ETFs Premiums and Discounts

The value of an ETF is obtained from measuring its net asset value (NAV) at the closing of each trading day. If the ETF has a higher market price relative to the net asset value, it is said to be trading at a premium. On the other hand, if the ETF’s market price is below the net asset value, it is said to be trading at a discount.

Moreover, the value of an ETF can be measured by its intraday net asset value (iNAV) based on the securities in the creation basket for that trading day. Similar to NAV, an EFT trades at a premium when its market price is above the iNAV. Otherwise, it trades at a discount.

The discounts and premiums can be expressed mathematically as:

$$ \begin{align*} \text{End of day premium or discount }(\%) &=\frac{\text{ETF price}-\text{NAV per share}}{\text{NAV per share}} \\ \\ \text{Intraday ETF premium or discount }(\%) &=\frac{\text{ETF price}-\text{iNAV per share}}{\text{iNAV per share}} \end{align*} $$

Sources of EFT Premiums and Discounts

1. Timing Difference

Exchange closing times differ between the underlying securities and the exchange where the ETF trades. This makes NAV a poor fair value indicator for ETFs that hold foreign securities. For instance, the closing prices for US-traded EFTs are different from those of European stock since Europe is ahead by hours.

Unlike ETFs, bonds do not trade on an exchange; hence the issuers rely on bid prices because there are no true closing prices. Moreover, bond pricing model inputs sometimes reflect the price at which a dealer is willing to buy the bonds and the risk and cost to a dealer carrying the bonds in inventory. Here, the ETF’s closing price is often higher than the bid prices of the underlying holdings used to calculate NAV, making it appear that the ETF is at a premium.

However, during times of economic downturns, fixed-income ETFs with bigger trading volumes trade at discounts to the net asset value.

2. Stale Pricing

Stale price is the current price of an asset that does not reflect recently revealed or other available information. If the ETF has not traded in the immediate hours before the market closes, NAV may have changed significantly during those hours due to market movement. This would result in a premium or a discount if the market and corresponding NAV declined or increased sharply during the trading period.

Moreover, ETF prices may be a more accurate reflection than NAVs or iNAVs where the underlying market is closed, underlying securities are less liquid, and when the underlying market has time lags.

Question

Consider an ETF with a share price of $42.55. Additionally, its net asset value and intraday net asset value are $30.11 and $36.13, respectively. Which of the following most correctly gives the intraday and end-of-day ETF premiums?

1. Intraday ETF premium: 17.77%; End-of-day ETF premium: 41.32%.
2. Intraday ETF premium: 15.09%; End-of-day ETF premium: 41.32%.
3. Intraday ETF premium: 17.77%; End-of-day ETF premium: 26.44%.

Solution

The correct answer is A.

$$ \begin{align*} \text{Intraday ETF premium } (\%) & =\frac{\text{ETF price}-\text{iNAV per share}}{\text{iNAV per share}} \\ & =\frac{$42.55-$36.13}{$36.13}=0.1777=17.77\% \\ \\ \text{End-of-day ETF premium } (\%) & =\frac{\text{ETF price}-\text{NAV per share}}{\text{NAV per share}} \\ &=\frac{$42.55-$30.11}{$30.11}=0.4132=41.32\% \end{align*} $$

Reading 39: Exchange Traded-Funds, Mechanics and Applications

LOS 39 (e) Describe sources of ETF premiums and discounts to NAV.