ETF: Creation, Redemption, Premiums and Discounts | Page 2 of 2 | ETF Trends

Factors That Affect the Premium/Discount

Among other things, market imbalances between supply and demand, limited access to local markets where the underlying securities can be found, or expensive arbitrage trades for APs may affect the likelihood of more persistent discounts and premiums in ETFs.

International ETFs that trade on a stock exchange in a different time zone than the U.S.-domiciled ETF can be trading in the U.S. when the foreign stock markets are closed. Since the underlying stock prices aren’t up to date, the ETF may trade at a discount or premium to NAV.

Furthermore, emerging market ETFs may trade at a premium if there isn’t enough liquidity in the underlying stocks available for APs to trade in creation units, which range from 25,000 to 600,000 shares.

The underlying securities in non-Treasury bond ETFs, such as municipal or corporate bond, are not as liquid as Treasuries. When interest rates fall, non-Treasury bonds will be in greater demand and may also trade at a premium as a result to the limited supply of the security. However, as rates rise, these ETFs may trade at a discount.

When commodity ETFs are restrained by position limits on futures contracts, the commodity ETF would likely trade at a steady premium to the underlying commodity. As a result, the ETF becomes less able to issue new shares.

How Discounts/Premiums Affect Trades

If the discount or premium moves during the time you are holding onto an ETF, a transaction cost would occur, more notably when the premium drops or the discount to NAV widens.

However, the flip side is that if the ETF’s premium to NAV increases during the time you hold the ETF then the change will lift returns.

As always, using limit orders is the preferred method of investing. By utilizing limit orders, you may choose the price at which you purchase or sell a particular ETF, putting more control over your investments into your hands.