7-12-8_DOC_G=
AS ETN CONVERGING
LINEAR & POLYNOMIAL DAILY OPEN FUNCTIONS, FRESH SEPARATION
GAS ETN CONVERGING LINEAR & POLYNO= MIAL DAILY OPEN FUNCTIONS, FRESH SEPARATION & SIGNIFICANT STATISTICAL R SQUA= RE AND P-VALUES ENTRY, EXIT, & STOP LOSS SWINGING TRADE RULES
= ;
Avi and Sara Rushinek, University of M= iami, arush@miami.edu arushine@aol.com
GAS ETN CONVERTING LINEAR & POLYNO= MIAL DAILY OPEN FUNCTIONS, FRESH SEPARATION & SIGNIFICANT STATISTICAL R SQUA= RE AND P-VALUES ENTRY, EXIT, & STOP LOSS SWINGING TRADE RULES
Abstract
This study develops and develops a pro= gram trading strategy. The trading program uses the GAS ETN fund converging linear & polynomial daily open functions, as the main indicator for the entry into a 1 week holding period= of a trade. The convergence has = to have a fresh degree of high separation between the models R Square. The models have to have a signific= ant statistical R Square and P-values for entry, exit, & stop loss swinging trade rules. Since the Polyno= mial model is superior to the linear model, it suffices to test the linear model= and assume that the statistical significance of the linear model also applies to the polynomial model.
This study
develops Gas ETN Trading Rules using Linear & Polynomial Daily Open Reg=
ression
models. It forecasts using
Automated HTML (Hyper Text Markup Language) and Java Script Software Develo=
pment
methods. This way the softwar=
e can
run on any HTML Java script compatible device. Initially we developed the softwar=
e in
Microsoft Excel and then we have converted it to HTML and Java script. Exchange Traded Notes (ETNs) Gas
funds are traded securities listed by Yahoo.com. The “iPath® S&P
GSCI™ Gas Total Return Index ETN is a sub index of the S&P
GSCI™ Commodity Index. The S&P GSCI™ Gas Total Return Index
reflects the returns that are potentially available through an unleveraged
investment in the West Texas Intermediate (WTI) Gas futures contract plus t=
he
Treasury bill rate of interest that could be earned on funds committed to t=
he
trading of the underlying contracts.” as http://www.ipathetn.com/G=
AS-overview.jsp
describes it.
We can trade them just like stocks, except that they are not simple stocks, and they represent the Crude Gas industry index. As tradable instruments, traders c= an trade them, and for this purpose the traders may want to forecast their next day values. The purpose of th= is study is to develop a method that facilitates such forecasts and trades, as well as evaluates the risk. T= his study builds several linear and polynomial models regressing Open and Close= Gas ETN values on date, and forecasting the values. These forecasts help measure the e= rrors and develop methodology for automated, continuous quality improvement in the trading rules. The system con= ducts testing hypotheses using ANOVA regression and residual analysis and plots, = compares and contrasts various methods and concludes with some recommendations.
INTRODUCTION AND LITRATURE REVIEW
Exchange Traded Notes
As Wikipedia, the free encyclopedia (http://en.wikipedia.org/wiki/Exchange_Traded_Not=
es)
explains as follows:”Jump to: navigation,
Exchange Traded Notes (ETNs)= are senior, unsecured, unsubordinated debt securities issued by an underwriting bank. Similar t= o other debt securities, ETNs have a maturity date and are backed only by the credi= t of the issuer.
ETNs are designed to provide investors= access to the returns of various market benchmarks. The returns of ETNs are usually linked to the performance of a market benchmark or strategy, less investor fees. When an investor buys an ETN, the underwriting bank promises to pay t= he amount reflected in the index, minus fees upon maturity. Thus an ETN has an additional risk compared to an ETF - upon any reduction of credit ratin= gs or if the underwriting bank goes bankrupt, the value of the ETN will be advers= ely eroded.
Though linked to the performance of a = market benchmark, ETNs are not equities or index= funds, but they do share several characteristics of the latter. Similar to equitie= s, they are traded on an exchange and can be shorted. Similar to index fund, they are lin= ked to the return of a benchmark index. But as debt securities, ETNs don't actually own anything it is tracking.
The first ETN, marketed as the iPath Exchange-Traded Notes, was issued by Barclays Bank PLC on 12 June 2006. This was soon followed by Bear Stearns, Goldman Sachs & Swedish Export Credit Corp. In 2008, additional issuers entered the market with their own offerings; these inclu= de Deutsche Bank, UBS,= Lehman Brothers, Morgan Stanley and Credit Suisse. As of April 2008, there were 56 ETNs from nine issuers tracking different indexes. The popularity of ETNs is mainly due to the advantages t= hat it offers to investors.
The returns of ETNs are linked to the performance of a market benchmark or strategy, less investor fees. Currentl= y, there are four types of ETNs, Commodity ETNs, Emerging Market ETNs, Currency ETNs and Strateg= ies ETNs available in the market. (Please refer to Appendix A for a list of available products in each category.)
