How to Buy ETFs Well: iNAV, Bid-Ask Spreads, Premiums and Market Makers

What you will learn: how an ETF's market price is kept close to the value of what it holds, how to read iNAV, spreads and premiums before you trade, what a single purchase really costs, and what protections exist when an ETF's market dries up.

Farhan Sheikh (an illustrative profile), 41, a chartered accountant in Lucknow, already has a demat account and wants to put ₹3 lakh into an equity ETF on a broad Indian index. Last month he watched a smaller ETF trade about 3% above its indicative value for most of a morning, and he is unsure whether that was a bargain, a trap or a glitch. His question: "How do I buy an ETF at a fair price, and what happens if I cannot sell it at one?"

An ETF is a mutual fund scheme whose units are listed on a stock exchange. What it owns, and how closely it tracks its index, is covered in tracking difference and total cost. This lesson is about the trade itself: the moment you buy or sell units from another investor rather than from the fund.

Three prices you need to tell apart

The gap between the market price and the iNAV is the premium (price above iNAV) or discount (price below). Premium or discount = (market price − iNAV) ÷ iNAV. An ETF trading at ₹257.50 when its iNAV is ₹250.00 is at a 3.0% premium. A buyer at that price pays ₹103 for every ₹100 of holdings and would get back only ₹100 if the premium later disappeared.

The iNAV is published on the stock exchange where the ETF is listed and often shown by brokers. It is indicative: when the underlying market is shut, as for many international ETFs during Indian hours, the iNAV can be hours old, so a premium measured against it may partly reflect news the iNAV has not caught up with.

Why the price usually stays close: creation, redemption and market makers

ETF units are created and redeemed in large blocks called creation units. Under SEBI's Master Circular, ordinary investors can transact directly with the fund house only for transactions above ₹25 crore; this threshold does not apply to market makers. Everyone else buys and sells on the exchange.

Each fund house must appoint at least two market makers for every ETF. Under the framework in the Master Circular, a market maker must post two-way quotes (a price to buy and a price to sell) for at least 75% of market hours, be present among the best buy and sell quotes, and honour its quotes at the stated price and quantity. Market makers deal with the fund house in multiples of creation units, and fund houses facilitate creation and redemption in the form of the underlying securities on a best-effort basis.

This creates an arbitrage that keeps prices honest. If the ETF trades well above iNAV, a market maker can sell ETF units, buy the underlying shares and create new units at NAV, pocketing the difference until the premium closes. If it trades well below, the reverse works. The arbitrage is only as strong as the market maker's ability to trade the underlying assets. It weakens when:

• the underlying market is closed (overseas indices, or gold during sudden global moves);
• new units cannot be created, for example when an industry-wide overseas investment limit stops fresh creation in international ETFs (see routes to invest abroad);
• the underlying securities are themselves illiquid, as with some bonds; or
• markets are under stress and market makers widen quotes.

Liquidity: read the order book, not just the volume

A low daily trading volume does not by itself make an ETF illiquid. Its true liquidity comes mostly from the liquidity of what it holds, because market makers can create units on demand. What matters to you is what is on offer at the moment you trade:

• Bid and ask: the best price a buyer is offering and the best price a seller is asking.
• Spread: (ask − bid) ÷ midpoint. Half the spread is roughly what you give up on each trade compared with the midpoint.
• Depth: the quantity available at each price. If your order is bigger than the quantity at the best ask, the rest fills at worse prices.
• Where the quotes sit relative to iNAV: a tight spread centred 2% above iNAV is still a 2% premium.

Worked example: what one purchase really costs

Assumptions (illustrative): Farhan invests up to ₹3,00,000 in a liquid broad-index equity ETF at 11 am. iNAV is ₹250.00. The best bid is ₹249.85 and the best ask ₹250.15, with enough quantity at the ask for his order. Brokerage is ₹20 per order. Statutory charges on the contract note are ignored here for simplicity.

