inverse ETFs, including single-stock ETFs, means they may quickly lose value in volatile markets. A hypothetical example illustrates this point, where a three times leveraged ETF lost 40% of its value after a series of price fluctuations, while the underlying stock remained essentially flat.

The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) have warned that current regulations may not be adequate to oversee single-stock ETFs, and that these may be inappropriate for most individual investors.

ETFs and mutual funds charge annual expense ratios that range from 0.02% to 1% of the investment value.

Mutual funds generally have higher annual fees due to higher marketing, distribution, and accounting expenses, also known as 12b-1 fees.

ETFs are cheaper to operate because they don't have to buy and sell securities or maintain cash reserves to accommodate shareholder purchases and redemptions.

Stockbrokers may charge different commissions for the purchase and sale of ETFs and mutual funds.

Sales of ETFs in the United States are subject to transaction fees that the national securities exchanges must pay to the SEC, which is $8 per $1 million in transaction proceeds, as of February 2023.

Many mutual funds can be bought commission-free from the issuer, but some charge front-end or back-end loads, while ETFs do not have loads at all.

Single-stock ETFs can be particularly volatile in the market, with a 20% up day followed by two 10% down days resulting in the underlying stock being worth $100, while the ETF lost 40% of its value.

The Financial Industry Regulatory Authority (FINRA) and the U.S. Securities and Exchange Commission (SEC) have both warned that current regulations may not be adequate to oversee single-stock ETFs.

Single-stock ETFs are designed for day trading or very short-term holding periods, as they naturally exhibit time decay and will tend to lose value over medium and long holding periods.

These products are intended for experienced traders who can handle the high risks involved, as they can quickly lose value in volatile markets.

Single-stock ETFs are constructed to maintain a proper derivatives position, which means they have a negative roll to keep pace with the underlying asset's performance.

Time decay is a natural consequence of this construction, causing single-stock ETFs to lose value over time, regardless of the underlying asset's performance.

Investing in ETFs can be a great way to diversify your portfolio, as they inherently provide diversification by holding a basket of securities. This reduces the risk of owning just one stock, which can be a riskier investment choice.

ETFs also expose you to many securities with only one purchase, whereas you would need to make multiple stock purchases to achieve similar diversification. This can be especially beneficial if your brokerage charges commissions.

One of the key advantages of investing in an ETF is the lower transaction costs and fees, which are typically lower than those of a comparable mutual fund. This is because ETFs are exchange-traded, placing costs on the brokers or exchange, rather than the fund itself.

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ETFs offer accessibility to markets that were previously hard for individual investors to access, such as emerging markets equities and bonds. This is due in part to their ability to be sold short and margined or leveraged.

Transparency is another advantage of ETFs, as they disclose their daily portfolios, giving investors a clear understanding of how their money is being invested. This is in contrast to hedge funds and mutual funds, which often only report their holdings on a quarterly basis.

ETFs are also more liquid than mutual funds, as they can be bought or sold throughout the day in secondary markets. This allows investors to quickly respond to market changes and make adjustments to their portfolio as needed.

Tax efficiency is another benefit of ETFs, as they reduce portfolio turnover and offer the ability to avoid short-term capital gains. This can result in significant tax savings for investors.

By using ETFs as part of your asset allocation process, you can gain broad market exposure or specific sub-segment exposure at a lower cost. This makes them an attractive option for investors looking to make tactical allocations to their portfolio.

Investors can easily increase or decrease their portfolio exposure to a specific style, sector, or factor with ETFs, especially during volatile market periods.

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ETFs offer a more diversified investment option compared to single stocks. Holding a single stock is typically a riskier investment choice.

A single stock's volatility isn't buffered by the diverse securities held in an ETF. This means that if one stock underperforms, it can have a bigger impact on your overall portfolio.

Holding a single stock may outperform an ETF with that stock in its holdings, but this is not always the case. In fact, an ETF exposes you to many securities with only one purchase, making it a more efficient way to diversify your portfolio.

If your brokerage charges commissions, each stock purchase may cost you a fee, whereas with an ETF, you only need to make one purchase. This can save you money in the long run.