Queue position and ETF–underlying arbitrage spillovers

ETF arbitrage can transmit pressure from an ETF order book to the underlying basket when a passive ETF fill is hedged with constituent market orders. This research letter studies a local condition under which weak ETF depth may reduce, rather than amplify, that pass-through. In a price–time-priority book, depth ahead of an arbitrage quote has two effects: it lowers the probability of execution, but it can also protect the arbitrageur from ETF flow that is costly to absorb before hedging. When that queue-protection benefit is strong, arbitrage-linked depth may withdraw from thin ETF books, weakening the hedge-induced spillover. This local response is termed reversal: after optimal arbitrage depth adjusts, spillover falls as non-arbitrage ETF depth ahead of the quote falls. A two-type order-flow mixture shows that reversal requires costly ETF flow to be sufficiently concentrated near the front of the book relative to benign flow. If costly flow is at least as persistent into the book as benign flow, the standard low-depth amplification result remains. The contribution is not a new theory of queue-position adverse selection, but an application of that logic to ETF–underlying arbitrage spillovers.