Our study contributes to the litera

Our study contributes to the literature by examining the role of hedging costs in determining option spreads and its implications for inventory management from a unique perspective. We show that rebalancing costs have two sources: costs due to inventory changes and costs due to delta changes. For market makers who maintain stable inventory positions, rebalancing costs due to inventory changes will be trivial and rebalancing costs will be mainly driven by delta changes. However, volatile inventory levels cost market makers more to adjust their hedging positions, and rebalancing costs due to inventory changes significantly affect option spreads. These cost relations imply that market makers will exert effort to stabilize their inventory positions around the optimal level. Thus, whether rebalancing costs due to inventory/delta changes are significantly related to option spreads becomes an important issue.