I'm new at this, but learning. I have searched the web and the prior threads on this board, but I haven't been able to find answers to a few questions. If any of you can offer any insight, or point in a direction where I might find answers, thanks in advance. 1) (principally in regard to nasdaq, but nyse might apply) Do market makers hold an inventory of shares to sell, or do they borrow them as needed? ie, are they flat on the day, and have to go short to sell to buyers every morning (assuming there are any)? It seems like they must have a net position on strongly trending days, and if so how do they hedge the overnight risk? Do MM's "volunteer" to make a market in a particular stock, or are they assigned by the exchange? 2) In regard to ETF's (eg, QQQ) - is the value of the ETF pegged to the value of the underlying securities, or does it's value fluctuate independently according to demand for the ETF? I assume the latter, but doesn't that open up a lot of opportunity for inefficient pricing and arbitrage?
There is a certain supply/demand impact on ETF pricing, but a combination of outright arbitrage and the ETF itself buying/selling the underlying equities tends to keep the prices within a margin of error. Example: as I'm writing this, the QQQ is trading @ 36.83 x 36.85 and the NDX is at 1479.20 (about a 5 NDX point differential - which should be about as much as you'll nominally see - much more than that would probably tend to trigger an arb program).
from what i've heard, they usually don't hold an inventory overnight. well, both. if you have a "creation unit" worth of QQQ-s (50k shares), then you can redeem them for a a portfolio of nasd100 stocks. however, the tick-by-tick price fluctuations of ETF-s are caused by supply and demand. check this: http://www.amex.com/indexshares/index_shares_faq.stm i used to perform some analysis on QQQ prices as compared to the underlying NDX index, and found them incredibly efficient: in fact, they don't just follow NDX, but lead NDX by about 30..60sec! - jaan