Question

POINT: Speculators should use currency futures because they can avoid a substantial premium. To the extent that they are willing to speculate, they must have confidence in their expectations. If they have sufficient confidence in their expectations, they should bet on their expectations without having to pay a large premium to cover themselves if they are wrong. If they do not have confidence in their expectations, they should not speculate at all.

COUNTER-POINT: Speculators should use currency options to fit the degree of their confidence. For example, if they are very confident that a currency will appreciate substantially, but want to limit their investment, they can buy deep out-of-the-money options. These options have a high exercise price but a low premium, and therefore require a small investment. Alternatively, they can buy options that have a lower exercise price (higher premium), which will likely generate a greater return if the currency appreciates. Speculation involves risk. Speculators must recognize that their expectations may be wrong. While options require a premium, the premium is worthwhile to limit the potential downside risk. Options enable speculators to select the degree of downside risk that they are willing to tolerate.

WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.

Answer 1

Solution:

There are different benefits and risk of using currecny futures or currency options. If speculator have confidence in their expectatios and goes for currency future, then definitely they can avoid substantial premium, however in this case their risk of loosing money is unlimited. If things will not go according to their expectation and currency moves in reverse direction, they have to bear huge loss as there is no limit on loss.

On the other hand, if speculator will go for currency options, then speculator have to pay substantial premium to buy currecny option. However in this case, if speculator is having confiedence on their expectation, they can earn without any limit if price of underlying assets moves in speculator directions on cost of fixed premium. However if things will not go to according to their expectation and currency moves in reverse direction, in that case their loss is limited up to cost of option premium only. In this case, speculator is able to limit their potential downside risk on cost of premium

Therefore both points are correct at their level. It depends on speculator, which path he choose, future or options according to his risk bearing capacity.

However i will support counter point argument. In my opinion, if we go for speculation at least we should limit our downside risk on cost of option premium. There is no limit on earning, if price moves as per our expecation and we should hedge our risk by opting for currency options.