How Do Market Makers Manage Their Inventory Risk Using Hedging Instruments?
Market makers hedge inventory risk by taking offsetting positions in related instruments. For a derivatives position, they might use the underlying asset (e.g.
Bitcoin) or another derivative (e.g. futures contracts) to balance their exposure. This reduces the risk of loss from price fluctuations in their inventory, allowing them to maintain a tighter bid-offer spread than they otherwise could.
Glossar
Market Makers
Function ⎊ Market Makers in cryptocurrency, options, and derivatives markets actively provide liquidity by simultaneously offering to buy and sell assets, narrowing bid-ask spreads and facilitating efficient price discovery.
Inventory Risk
Exposure ⎊ The core of inventory risk within cryptocurrency derivatives, options trading, and financial derivatives stems from the potential for losses arising from unhedged positions or imbalances between assets and liabilities.