Hedging and Speculating

chichi · May 10, 2008

Hi I am new to all of this and I have a question that hopefully someone can help me with.

In regards to foreign currency risk options - Why do hedgers generally let the option lapse but speculators prefer to exercise the option? In addition when would they both exercise?

thanks
Joanne

nine · May 10, 2008

Someone who knows the answer should respond but I'll speculate.

Hedgers are using the options to reduce risk so they continue to do so until expiration.

Speculators are attempting to profit from directional ownership of an option or direction/volatility changes for a combination of options. Taking the target or optimal profit probably requires buying/selling to close the position and may be done when it is judged that the goal has been reached or profit is less likely to keep improving.

Rhody Trader · May 10, 2008

To extend what Nine said - which I think hits the mark - I would argue that speculators are more likely to not exercise. Generally there is no reason to do so and several potential reasons not to. I can see hedgers exercising options more often.

chichi · May 10, 2008

I am confused, why does a hedger of foreign currency risk prefers to
let a foreign currency option lapse, while a speculator prefers to
exercise the foreign currency option? In addition, is there a
circumstance where both are pleased they will both exercise?

This is the exact wording of the question (for a university subject.). John and Nine thanks for your responses. John I had the same idea as you that a speculator generally lets the option lapse but this contradicts the question so I came on here to see what other people think.

Rhody Trader · May 10, 2008

chichi said:
I am confused, why does a hedger of foreign currency risk prefers to
let a foreign currency option lapse, while a speculator prefers to
exercise the foreign currency option? In addition, is there a
circumstance where both are pleased they will both exercise?

This is the exact wording of the question (for a university subject.). John and Nine thanks for your responses. John I had the same idea as you that a speculator generally lets the option lapse but this contradicts the question so I came on here to see what other people think.

I'd inquire about the figures backing up the question - if that's possible. Unless the question is just inquiring what circumstances would cause...

If so, then a hedger would allow the option to expire if the market went in the favor of the hedger's position, leaving the option with no value. And the speculator would exercise if it was more financially practical (lower transaction costs, or an illiquid OTC option) than just selling the option.

Hedging and Speculating

chichi

Newbie

nine

Senior member

Rhody Trader

Senior member

chichi

Newbie

Rhody Trader

Senior member

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