What are creation units related to ETFs?

Creation units are a fundamental concept in the structure and operation of exchange-traded funds (ETFs). They refer to large blocks of ETF shares that are created or redeemed through transactions with authorized participants, typically institutional investors.

When a new ETF is launched or when current ETF shares need to be increased, an authorized participant can create these shares by delivering a specified basket of underlying securities to the ETF's sponsor. This process ensures that the ETF's price closely tracks the net asset value (NAV) of its underlying portfolio. Conversely, if the ETF’s shares are trading at a premium to the NAV, authorized participants can redeem a block of ETF shares in exchange for the underlying securities. This mechanism helps maintain liquidity and price efficiency for the ETF in the secondary market.

Understanding creation units is crucial for grasping how ETFs function, particularly how they facilitate arbitrage opportunities for investors and contribute to the overall stability of the ETF market.