5.4. USING FORWARD CONTRACTS (3): SPECULATION 189
Figure 5.5:Speculating in the spot marketVT^6STFt,TST−Ft,TBuy forwardMilton thinks
he’ll end hereVT^6STFt,TFt,T−ST
Sell forwardMaynard thinks
he’ll end here @@
@ @ @ @ @ @ @ @ @ @@@we know, the profit from buying forward will beS ̃T−Ft,T. Almost tautologically,
the market thinks that the expected profit, after a bit of risk-adjustment is zero—
otherwise the forward price would have moved already. But Milton thinks that, in
reality, there is more of the probability mass to the right ofFt,T, and less to the
left, than the market realizes. Since the potential of profits is underestimated and
the room for losses overrated, Milton thinks, a forward purchase is a good deal,
warranting a big position.
Example 5.16
Suppose Maynard Keenes is less optimistic about the Dollar than is the market.
The profit from selling forward will beFt,T−S ̃T with a risk-adjusted expectation
of zero—according to the market. But Maynard knows more than the market (or
at least he thinks he does): depreciations are more probable, and appreciations less
likely, than the market perceives. Betting on depreciations, Maynard sells forward.
In both cases, the speculator thinks that the chances of ending in the red are
overrated, and the chances of making a profit underrated.^10 Note also that the
forward position is closed out at the end by a spot transaction: at timeT, Milton
has to sell spot to realize the gain he hopefully made; and Maynard must buy spot
atT because under the initial forward contract he has promised to deliver. In
hedge applications, in contrast, no spot deal is needed because there already is a
commercial contract which generates an in- or outflow atT.
(^10) To the purists: yes, the argument is sloppy: I should talk not about chances of profits, but
partial expectations. But you all know what I mean.