Inventory risk refers to the exposure faced by market makers due to holding an unbalanced portfolio of assets. In options trading, this risk arises from changes in the underlying asset price and volatility, which can lead to losses on the market maker’s inventory of options and underlying assets. Managing this exposure is essential for maintaining profitability.
Strategy
Market makers employ dynamic hedging techniques to manage inventory risk, adjusting their positions in the underlying asset to maintain a delta-neutral or gamma-neutral portfolio. This involves continuously rebalancing the inventory to offset potential losses from price movements. The goal is to minimize the impact of market fluctuations on the overall portfolio value.
Hedge
Hedging strategies aim to minimize the impact of market fluctuations on the overall portfolio value. In crypto derivatives, this often involves using perpetual futures or spot market trades to offset the risk generated by providing liquidity in options markets. Effective inventory risk management requires sophisticated algorithms that calculate and execute hedges in real-time.
