Speculative Risk
Speculative risk is a category of risk that, when undertaken, results in an uncertain degree of gain or loss. In particular, speculative risk is the possibility that an investment will not appreciate in value. Speculative risks are made as conscious choices and are not just a result of uncontrollable circumstances. Since there is the chance of a large gain despite the high level of risk, speculative risk is not a pure risk, which entails the possibility of only a loss and no potential for gains.
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.
If you buy a call option, you know in advance that your maximum downside risk is the loss of the premium paid if the option 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 a 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.
Almost all investment activities involve some degree of speculative risk, 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 risks, including speculative risk, that can be hedged or limited.
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