A speculative transaction is the conduct of a financial trade where the risk of loss is high, but the participants also expect a significant profit.
How a Speculative Transaction Works
A speculative trader is an investor that buys into securities with an expectation of the price changing favorably. A speculative transaction is where the contract for purchasing or selling commodities, including shares and stocks, can be settled other than by actually delivering the commodity. Typically, the increased possibilities of positive return offset the risk of loss in a speculative transaction.
The risk associated with this type of investment is higher than usual, but a speculative investor is more concerned with fluctuations in the market value as opposed to long-term investments. A speculative transaction can also involve buying foreign currency with the aim of selling the currency when the rate appreciates.
Substantial gains are the primary motivation for engaging in a speculative transaction. The difference between a speculative transaction and an investment depends on factors a market player considers, including the amount of leverage to exposure, nature of the asset, and expected holding duration.
Example of a Speculative Transaction
An excellent example of a speculative transaction happens in intra-day share trading where there's no actual asset delivery. Intra-day trades happen within the same day as they are speculative purchases that keep the market active, as investors seek short-term fluctuations in price.
Shares exit from and enter to a trading account on the same day and they don't go into the dematerialized (DEMAT) account. Because of this, there is no delivery. Day traders can speculate on any commodity, derivative, or futures markets, choosing cyclical, non-defensive, and short-term volatile shares for high leverage.
In a speculative transaction, the investor is seeking to profit when the future value of a financial instrument or asset increases. A speculative investor looks into the market price technicalities rather than fundamentally assessing the security or asset.
Significance of a Speculative Transaction
Speculative transactions are defined as where actual delivery of purchased or sold assets is ultimately and periodically settled under the income tax act, section 45(5). For instance, in real estate, there is a line blur between speculation and investment, as buyers purchase property with minimal costs to resell them quickly for significant gain.
The Internal Revenue Service treats speculative transactions differently from other businesses even when transacted by the same taxpayers. Price risk in the market is hedged as a speculative business provides a narrower bid-ask spread for market liquidity, keeping in check asset price bubble formation and rampant bullishness.
Foreign exchange speculative transactions are done by hedge and mutual funds, settling contracts only by paying differences in the purchase and the selling price. Without speculative investors, the commodities market would slow down to a snail's pace since the only other participants are food and agricultural companies.
Types of Speculative Transactions
Specifically, in the foreign exchange markets, speculative transactions are similar to hedging practices by financial institutions. These transactions consist of spot selling and buying of currency pairs delivered through simple exchanges or options. These common types of speculative transactions are conducted in the forex, stock, and commodities markets:
These transactions involve speculators exercising their right to buy and sell securities at specific times and prices. Traders perform speculative transactions for purchasing assets, named call option and put option, which allows them to sell securities at a future higher price.
This is a speculative transaction that involves purchasing assets with funds borrowed from the brokerage firm. Any transaction that the broker conducts debits or credits the investor's account, depending on the securities or cash margins agreed upon.
A speculator can buy a security in one market where it's cheap and sell it on another where the price is higher. Domestic arbitrage is when these markets are located in the same country, while foreign arbitrage features both markets abroad.
This is a transaction where a speculative investor conspires with brokers to perform fictitious trades of an asset from one investment house to another. Since the stock is bought cheap and sold high, the market reacts like it's going up, causing frenzied buying, benefiting the speculator and brokers.
When an investment fund or individual acquires a controlling portion of an asset or security, it's called cornering, which leads to rigging.
Although now illegal, blank transfers contain the seller’s details but not the buyers and have been accused of encouraging tax evasion.