If there is an asset class where the price is trending up or down and there is no way of hedging the exposure, how do market makers post bid and ask. Is there a stop loss as it is hard to predict the random momentum up or down at any instance in time.
ask yourself a different question. how did specialist on the floor on the nyse and market-makers make money before the CBOE. when you figure out that answer your question becomes void.
They lost money. Every share I sell drives my entire inventory down. There is little open interest that isn't me and it's not well correlated to any index.
Specialist on NYSE and Options would declare a fast market and rip the eye balls out of the retail crowd and if it was full blown one way market they would halt the stock.. I don’t think NYSE Specialists ever hedged with Options but I could be wrong. They had a license to print money.
correct. read classic books by richard ney. it was a license to print money because in order to maintain an orderly market they were forced to sell to the public who were inevitably wrong. buying at the top and selling at the bottom it is harder nowadays because increments are in pennies. that is why the SOBs in the industry are fighting to bring back nickel increments and to reinstall the uptick rule for shorts, just like in the old days. of course they and their cohorts were exempt from uptick rules and locate rules for shorts.
MM's hedge stocks, futures and options with each other. One way market or not. Otherwise they go home.
It depends on so many factors... If hedging out a blue chip and for some reason you couldn't hedge with that same product at some point, you would get creative. One example might be hedging via a basket of highly correlated stocks until you can hedge properly. If hedging out a micro cap stock with low OI it will be done via phone. If a client inquires about it, then you will put the feelers out with other MMs and see if any clients are holding this particular stock. In most cases someone will find someone who has some and you add on your spread to the bid/ask. To answer a more broad Q from the OP...Every MM will vary depending on in house risk management practices but from past exp. - using FX as an example, you will have limits on the size of a position you can build up directionaly for each ccy. For G10 your limits will be much higher than exotics for example, and flow will usually net off to some extent, but if your book starts getting heavy on one side, say you are Long USD, you will start posting really attractive Offers on USD in order to attract flow looking to buy USD from you. If you breach limits you will need to hedge out risk asap and as your book moves against you you will need to start hedging out as well to mitigate losses.