Question

1) Assume that you are a speculator. What would you choose in terms of instruments: options or futures/ forwards? Explain your answer. Also if you believe that there is a trade-off between the two, clearly explain the cases when you would use one over the other?

a. ) Answer question 1 from the perspective of a US MNC

Answer 1

(1): As a speculator my main objective will not be hedging but it will be speculation. Thus my main objective will not be to reduce the amount of risk or volatility but it will be to make a profit from price changes of the underlying asset.

As such as a speculator I will make use of futures/forwards. As a speculator I will earn a profit when the futures contract is offset to my benefit. The modus operandi will be that I will buy futures/forwards contracts and then sell them back at a higher price. This will be higher than that at which the contract was purchased.

Yes, there is a clear tradeoff between the two. In case of use of options for hedging the amount of risk will be minimized while in case of use of futures/forwards the return or the profit amount will be maximized. Thus the tradeoff will be with regards to return and risk.

(a): From the perspective of a US MNC the objective will be to minimize their risk and volatility. As such a US MNC will look more at using options to manage their volatility rather than seeking to maximize returns from speculative opportunities by making use of futures/forwards.