As discussed previously, ETNs are debt= notes. When held to maturity, the investor will receive a cash payment that is lin= ked to the performance of the corresponding index during the period beginning on the trade date and ending at maturity, less investor fees. Typically, ETNs = do not offer principal protection.
ETNs could also be liquidated before t= heir maturity by trading them on the exchange or by redeeming a large block of securities directly to the issuing bank. The redemption is typically on a weekly basis and a redemption charge may apply, subjected to the procedures described in the relevant prospectus.
The investor fee is calculated cumulat= ively based on the yearly fee and the performance of the underlying index and increases each day based on the level of the index or currency exchange rat= e on that day. Because the investor fee reduces the amount of return at maturity= or upon redemption, if the value of the underlying decreases or does not incre= ase significantly, the investor may receive less than the principal amount of investment at maturity or upon redemption.
Since ETNs are unsecured, unsubordinated debts, they are not rated, but are backed by the credit of underwriting banks. Like other debt securities, ETNs do not have voting rights. But unlike other debt securities, interest will not be paid during the term of the most ETNs.
Pros and Cons of ETNs
Advantages
Tax efficiency
ETN offers a tax-efficient way to inve= st. It is treated for tax purposes as prepaid contracts (A prepaid contract is a financial instrument, such as a forward contract. The owner of a prepaid contract pays an initial amount in order to receive a future contingent pay= ment based on the value of an index or other underlying benchmark at a specified time).
Very often index m= utual funds and ETFs are required to make yearly income and capital gains distributions to fund holders which are taxable. Meanwhile, for ETF, when a fund is forced to sell stock to change its composition, for example, when an index rebalances, the fund holders have to pay tax on whatever the capital = gain was, when the stock is sold.
In contrast, for ETN, there is no interest payment and dividend distribution, so neither the tax. The timing of the realization of gains or losses on their ETN is based on when investors buy and sell their investmen= ts. Since the entire gain is treated as a capital gain, the investor can defer = any gain until the security is either sold or it matures. Because long-term capital gains are treated more favorably (Holding more than 1 year, all the gai= ns will be taxed as long-term gains at 15%) than short-term capital gains and interest, the tax treatment of ETNs should be more favorable than that of E= TFs. There is no way to avoid capital gains, but delaying it is valuable because= the amount that would have been paid as tax can continue to accumulate wealth. Control over the timing of this capital gain is a big benefit to any invest= or looking to defer the payment of income taxes.
Recent tax rulings have additionally s= uggested that ETNs may be qualified tax shelters for the purpose of changing current interest income into deferred capital gains income.[1]
ETNs give investors a broad-based index without any tracking error to the index, doing away with the discrepancies = that exist between the returns of many ETFs and their underlying indexes. One re= ason of the tracking error observed in ETFs might be attributed to the diversification issues that stem from the inability of a fund to replicate = an index due to an upper limit on the maximum asset allocation to a single sto= ck. But for ETN, this constraint does not exist, because though ETN is also tracking the index, the return is not based on the underlying securities. T= he ETN issuer guarantees the holder a return that is an exact replica of the underlying ind= ex, minus expense fees. The bank also agrees to pay large shareholders the exact value of the note on a weekly basis through redemption, which helps the ETNs track very closely to the underlying index return.
ETN is a significant innovation to imp= rove liquidity of structured products. Not like other buy-an= d-hold structured products, ETN can be bought and sold during normal trading hours= on the securities exchange. For institutional size redemption, investors may o= ffer their ETN for repurchase by the issuer on a weekly basis. Investors can eas= ily track the performance of their ETN. In this sense, ETN is structured to resemble ETF. But ETN is different from ETF, as they consist of a debt instrument with cash flows derived from the performance of an underlying as= set – a structured product.
<=
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lang=3DEN>Access to new markets and strategies
ETNs have provided access to hard-to-r= each exposures, such as commodity futures and the Indian stock market. Certain a= sset classes and strategies are not easily accessible to individual investors. F= or example, the “momentum investing” strategy, which is used in SPECTRUM Large Cap U.S. Sector Momentum Index, is to take advantage of the varied performances of the 10 sub-indexes of the S&= ;P 500 Total Return IndexSM (SPTR) relative to each other and to the SPTR. The wei= ghts of the 10 sub-indexes are computed each day based on performance and correlation. This makes SPECTRUM Large Cap U.S. Sector Momentum Index diffi= cult to track through ETF. On the contrary, ETN provides opportunities to gain exposure to these types of investment strategies in a cost-efficient way.
Disadvantages
<=
span
lang=3DEN>Credit Risk & Lack of Risk Metrics
ETNs, as debt instruments, are subject= to risk of default by the issuing bank as counter party. Even though the possibilit= y of default turning into a reality is relatively low, it ought to be measured a= nd accounted for. ETN investors will require a credit risk metric that facilit= ates answer to questions regarding the magnitude of the risk and its variation w= ith time. With new players foraying into the ETN space, how will the risk vary = by issuer? Who will take up the risk evaluation process? If and when the ETN sector grows, in order to partcipate, retail and institutional investors wi= ll need a source for ETN key data which is easy to assimilate.
