can anyone explain the difference between these three? Textbook says speculators use futures contracts to gain exposure to changes in the price of the asset underlying a futures contract. A hedger will use futures contracts to reduce exposure to price changes in the asset. not sure about what does this mean?
a speculator would typical buy an option without owning the underlying asset/security. if the option ends up in the money, the speculator would take the profit. otherwise let it expire worthless. a hedger usually owns a security and wants to protect their postion from a downward movement of the market, or they want to take the profit without selling the security. they use put option/ short futures to do that, so any loss from downward movement of the security is compensated by gain in the option/future contract. this effectively “locks” price of a secuirty at the strick price of the option.
an arbitrager finds identical cash flow streams (bond, security, physical goods), and if the market pricing of these identical cash flow is different. an arbitrage would take a profit from that until the price and PV reach equilibrium for example, a 10- year bond that pays with 10% coupon is priced at 100 dollars. at the same time, a prefer share that pays 10 dollars in dividend annually is priced at 99 dollars. an arbitrager would buy the preferred share and issue a 10 year bond at the same time, and the profit from that would be 1 dollar difference between the price of the bond and the preferred share that would give the same cash flow over 10 years.
I got it:) Thanks for the explanation!