Yes, they will short BitUSD (go longer BTS) but as a hedge they must also sell BTS on the exchange, otherwise their BTS exposure has changed and its not risk-free. (If they did not do this, even though they may make money on the premium to the feed price, they will be exposed the the movement of the feed price during their holding period). As a result there is no new net demand for BTS from the arbitrager.
I see what you are saying about the exposure. But I still think there is net demand when someone holding USD wants to buy BitUSD. Let me go through it all again more carefully so I don't make a mistake. But it's pretty late so I am sure I will make mistakes and I am counting on you to point them out.
2) Seeing this favourable price, some arbitragers buy bitUSD with their BTS, sell it at the exchange for the higher fiat USD price, buy back their original BTS with fiat USD, and pocket a profit. This leads to an equalisation of the bitUSD premium on the exchanges and on the BTS/bitUSD exchange, but has had no net effect on BTS demand.
I don't see why this doesn't have a net effect on BTS demand. If I buy BitUSD using BTS on the decentralized exchange, I drive the price of BitUSD relative to BTS up, but haven't yet affected the price of BTS relative to USD. I am also exposed to the dollar rather than to BTS like I want to be. So to correct that I first sell the BitUSD for USD at a premium due to the high demand for BitUSD at the outside exchanges and then use some of the USD to buy back my BTS position, and some USD is left over as profit from the arbitrage. The buy demand of BTS using USD on the exchange drives the price of BTS relative to USD up.
Now compare this to the case where the desperate BitUSD buyer was to take an alternative path to get more bang for their buck. They could have used their USD to buy BTS and then used the BTS to buy BitUSD on the decentralized exchange. Because of the higher liquidity on those exchanges, they could have gotten more BitUSD for their USD. The difference between the two cases would have been the extra profit that I would have not realized through arbitrage if the BitUSD buyer was smarter.
In both cases, there should be USD purchasing BTS (but not the other way around) which drives the price of BTS relative to USD up.
3) Now seeing this favourable BTS/bitUSD price another set of arbitragers that are current holders of BTS are able to come in and create new supply in bitUSD through shorts. The arbitrage is to short bitUSD (making them longer BTS), and to sell BTS on the exchanges, which maintains their overall exposure to BTS. Again there has been no net effect on BTS demand. But importantly BTS has moved from the hands of the arbitragers into the collateral pool to support the larger supply of bitUSD.
Yes, if they have to maintain their exact same exposure there is no net effect on BTS demand from this step. Let me go in more detail with an example.
Let's say I have 4000 BTS which is currently worth 100 USD. I am happy with this exposure. The decentralized exchange however is trading 42 BTS for 1 BitUSD, meaning BitUSD is at a premium compared to USD. This may be because someone pursuing an arbitrage opportunity described in the previous step bid the price of BitUSD up while trying to convert BTS into BitUSD. There is an arbitrage opportunity here that I want to take advantage of without changing my exposure. In other words, if the price of BTS (in USD) drops in half, I don't want the USD value of my holdings to drop by more than half. I use 3000 BTS to short 24 BitUSD, and use the other 1000 BTS to buy 25 USD (yes this is BTS sell pressure). My short at 0% interest is matched by someone who purchased 24 BitUSD using 1000 BTS. The amount of BTS I own that is locked in the collateral is 4000 BTS, but of course I owe the network 24 BitUSD (luckily I also own 25 USD). Therefore, my exposure is more or less what it was before (assuming the peg more or less holds in the medium term). When the peg returns back to normal (40 BTS for 1 BitUSD), I can sell 25 USD for about 1000 BTS (this is the BTS buy pressure that counteracts the earlier BTS sell pressure which results in no net effect on BTS value in terms of USD through this process) and use 960 BTS to buy the 24 BitUSD I need to cover my short and get back my 4000 BTS. The end result of this process is that I am back to where I started except I gained an extra 40 BTS (ignoring exchange fees and assuming high liquidity on the BTS/USD market).
So based on this analysis I would say the second step has no net effect on BTS/USD but the first step does increase the value of BTS relative to USD.