Exchange traded funds can be bought and sold like a single security throughout a regular trading day, but like traditional mutual funds, they are made up of a bundle of stocks or other securities. As such, investors may notice a discount or premium to in ETFs, compared to the net asset values.
What are “premiums” and “discounts?” The net asset value (NAV) is calculated by dividing the value of all securities in the portfolio by the number of outstanding shares, and the market price of an ETF is determined by its underlying shares. Since an ETF’s price is constantly changing, a price difference may manifest between the price of the ETF and its NAV. When the ETF’s price is lower than the NAV, the ETF is said to be at a “discount” – the ETF is valued less than the fund’s overall holdings. If the ETF’s price is above the NAV, the ETF is said to trade at a “premium” – the ETF is trading higher than what the underlying holdings are worth.
Why discounts/premiums occur. Imbalances between supply and demand, especially in illiquid markets that offer limited access like emerging markets, will affect the availability of trades in the underlying assets. International ETFs also trade on stock exchanges in different time zones. Since the underlying stock prices are not up-to-date, the U.S.-listed ETFs will show a discount or premium to the NAV. In commodity ETFs, if position limits on futures contracts restrain trades, the ETF could trade at a steady premium to the underlying commodity prices. [How Lower Trading Volume Impacts ETF Investors]