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Ask HN: Why be an option/futures/day trader when it is zero-sum?

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Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#11

Post by chwolfe »

utnick wrote: post #2

Don't some people, especially big organizations buy options/futures as hedges for another investment?... so it might not be a true zero sum game in the sense that some of the players aren't really playing to win.. they are just putting money in for insurance

Correct. There is a big difference in leveraging options when you own tons of stock in a company vs. using options as a high class lotto ticket.

Example: Mark Cuban used options to guarantee he would be set for life no matter what happened to Yahoo's stock after they bought Broadcast.com for $5 billion (in stock mostly).

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#13

Post by hugh »

Tichy wrote: post #10

I am not sure that traders don't create value. Their job is to allocate money to the most useful company, I suppose?

Except the companies don't see any of the money once the IPO is finished.

Of course, the only reason the IPO can proceed is because people who buy shares know that they can sell them to other people later. So I suppose in that sense they help. However, once the market already exists, no extra value is created by an extra trader entering it.

As others have pointed out though, there genuinely is value created by the options trading market, since the existence of options allows risk to be spread.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#14

Post by jaydub »

I think it has to do with the "superstar" phenomenon that Taleb discusses in Fooled by Randomness & The Black Swan. Being a dentist, you are not likely to see a multi-million dollar salary - yet you can definitely live comfortably.

What I believe Taleb's philosophy _was_ (he now remarks in bold text: "Finance is for philistines!" on http://fooledbyrandomness.com/ ) that by exploiting the random nature of markets he could "swing for the fences" by placing many small extremely risky bets that if they paid off -- even infrequently -- would guarantee him a lot of money.

From the little that I know/think I know: Options are a good way to leverage small amounts of capital into potentially large gains. If the price of the underlying security doesn't behave as you expected you can let your option contract expire worthless - meaning you have a defined risk which is what appealed to Taleb. Even in the worst case he knew how much was at stake.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#15

Post by muerdeme »

brentr wrote: post #8

First, options and futures involve a sub-zero game. Money leaks out via commissions. Second, there are two types of players in this game. The first group is the speculators. They play the game for profit from the game. The second group is risk managers. They play the game for risk reduction. Speculators serve the risk managers. The speculator's strategy is starkly different than the risk manager's strategy. The specu…

My understanding is the "speculators" create liquidity for the risk managers, thereby assuming their risk.

Why does the money leaking via commissions necessarily make the game sub-zero sum? Is it because we aren't looking at the big picture where everyone wins?

It seems like the risk managers must have a positive incentive to sell their risk on the marketplace instead of assuming it themselves. I.e. hedging another investment like someone else said already.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#16

Post by brentr »

muerdeme wrote: post #15
brentr wrote: post #8

First, options and futures involve a sub-zero game. Money leaks out via commissions. Second, there are two types of players in this game. The first group is the speculators. They play the game for profit from the game. The second group is risk managers. They play the game for risk reduction. Speculators serve the risk managers. The speculator's strategy is starkly different than the risk manager's strategy. The specu…

My understanding is the "speculators" create liquidity for the risk managers, thereby assuming their risk. Why does the money leaking via commissions necessarily make the game sub-zero sum? Is it because we aren't looking at the big picture where everyone wins? It seems like the risk managers must have a positive incentive to sell their risk on the marketplace instead of assuming it themselves. I.e. hedging another i…

Liquidity is one type of risk. There exist also interest rate risk, price risk, etc.

Commissions are an expense that both sides pay to play the game. Money is not transferred from one player to another, it is transferred to outside the game.

It is true that there is a positive incentive to sell risk from the risk-manager's view. That is the whole reason the markets were initially established, both derivatives and the underlying of the derivative.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#17

Post by kirubakaran »

utnick wrote: post #2

Don't some people, especially big organizations buy options/futures as hedges for another investment?... so it might not be a true zero sum game in the sense that some of the players aren't really playing to win.. they are just putting money in for insurance

Yup, This is called an Equity Collar. One should consider getting this insurance even as an individual investor... to protect your investments against worst case scenarios.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#18

Post by brentr »

muerdeme wrote: post #15
brentr wrote: post #8

First, options and futures involve a sub-zero game. Money leaks out via commissions. Second, there are two types of players in this game. The first group is the speculators. They play the game for profit from the game. The second group is risk managers. They play the game for risk reduction. Speculators serve the risk managers. The speculator's strategy is starkly different than the risk manager's strategy. The specu…

My understanding is the "speculators" create liquidity for the risk managers, thereby assuming their risk. Why does the money leaking via commissions necessarily make the game sub-zero sum? Is it because we aren't looking at the big picture where everyone wins? It seems like the risk managers must have a positive incentive to sell their risk on the marketplace instead of assuming it themselves. I.e. hedging another i…

I was thinking about how to better answer your question concerning the sub-zero game statement I made. Let's remove ourselves from finance for a minute into something that is more traditional in the game theory studies--namely poker.

If the game is played where the players arrange transfers face to face such as in a home poker game, then the game is zero-sum. Your losses are my gains. No money is created. No money is destroyed. It stays inside the game. The minute we go to a casino to play the same game, the game becomes sub-zero due to the rake. You lose X to me and Y to the rake. I gain your X and lose Y to the rake.

Your cash flows: -X - Y. My cash flows: X - Y. In a zero-sum game your cash flows are the negative of my cash flows. This implies -(-X - Y) = X + Y. This is a contradiction. Therefore, the game is not zero-sum.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#19

Post by danteembermage »

utnick wrote: post #2

Don't some people, especially big organizations buy options/futures as hedges for another investment?... so it might not be a true zero sum game in the sense that some of the players aren't really playing to win.. they are just putting money in for insurance

The other thing worth noting is that a well functioning capital market is not zero-sum, it puts the capital in the most profitable growth opportunities. So speculators may be incorporating information into prices that has value. Of course they may be incorporating disinformation as well; hence the importance of regulation against cornering the market or pump-and-dump schemes.
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