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.