Are popular ETF's like SPY, DIA and Q's run fully by computers? Take SPY for example, its based on the S&P 500 and should be trading at a specific price on a second by second basis based on what the components of the s&p 500 are trading at. So, do the various firms that make markets in these big etf's just have some computer that calculates the value continuously and just posts bids and offers looking to capture the penny spread? And what incentive do they have to make markets in these deep liquid etf's, how do they make money?
mkt makers hedge etfs with related components. For example, etf M is based on stock A and B. The price of M equals to,say, 0.5*(price of A + price of B). And now, price of A is 5, and price of B is 5, and M is 5 too. One minute later, maybe, we have some good news on B and price of B is up to 15. In theory, price of M should be 10. However, because distribution of news needs time,even though couples of seconds, at the time when we have good news on B, price of M is still 5. The mkt maker will buy M at 5, and redeem to M's creator to exchange for the components A and B. And when they get A and B, they actually buy A and B at 5. And then they sell A and B to the mkt at 5 and 10.