Hedging and Speculation

Let’s learn more about hedging and Speculation. Speculators and hedgers are different terms that describe traders and investors. The speculation involves trying to make a profit from a security’s price change, whereas hedging attempts to reduce the amount of risk, or volatility, associated with a security’s price change.

Hedging involves taking an offsetting position in a derivative in order to balance any gains and losses to the underlying asset. Hedging attempts to eliminate the volatility associated with the price of an asset by taking offsetting positions contrary to what the investor currently has. The main purpose of speculation, on the other hand, is to profit from betting on the direction in which an asset will be moving.

For example, assume that a company specializes in producing jewelry and it has a major contract due in six months, for which gold is one of the company’s main inputs. The company is worried about the volatility of the gold market and believes that gold prices may increase substantially in the near future. In order to protect itself from this uncertainty, the company could buy a six-month futures contract in gold. This way, if gold experiences a 10 percent price increase, the futures contract will lock in a price that will offset this gain.

It include the followings:

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