Premiums and Discounts of Exchange-Traded Notes

As is the case with all exchange-traded products, it is a good practice to assess whether the market price of a given ETN represents a premium or discount to its indicative net asset value. Large premiums can rapidly collapse upon the issuance of new shares of an ETN, resulting in an adverse investor experience. Conversely, steep discounts may be an indicator that the ETN's issuer is in dire financial straits. A sizable premium or discount would be a "red flag," an indication of the market's nervousness related to the issuer's creditworthiness or ability to create and redeem new shares. But, because the arbitrage mechanism tends to minimize discounts, to fully grasp the extent of the credit risk associated with a given ETN, investors should lean more toward a stronger fundamental analysis of the bank.

Let's look at a real-life case

A real-life case study will illustrate what could happen in a worst-case scenario. In 2008 Lehman Brothers had three ETNs issued under the "Opta" brand name: two following commodity indexes and one tracking a private equity index. Investors in these ETNs had plenty of warnings about the bank's precarious financial situation and could have sold out prior to the collapse. In fact, the ETNs continued to trade normally, with no discount, right up until the end. However, those investors who held the ETNs at the time bankruptcy was announced had to get in line with the company's other creditors in order to receive reimbursement. After lengthy court proceedings, those investors received only pennies on the dollar.