Let’s say you hold some sort of leveraged inverse index ETF. So if the general index falls your ETF makes money.
What happens if the fall is so bad (imagine it was 1987 all over again but worse) that there is no buyer for you to sell your ETF to? I’m guessing there is no obligation on a market maker to trade? What would be the point of holding an inverse index ETF if you couldn’t sell it when the market collapses? Can this happen?
Market makers are obliged to show markets at all times , within the exchange’s restriction of the bid/ask spread - they are however exempt from following these restriction during times of extreme volatility. That said, they have to show markets - they may not show a market a few seconds or even a minute or two after a certain news is out (you can see that on screen today after nonfarms) but they do eventually come back on screen.
If you want to sell something after price has dropped and there is no bid, your offer will flash on the screen and it is very likely that another market maker’s sytem will dime it and show a better offer - meaning you will also have to keep updating your offer as fast (or faster) than the market is dropping to get an execution or simply click the bid (if it’s there) and you’ll get, it if you’re fast enough.
So basically around big moves MM start quoting uber wide markets and that spread is then used to compensate for the potential of loss. However, sometimes the rebate we get for market making from the exchange (the only financial incentive we have to MM) is just not worth it to risk showing two way markets in times of extreme volatility - but in those times markets are so choppy that not just one but no MM would show those markets and as such, the exchange relaxes it’s rules on a case-by-case basis.
So there is no guarantee that the MM will bid? Particularly in extreme market volatility (which is exactly when the benefit of an inverse index ETF would be supposed to be occuring).
If you’re holding an inverse index ETF and the market drops 25% in a day, would you be able to sell it? Would there be any buyers of an inverse ETF (outside of the MM, who may make a quote anyway) in such a situation?
When market drops - someone would’ve sold all the bids (100 99 98 97 96 95 94 93 …etc) or bids pulled faster and once those bids are out you would see bids in relatively small volume and they will be taken out one by one until the market settles at 75 (from say 100, assuming 75 is a fair level determined by market forces) then bids start coming in around that number and again in smaller volume than before.
Yes, it’s true that outside of market makers there’s practically nobody quoting prices in such volatile markets - but good market makers will always quote, ALWAYS!