17/12/2019 Speculative Risk

TRADING SKILLS & ESSENTIALS RISK MANAGEMENT

Speculative Risk
By WILL KENTON | Updated Nov 25, 2019

What Is Speculative Risk?

Speculative risk is a category of risk that, when undertaken, results in an uncertain degree of
gain or loss. All speculative risks are made as conscious choices and are not just a result of
uncontrollable circumstances. Since there is some chance of either a gain or a loss,
speculative risk is the opposite of pure risk, which is the possibility of only a loss and no
potential for gain.

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Almost all investment activities involve some speculative risks, as an investor has no idea
whether an investment will be a blazing success or an utter failure. Some assets—such as an
options contract—carry a combination of speculative risk and risk that you can hedge.

Understanding Speculative Risk

Some investments are more speculative than others. For example, investing in government
bonds has much less speculative risk than investing in junk bonds because government
bonds have a much lower risk of default. In many cases, the greater the speculative risk, the
higher the potential for profits or returns on the investment.

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KEY TAKEAWAYS
Speculative risk happens when there is an uncertain potential for gains or losses.
Assuming speculate risk is usually a choice and not the result of uncontrollable
circumstances.
Pure risk is the potential for losses and, in contrast to speculative risk, there is no
opportunity for gain.
Buying a call option contract is an example of taking on a speculative risk, as there
is potential for gains, while the possibility of losses—in terms of the premium paid
for the contract—exist as well.
Sports betting, investing in stocks, and buying junk bonds are other examples of
activities that involve speculative risk.

A speculative risk has the potential to result in a gain or a loss. It requires input from the
person looking to assume the risk and is therefore entirely voluntary in nature. At the same
time, the result of a speculative risk is hard to anticipate, as the exact amount of gain or loss
is unknown. Instead, various factors—such as company history and market trends when
buying stocks—are used to estimate the potential for gain or loss.

Speculative Risk vs. Pure Risk

In contrast to speculative risk, pure risk involves situations where the only outcome is loss.
Generally, these sorts of risks are not voluntarily taken on and, instead, are often out of the
control of the investor. Pure risk is most commonly used in the assessment of insurance
needs. For example, should a person damage a car in an accident, there is no chance that
the result of this will be a gain. Since the outcome of that event can only result in a loss, it is a
pure risk.

Examples of Speculative Risk

Most financial investments, such as the purchase of stock, involve speculative risk. It is
possible for the share value to go up, resulting in a gain, or go down, resulting in a loss. While
data may allow certain assumptions to be made regarding the likelihood of a particular
outcome, the outcome is not guaranteed.

Sports betting also qualifies as having speculative risk. If a person is betting on which team
will win a football game, the outcome could result in a gain or loss, depending on which
team wins. While the outcome cannot be known ahead of time, it is known that a gain or loss
are both possible.

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If you buy a call option, you know in advance that your maximum downside risk is the loss of
the premium paid if the options contract expires worthless. At the same time, you do not
know what your potential upside gain will be since nobody can know the future.

On the other hand, selling or writing a call option carries unlimited risk in exchange for the
premium collected. However, some of that speculative risk can be hedged with other
strategies, such as owning shares of the stock or by purchasing a call option with higher
strike price. In the end, the amount of speculative risk will depend on whether the option is
bought or sold and whether it is hedged or not.

Related Terms
Pure Risk: What Everyone Should Know
Pure risk is a type of risk that cannot be controlled and has two outcomes: complete loss or no loss at
all. more

How a Protective Put Works

A protective put is a risk-management strategy using options contracts that investors employ to guard
against the loss of owning a stock or asset. more

Define Employee Stock Option (ESO)

An employee stock option (ESO) is a grant to an employee giving the right to buy a certain number of
shares in the company's stock for a set price. more

Exploring the Many Features of Exotic Options

Exotic options are options contracts that differ from traditional options in their payment structures,
expiration dates, and strike prices. more

Risk
Risk takes on many forms but is broadly categorized as the chance an outcome or investment's actual
return will differ from the expected outcome or return. more

Why Investors and Credit Card Holders Need to Know Counterparty

Risk
Counterparty risk is the likelihood or probability that one of those involved in a transaction might
default on its contractual obligation. more

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