Is that ETF premium an arbitrage?

When a discount is real and when it is stale marks.

Interactive: is that ETF premium an arbitrage?Medium

An ETF trades at a premium or discount to its net asset value. The creation and redemption mechanism closes any gap wider than the cost of doing it — so the question is always whether the gap exceeds that cost.

Net asset value Market price Creation fee (bp) Underlying spread (bp) Hedging cost (bp)

Premium / discount: —
In basis points: —
Arbitrage band: —
Beyond the band: —
Reading: —
In stressed markets: —

Widen the underlying spread to 200 basis points — a corporate bond ETF in a stressed week — and the band becomes so wide that a 1% "discount" is entirely explained by the cost of arbitraging it. That is the honest reading of ETF discounts in March 2020: the exchange price was current and the underlying marks were stale, so the ETF was the better price rather than the wrong one. See what liquidity costs.

The idea behind it

This calculator belongs to Market Microstructure, where the mechanism it computes is explained step by step, with the formula, what each input means and where the simple model stops being right. Everything is computed in your browser; nothing you type is sent anywhere.

Instruments it applies to

Exchange-Traded Fund — A whole portfolio wrapped into one share that trades all day — the cheapest way to buy a market.

All calculators

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The same in full — six points, and why each one matters

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