How Does a Market Maker Hedge a Large RFQ Trade for an Illiquid Altcoin Option?
Hedging an illiquid altcoin option often relies on delta hedging using the underlying altcoin itself, but with significant challenges. Due to low liquidity, large spot trades for the hedge can cause substantial market impact, increasing execution risk.
Market makers may use smaller, staggered trades or rely on correlation to a more liquid asset (like BTC) as a proxy hedge, though this introduces basis risk. They also adjust the option price (wider spread) to compensate for the higher hedging cost and risk.
Glossar
Illiquid
Valuation ⎊ Illiquidity in cryptocurrency, options, and derivatives manifests as a divergence between marked-to-market prices and intrinsic value, often amplified by limited arbitrage opportunities and information asymmetry.
Altcoin
Definition ⎊ An altcoin refers to any cryptocurrency other than Bitcoin, encompassing a broad category of digital assets with varied functionalities and market capitalizations.