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Sunanda K. Chavan
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Speculation - October 19th, 2010

Speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum.

With the help of options, one can minimize the downside risk, which is not possible in the case of futures.

Illustration (1): A trader in the market expects the price of wheat to rise due to damage to the crops in Punjab. So he buys a future contract for wheat for 10,000 kg which is trading at Rs. 5. After some days, when the price of wheat goes to Rs.6, he will sell the futures contract and pocket a difference of Re.1 per kg or Rs. 10,000. But if the price of wheat falls to Rs. 3 instead of rising, and remains depressed throughout the remainder time of the contract, the trader would lose Rs.2 per kg or Rs. 20,000.

Illustration (2): If the same trader had taken a call option to purchase wheat at Rs.5 per kg or Rs. 50,000 per contract by paying a premium of Rs.500, he would have made a profit of Re. 1 per kg (or Rs. 10,000 for the contract) if the price of wheat went up to Rs.6 per kg or a loss of Rs. 500 only in case the price went down to Rs.3 (as he would let contract expire), thus saving Rs.19,500 of losses in the futures contract.
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