We often only know the one way to do any particular task, unaware of the alternative way. It also happens that the alternative one is quite simple and handy and also saves a lot of time, effort, and energy.
The same thing is with the future market; there is more than one way to participate in future markets, and we will study them in detail in this article. There are majorly 3 participants in the futures and options market Speculators, Hedgers, and Arbitrageurs.
Let us understand Speculators:
Speculators are players who invest in derivatives depending on their market expectations. For example, if the investor thinks the market is rising, he should lock in a buy price for a long position in the Futures contract. Similarly, if he believes the market will fall, he should sell short. Speculators stake their money on the potential of market speculation.
Speculators are not required to have a position in the underlying asset. They place bets on whether the price of the future will rise or fall and then act accordingly. Speculators bet on the possibility of a market movement, but they do not necessarily own any of that underlying asset.
Speculators are not required to have a position in the underlying asset. They are investors who take a long or short position in a futures contract to earn a profit. Speculators help ensure that prices on futures contracts remain close to their actual levels by taking opposing positions, thus creating an opening for arbitrageurs who then correct any mispricing.
Let us understand Hedgers:
Hedgers are those who use futures and options contracts to protect themselves against price movements in the underlying asset. They are usually producers, manufacturers, and distributors of a commodity or product.
Hedgers can also be consumers that want to protect themselves from price fluctuations in their end products by purchasing insurance (futures or options) through a Futures Commission Merchant.
The role of hedgers is very important to market participants as they help stabilize prices by taking positions on both sides of the market.
For example, suppose there is high demand for corn. In that case, farmers will buy corn futures contracts because it allows them to lock in today's pricing of their product so that when they harvest their crops later this year, they will know its worth then, even if there was an increase or decrease after they sold it off during harvesting season.
This prevents them from having too much inventory, leading to bankruptcy because prices may have already dropped below what initially expected them to be worth at harvest time."
Let us understand arbitrageur:
An arbitrageur is a trader who seeks to profit from price differences in the futures and options markets. They are often known as market makers (or simply arbitrageurs) since they stand ready to buy or sell any commodity at almost any time.
Arbitrageurs do not participate in producing the underlying commodity; their only function is to facilitate trade by providing liquidity in both markets. The futures and options market has a variety of trading participants.
Some hedgers trade to reduce risk in their business, speculators trade to make an investment profit, arbitrageurs attempt to profit from price differences between markets, and market makers buy and sell for their account and make money on the bid-ask spread. These exchanges provide clearing services for their members and other types of traders.
Exchanges offer a venue where buyers meet sellers, such as when farmers sell grain futures contracts or crude oil contracts to people who need them at specific prices in the future.
The exchanges also serve as a central point where information about opening prices is disseminated quickly so that all participants can trade on it at once.
In conclusion, speculators participate in the futures and options market to express opinions about the future price movements of an underlying asset. They are willing to risk their capital in return for any profits they may make from their speculation.
Arbitrageurs will not have to speculate if the prices of contracts are equivalent to those of the underlying assets. At the same time, the hedgers need not use futures contracts because they are already exposed to price movements in the underlying assets.