Free Money In ETNs?

December 28, 2010

With thinly traded ETFs trading at wild premiums and discounts, is there a chance to print free money? Think again.

One of the data points I look at every day is the outliers on premiums and discounts. For example, here’s the table from last night:


Top 10 Highest Premiums


PEK Market Vectors China 15.02
VNM Market Vectors Vietnam 4.07
BRXX Emerging Global Shares Indxx Brazil Infrastructure 3.14
INP iPath MSCI India ETN 2.70
DEE PowerShares DB Commodity Double Short ETN 2.66
FLYX Direxion Airline 2.45
CRBA Jefferies TR/J CRB Global Agriculture Equity 2.35
AXFN iShares MSCI ACWI ex-US Financials 2.34
GAZ iPath Dow Jones-UBS Natural Gas Sub Total Return ETN 2.28
BRAZ Global X Brazil Mid Cap 1.97


Bottom 10 Lowest Discounts


Ticker Name Discount
GWO ELEMENTS Credit Suisse Global Warming ETN -20.35
JFT KEYnotes Exchange Traded Notes First Trust Enhanced 130/30 Large Cap ETN -8.59
IFNA iShares FTSE EPRA/NAREIT North America -2.96
BSC ELEMENTS Benjamin Graham Small Cap Value - Total Return ETN -2.49
TDX TDX Independence In-Target -2.47
INY SPDR Barclays Capital New York Municipal Bond -2.45
TDH TDX Independence 2020 -2.34
TDV TDX Independence 2040 -2.26
CMF S&P California AMT-Free Municipal Bond -2.11
TFI SPDR Barclays Capital Municipal Bond -1.92

Most of the time, this list is predictably dominated by tiny, illiquid ETFs. Thinly traded ETFs are easy to push off net asset value, especially at the end of the day. And you don’t get much more thinly traded than some of the ETNs on this list. Many of them hit the list as the result of trading only a few hundred shares during the day. It’s not uncommon for a single trade in the middle of the day to be marked as the official close on the consolidated tape.

Of course, net asset value changes all the time, as the securities backing the ETF or ETN index trade. And ETF issuers diligently keep producing intraday net asset values and closing values.

The poster child for this disconnect between the barely trading ETN and the constantly trading underlying securities is GWO, the Credit Suisse Global Warming ETN (NYSEArca: GWO).

On the surface, a 20 percent discount in GWO seems like an amazing, free-money trade. The underlying index of 50 stocks is certainly hedgeable, and there’s nothing particularly toxic about them; they’re just big companies like Monsanto and Waste Management, for the most part.

Even better, the ETN has a provision in its prospectus suggesting that if the ETN doesn’t have $5 million under management by April next year, it can be called at fair value. That’s a possible guaranteed buyer for the 20 percent discount! Free money!

The problem is that this discount is actually a myth, because the last time GWO traded was on Dec. 22. And until someone steps up to the plate and actually makes a trade, the “closing price” of GWO will remain the $6.85 as of 4 p.m. last Wednesday. That’s regardless of the fact that the actual NAV of the ETN is well over $8. So, the prospect of actually executing a trade at the “price” of $6.85 is an illusion.

GWO, like so many funds at the bottom of the volume scale, exhibits huge premium/discount response to trading activity and timing. Here it is over the last year:



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