Differences in Hedging And Speculation
Speculators and hedgers are different terms that describe traders and investors. Speculation involves attempting to profit from a change in the price of a security, while hedging efforts to reduce the amount of risk, or volatility, are related to changes in the price of a security.
Hedging involves taking an offsetting position in a derivative to balance the gains and losses on the underlying asset. Hedging tries to eliminate the volatility associated with asset prices by taking offsetting positions as opposed to what investors currently have. The main purpose of speculation, on the other hand, is to profit from a position in the direction in which the asset will move.
Hedgers (hedging actors) reduce their risk by taking the opposite position in the market for what they are trying to protect its value. The ideal situation in the hedge will cause one effect to cancel the other. For example, suppose that the company specializes in producing jewelry and has a big contract in six months, where gold is one of the main ingredients of the company. The company is concerned with the volatility of the gold market and believes that gold prices may rise substantially in the near term. To protect yourself from this uncertainty, the company can buy a six-month contract with gold. In this way, if gold experiences a 10% price increase, futures contracts will lock prices that will offset these gains. As you can see, although hedgers are protected against losses, they are also limited from any profit. The portfolio is diversified, but remains systematically at risk. Depending on the company’s policies and the type of business it is running, a company may choose to hedge against a particular business operation to reduce its profit fluctuations and protect itself against downside risks.
To mitigate this risk, investors hedge their portfolios by selling short futures on the market and buying put options against old positions in the portfolio. On the other hand, if the speculators are concerned about this situation, he may be looking for short positions of ETF assets and futures contracts in the market to make a potential profit on downside movements.
Trading by speculators is based on their best guess about where they believe the market is headed. For example, if the speculator believes the stock is too expensive, he may sell his stock for a while and wait for the stock price to fall, and at which point he will buy back the stock and receive the profit. Speculators are vulnerable to downside risks as well as market risks; Therefore, speculation can be very risky.