NAV, Premiums and Discounts
An ETF's market price can drift from the true value of what it holds. Arbitrage by authorized participants pulls the price back to NAV.
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Text version · Indexes & ETFs, lesson 4: “NAV, Premiums and Discounts”
An ETF's market price can drift from the true value of what it holds. Arbitrage by authorized participants pulls the price back to NAV.
Real value vs trading price
NAV is the total value of the fund's assets ÷ units outstanding; the market price is what buyers and sellers trade at on the exchange. A higher market price is a premium, a lower one a discount.
The authorized participant pulls the price back
An authorized participant can swap a basket of stocks for ETF units with the fund company, or ETF units back for stocks, in creation units. It sells whichever side is pricier, and the gap gets smoothed away bit by bit.
Check the indicative NAV before you buy
Trading apps usually show the IOPV. If you buy when the market price is clearly above it, you lose that extra when the premium fades. Thinly traded ETFs have fewer arbitrageurs, so premiums and discounts tend to be bigger and last longer.
Key takeaways
- NAV = total value of the fund's assets ÷ shares outstanding. During trading hours you can see a real-time estimate (IOPV).
- A market price above NAV is a premium; below NAV is a discount. Premium = (market price − NAV) ÷ NAV.
- Authorized participants arbitrage through creations and redemptions, keeping the market price close to NAV.
- Chasing an ETF at a clear premium means losing that extra once the premium disappears.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click "Example": NAV $100, market price $102. Is that a premium or a discount? How big?
- Keep "Wait" and press ▶: does a premium driven by sentiment disappear on its own?
- Switch to "Arbitrage": what three steps does the authorized participant take, and how much of the premium is squeezed out?
- Drag market sentiment to −3% (pessimistic): why does the arbitrage flip direction?
Quiz and explanations
- 1. An ETF's NAV is $100 and its market price is $102. It's trading at…
- Answer: A 2% premium.The market price is 2% above NAV.
- 2. When an ETF trades at a premium, arbitrageurs will…
- Answer: Buy the constituents, create ETF shares, and sell the ETF on the market.They buy the cheap constituents, swap them for the pricier ETF and sell it, and the selling pushes the premium back down.
- 3. An ETF's NAV is $50 and its market price is $49. What will an authorized participant most likely do?
- Answer: Buy the cheap ETF on the market, redeem it for a basket of stocks and sell them.It's a 2% discount: buy the ETF at $49, redeem it for about $50 of stock and sell. The buying pushes the ETF price back toward NAV.
Terms in this lesson
- authorized participant (Authorized Participant): A large institution that can create ETF shares with a basket of stocks or redeem ETF shares for that basket.
- creation unit (Creation Unit): The minimum batch an authorized participant can create or redeem, usually tens of thousands of ETF shares; ordinary investors trade on the secondary market.
- premium / discount (Premium / Discount): How far an ETF's market price sits from its NAV: above NAV is a premium, below is a discount.
- IOPV (Indicative NAV): An ETF's indicative NAV during trading hours, estimated from its holdings' live prices and updated every few seconds.
- NAV: Total value of a fund's holdings ÷ number of shares: what each fund share is really worth.