How options and futures can mitigate price risk

How options and futures can mitigate price risk

Before injecting cash into any project, investors tend to focus on time, returns and risk associated or inherent in an investment.

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Investors who are in most cases informed and rational tend to raise questions about assets before giving out their resources. These questions include: What will I benefit?

What are the chances that I will get that return (risk)? When will that benefit be realised (time)? No rational investor will take a risk if he or she is not adequately compensated.

This is why Options and Futures are used to manage risks and enhance returns from employed assets. Their trading at the Nairobi Securities Exchange(NSE) next year is thus welcome.

Every market has its players in the Option and Futures market, namely hedgers, speculators, and arbitrageurs.

An authority in Options, Hull, tells us that these three groups use Option and Futures reducing assets’ risks to speculate (take a view on the future direction of the market); to lock in an arbitrage profit; to change the nature of a liability as well as the nature of an investment without incurring the costs of selling one portfolio and buying another.

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A hedger insures his trade to reduce the risk. This explains why we need a vibrant Futures and Option’s market.

Assume you are a farmer and your crop will be ready in three months. Your biggest worry would be the price of the crop in December. That price can either be favourable or unfavourable.

You can manage the risk of unfavourable price by hedging, which requires one to enter into a contract to sell the crop at an agreed price in December. A future contract is a legal agreement to buy or sell something at a predetermined price at a specified time in the future. ALSO READ: Safaricom faces 499m fine for blocking calls Certain price It is an agreement to buy or sell an asset for a certain price at a given time and form a contract that will be traded at the NSE. It means you can reduce that risk with a Futures contract.You stand to gain when the price decreases and lose when it increases because the extra cash will not come to your pocket., then buy a Futures contract to hedge the risk.Thus you can either buy or […]

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