Illiquidity
Given its relative newness, there is a= flurry of ETNs hitting the market. They are, however, yet to engage the market pla= yers enthusiastically, several of whom are probably opting for the wait and watch approach. Under such circumstances, the liquidity of the notes in the secon= dary markets may be threatened should they fail to gain sufficient trading momen= tum. The effectiveness of ETNs at tracking indices is contingent on their abilit= y to garner enough support in the market.
Another flipside of ETNs relates to th= eir redemption feature. While ETNs can be sold daily on the secondary markets or held until maturity, institutional investors who wish to redeem blocks of 50,000 units or more directly with the issuer can only do so once a week. In contrast, other structured products, ETFs for instance, can be redeemed any= time during a trading day.
Tax benefits speculative
The ETN issuers are using tax efficien= cy as their trump card. As things stand, there is significant tax saving to be ga= ined from investing in ETNs. In reality, however, the Internal Revenue Service is yet to decide on the proposed tax treatment. So, the tax benefit status is still arguable.
ETNs have their worth decided by two f= actors:
• Performance of the index they = are set to track
• Credit ratings of the issuer
Suppose the issuing bank has been impa= cted negatively, if only marginally, by a crisis like the recent (2007-2008) subprime mortgage turmGas and the ratings agencies depreciate the overall credit rat= ing of the issuer to reflect the event.
In the aforementioned set-up, even tho= ugh the index it is tracking is showing growth, a decline in rating of an ETN issui= ng financial institution could negate the worth of an ETN.
Unprofitable trading strategies=
The GSCI has lost nearly 20% of its va= lue since January 2006, despite soaring commodity prices, all thanks to Contango. This is one instance where ETN tracked commodity indices like GSCI have ended up doing exactly the opposite of what they had set out to do.
Contango is a scenario where the cost = of the next-month futures contract is costlier than the current month contract. In this event, the issuing bank books a loss each time a current month contrac= t is sold and the next month contract is bought. Contango has hit hard the energy futures over the past few years and markedly brought down the returns from energy markets. Indices are taking varied steps to hedge against the condit= ion. Their results remain to be seen though.
The UBS Bloomberg Constant Maturity Co= mmodity Index (CMCI) addresses the issues of Contango and b= ackwardation by introducing the concept of constant maturity, which provides diversifica= tion across futures contract maturity dates. This is intended to smooth out the volatility often associated with commodity investments.
= ;
Prospect and Conclusions<= o:p>
As a new product, ETN has a very short history. However, it has been growing very rapidly. The ETN represents a ni= fty product structure that is gaining respect and funding in the market. By 18 July= 2006, just one = month after the launch of first two ETNs, GSP and DJP, GSP had attracted more than $40 million in assets, and DJP had pulled in more than $130 million for Barclays. Investments in iPath ETNs surpassed $2 billion by late April 2007= . In just over a year Barclays has gathered close to $3 billion in eight funds. Encouraged by the good performance of the ETNs launched by Barclays, other financial institutions have either launched their own products or are drawi= ng plans to partake of the ETN space. We believe more ETNs will be launched to raise more equity for financial institutions. For the customers, the advant= ages such as tax-efficiency and good liquidity of ETNs will attract more investo= rs to this innovative structured product. All of these imply that ETN is becom= ing more and more popular.
However, now the question is whether t= his trend is going to last long. Several industry gurus point to factors that m= ay well dampen the initial euphoria surrounding this product of financial engineering. The lack of historical record – upon which to base their decision to make ETN a part of their portfolio or not – could be keep= potential investors at bay. More importantly, the issuing banks advertise tax-efficie= ncy as ETNs USP. If the IRS rules in the issuers’ favor, the implications= of which have been discussed at length in Chapter 3, ETN sales could explode. = But what if the IRS delivers an unfavorable word-or never rules? A line of thou= ght that is doing rounds is that even if the IRS delivers an unfavorable word-or never rules at all-the ETNs could still be enormously successful. The reaso= n is that ETNs provide efficient access to segments of the market that would otherwise be difficult for retail investors to reach. But how could we expe= ct that the investors would still prefer ETNs to ETFs, or any of the multitude= s of other structured products out in the market, if there is no tax-efficiency = for ETNs. Drawing a comparison to ETFs, another structured product, which suffe= rs from only market risk, ETNs face both counter party risk and market risk. E= TNs, bereft of their tax advantage, may lose their shine in the eyes of an entir= e class of investors.
To conclude, ETNs have performed very = well so far as a new kind of structured product with lower fees, better liquidity a= nd tax-efficiency. However, both financial institutes and investors should kee= p an eye the status of the tax opinion from the IRS on ETNs while seeking ETNs as business or investment possibility.”