ALL ABOUT ETPs: PREMIUMS AND DISCOUNTS

Exchange traded products (ETPs) have become indispensable tools for investing in financial markets. While there are many ways to evaluate ETP performance, one measure — an ETP’s premium or discount — can be more nuanced than the others.

ETPs combine many of the features of mutual funds and stocks. Like mutual funds, ETPs are pooled investment vehicles that offer access to a broad mix of stocks, bonds, or other assets. Unlike mutual funds, most ETP investors don’t interact directly with the fund provider when buying or selling fund shares. Instead, they generally trade existing ETP shares with each other during market hours, on an exchange, just like trading stocks.

Most ETP trading activity happens on exchange, or in the “secondary” market, where investors buy and sell existing ETP shares. As with stocks, the price of the shares is determined in real-time. A separate, “primary” market exists where large financial institutions, called “authorized participants” (APs), transact with ETP issuers to create or redeem ETP shares based on market demand.

An ETP’s market price is typically in-line with the value of its underlying securities or assets, but it’s possible for an ETP to trade at a price above (premium) or below (discount) the current value of its assets. If the price of an ETP share is greater than the value of its underlying securities or assets, the ETP is said to be trading at a “premium.” In response, APs may buy the ETP’s underlying securities and exchange them with an ETP issuer in return for newly created ETP shares, which may then be sold in the market for a profit.¹ Likewise, if the market price of the ETP falls below the value of its underlying securities (the ETP is trading at a “discount”), an AP could buy shares of the ETP and redeem them with the ETP issuer in exchange for the ETP’s underlying securities or cash.

This “arbitrage mechanism” generally helps keep the price of an ETP share in line with the value of its basket of underlying securities or assets. However, evolving market conditions can result in large or persistent ETP premiums and discounts. Premiums and discounts can also arise from a “timing mismatch” between when an ETP’s net asset value (NAV) is calculated and when the trading window for the ETP closes.

While some premiums and discounts present actionable arbitrage opportunities, where APs have an economic incentive to create or redeem ETP shares, others may simply be “optical” discounts.² In these instances, there could be a timing mismatch (as described above), or the ETP could be providing price discovery, reflecting the real-time value of its underlying securities or assets.

ETP premiums and discounts can provide valuable information to investors who are assessing the cost of an ETP relative to other market access vehicles. However, it’s important to understand what is behind a reported premium or discount.

A closer look at the impact of timing mismatches on ETP premiums and discounts

Certain asset classes, like commodities and international equities, may experience premiums or discounts related to the timing of the prices used to calculate the ETP’s NAV. Because ETPs trade on exchanges, their final daily market price is generally determined by the official closing price of the ETP shares at market close (typically at 4pm ET). While the market price of the ETP is generally based on its price at the time its respective exchange closes, the ETP’s underlying assets may be valued using prices struck at a different time.

For example, the NAVs of both the iShares Gold Trust (IAU) and iShares Silver Trust (SLV) are calculated based on the London Bullion Market Association (LBMA) Gold and Silver Prices, respectively. These prices are struck at 10am and 7am ET, respectively—well in advance of the 4pm ET U.S. market close.³ Because the ETP can continue to trade until the U.S. market closes, any demand to buy or sell shares of the ETP will likely cause the exchange price of that ETP to deviate from the price used at the time the NAV was calculated, creating an optical premium or discount.

Another example is U.S.-listed ETPs that hold international equities where the ETP will continue to trade even when the local markets for its underlying securities are closed. Some ETP providers, such as BlackRock, apply fair-value adjustment methods when determining the NAV of ETPs that have international equities. This often results in more precise pricing for the NAV but may result in premiums or discounts that look different than the premiums or discounts of ETPs that do not make these adjustments.

The launch of spot bitcoin ETPs in the U.S. in January 2024 added another dimension to evaluating ETP premiums and discounts, as bitcoin trades 24/7 and does not have an official closing price. This means that issuers of spot bitcoin ETPs may each use a unique methodology to calculate the NAV of their ETP. For example, the iShares Bitcoin Trust ETF (IBIT) calculates daily NAV using the volume-weighted average price (VWAP) of bitcoin over multiple crypto exchanges between 3pm and 4pm ET, while other ETPs may use the price of bitcoin at 4pm ET. Because IBIT uses an average price to calculate daily NAV, major changes in the price of bitcoin towards the end of the trading day can manifest in a larger premium or discount. Additionally, these different methodologies can result in seemingly similar funds exhibiting different premium and discount behavior, based on their respective NAV calculations. Note that IBIT, IAU and SLV are not investment companies registered under the Investment Company Act of 1940, and therefore are not subject to the same regulatory requirements as mutual funds or ETFs registered under the Investment Company Act of 1940.

We summarize some of these differences in NAV calculation methodologies below (Figure 1).

The emergence of ETP premiums and discounts can simply be a result of the different methodologies used to determine the calculation of an ETP’s NAV. When evaluating ETP premiums and discounts, it’s important to understand the methodology used to determine whether there is a “true” deviation from the value of an ETP’s underlying securities, or just an optical one.