ETF Premiums and Discounts

ETF Discounts & Premiums

In comparison to mutual funds, ETFs are not traded at a price equal to their net asset value.  Remember, mutual funds are priced nightly at a value equal to the intrinsic value of the securities held within the fund.  ETFs, on the other hand, are traded during normal market hours on major stock exchanges such as the AMEX and their market value is determined by the forces of supply and demand.  An ETF is said to be trading at a premium if its market price is greater than its' net asset value (NAV) and at a discount if the market value is below the NAV.

ETF Arbitrage

Many traders leverage ETFs to engage in arbitrage.  Essentially, when ETFs are trading at a discount, traders will buy large amounts of the ETF and then exchange them for the individual components of the ETF and sell them on the open market for a profit.  Conversely, when ETFs are trading at a premium, institutions will buy the underlying stocks within the fund and exchange them for the ETF and sell it at a profit on the open market.

Typically, the best arbitrage situations arise in new ETFs which have a heightened level of interest and trading volume which tends to increase the premium or discount.
<< Part 1:  Introduction to ETFs
<< Part 2:  Leveraged ETFs
Part 4:  Actively Managed ETFs >>
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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