Mermaids, Fireflies, and the Bid-Ask Spread

Responding to a reader and then some

Friends,

A reader asks:

Do you have any insight into the activities of market makers when they act as authorized participants in the ETF market?

If you ask the internet how market makers earn profits, the typical response is something like "by capturing the (bid-ask) spread." I have always wondered how "capturing the (bid-ask) spread" can be so enormously profitable and consistent.

I have been looking at deviations of ETF prices from net asset value and am now under the impression that "spread" means something totally different to the market maker (in particular, authorized participants).

Am I way off here?

My answer below, plus some story-telling on ETF options and option market-making generally: