and not because they are convinced at the outset that their view on the market will be vindicated subsequently.
Hindsight, as someone said, is a ‘perfect science’. Hedgers are not prescient and, hence, there is every possibility that in their quest to mitigate risk, they end up looking foolish to the uninitiated. To hedge or not to hedge is a classic dilemma that is faced by a treasurer or a CFO. The hard part is convincing the CEO that the outcome with hedging will not always be better than the outcome without hedging. In other words, we hedge because we wish to avoid risk, and not because we are assured about our ability to predict the future.
Thus, the counterparties to such contracts may be both hedgers or may be both speculators, with contrasting price expectations. The other possibility, of course, is that one of the two parties is a hedger, while the other is a speculator.
From the standpoint of speculators, there is no upper bound on the futures price while there is a lower bound of zero, as is the case in the spot markets. Thus, bulls who take futures positions face the spectre of finite losses and infinite profits, while bears who tend to go short in futures are confronted with the possibility of finite profits and potentially infinite losses, as is the case with those who short sell in spot markets.
The writer is the author of ‘Fundamentals of Financial Instruments’, published by Wiley, India
Playing on future
* Futures and and forward contracts, which we term as derivative securities, help traders to both speculate on the future as well as minimise, if not eliminate, the risk to which some of them may already be exposed
* Such contracts are what we term as ‘commitment contracts’, for the assumption of a position in such contracts amounts to a binding commitment to perform on a future date. Such contracts require two counter-parties who are termed as the ‘long’ and the ‘short’, respectively