• Midpoint = (249.85 + 250.15) ÷ 2 = ₹250.00. Spread = ₹0.30 ÷ ₹250.00 = 0.12%.
• Units bought: 1,199 at ₹250.15 = ₹2,99,929.85.
• Paid above iNAV: 1,199 × ₹0.15 = ₹179.85, which is 0.06%.
• Total entry cost against iNAV including brokerage: ₹199.85, about 0.067% of the amount invested.

The adverse case: a thin ETF and a market order

Now assume the same 1,199 units in a thinly quoted ETF on the same index, also with an iNAV of ₹250.00, where the order book shows 300 units offered at ₹252.40, 400 at ₹253.10 and 800 at ₹254.00. A market order sweeps all three levels:

• 300 × ₹252.40 + 400 × ₹253.10 + 499 × ₹254.00 = ₹3,03,706.
• Average price ₹253.30, a 1.32% premium to iNAV.
• Extra paid against iNAV: ₹3,956, or ₹3,976 with brokerage, about 20 times the ₹199.85 in the liquid case.

A limit order near iNAV, for example ₹250.40, would not have filled against those thin offers immediately, but it would have stopped him paying ₹254.00. How limit and market orders work is explained in how the stock market works.

The damage can repeat on exit. If, years later, the iNAV is ₹280.00 and Farhan has to sell at a 0.5% discount (₹278.60), he receives ₹1,678.60 less than the units are worth. In the liquid case, selling at a bid ₹0.15 below iNAV would cost ₹179.85.

Price bands and what happens when the market dries up

Two sets of rules apply when trading becomes disorderly.

Price bands for ETFs from 7 September 2026

SEBI's circular of 15 June 2026, whose start date was moved to 7 September 2026 by a circular of 28 August 2026, changed how exchanges limit ETF price moves:

• The base price is the previous day's closing price (the volume-weighted average of the last 30 minutes), replacing the earlier use of the NAV from two days before. The circular asks exchanges and fund houses to move to the previous day's closing NAV as the base from 1 April 2027.
• Equity and debt ETFs (other than overnight and liquid ETFs) have a dynamic band starting at 10% either way, which can be widened by 5% of the base price after a 15-minute cooling-off period, at most twice in one direction (to 20%).
• Overnight and liquid ETFs have a fixed 5% band.
• Gold and silver ETFs start with a 6% band that widens in 3% steps, and now have a call auction in the pre-open session to help discover an opening price.

The liquidity window: selling to the fund house

Under the Master Circular, investors can redeem ETF units directly with the fund house, for transactions up to ₹25 crore and without exit load, if any of these happens:

• the ETF's closing price is at a discount of more than 1% to the day-end NAV for 7 continuous trading days;
• no quotes are available on the exchange for 3 consecutive trading days; or
• the total bid size on the exchange is less than half the creation unit size daily, averaged over 7 consecutive trading days.

Applications received by 3 pm on a trading day are processed at that day's closing NAV, and the fund house must track these conditions and disclose on its website when one arises. The window does not help with a premium you paid on entry, and it is triggered by sustained problems, not one bad hour.

Try this: a pre-trade checklist

1. Open the ETF's quote and its iNAV side by side. Calculate the premium or discount before placing any order.
2. Check the bid, ask and depth at the best few prices. If your order is larger than the quantity at the best price, split it or use a limit.
3. Use a limit order at or close to iNAV plus half a normal spread, rather than a market order.
4. Avoid the first and last few minutes of trading, when quotes can be wide or stale.
5. For international or gold ETFs, remember the iNAV may be stale and premiums can persist when new units cannot be created.
6. After the trade, compare your contract note price with the iNAV at that time and note the total cost, so you can judge whether an index fund would suit your next purchase better.

Common questions

Where to go next

• Tracking difference and total cost to compare an ETF with an index fund over your holding period.
• Mutual funds and NAV for the difference between NAV and an ETF's trading price.
• Building a passive core for deciding which indices to own.
• Further reading: how to read a mutual fund factsheet.