Zero-sum vs. positive sum trading

[billyjoerob]

If you walked into a casino and were told that on the left, everybody can leave the table a winner, and on the right, somebody always has to lose and often nobody wins but the dealer, you'd be crazy to go the right, correct?

Then why do traders trade futures and options, which are zero-sum markets? The same goes for shorting, too. As I look back on my trading, I've always made money going long . . . and always lost money on shorts and options. (Never bothered with futures. Not quite sure what they are, actually).

If Wall Street is a casino, then pick the right table . . . Am I right or am I right?

 

[Pekelo]

Quote from billyjoerob:

Am I right or am I right?

You are wrong and wrong....

First, there is no such a side that everybody can leave a winner, so there is your first wrong.

Second, as an answer to your basic question, because people think that they will be in the small group of winners, even if overall it is a zero sum game. Zero sum doesn't mean everybody loses. So there is your second wrong. Quite simple really...

 

[sjfan]

Why are the markets (stock, futures, options, whatever) zero sum? You could argue that within each market (say, IBM equity options), every winner has an offsetting loser, but then you are leaving out the external real economic motivations. The loser might be using the option to hedge a real economic exposure to IBM (say, he's a supplier to IBM) and thus that loss is not really a loss to him.

The equity market is definately not zero sum as long as the size of GDP doesn't stay constant.

So, in short, it's not zero sum. Not derivatives, not equities - because the real economy isn't constant.

Quote from billyjoerob:

If you walked into a casino and were told that on the left, everybody can leave the table a winner, and on the right, somebody always has to lose and often nobody wins but the dealer, you'd be crazy to go the right, correct?

Then why do traders trade futures and options, which are zero-sum markets? The same goes for shorting, too. As I look back on my trading, I've always made money going long . . . and always lost money on shorts and options. (Never bothered with futures. Not quite sure what they are, actually).

If Wall Street is a casino, then pick the right table . . . Am I right or am I right?

 

[cgeorgan]

You're forgetting that a participant's cost of funds (or, more broadly, cost of doing business) is a major determinant of overall profitability.

You and I could be running the same set of strategies, but if I can borrow more cheaply, and face lower overall transaction costs, I can be profitable while you will not be. Furthermore, if I am in the position to benefit from economies of scale regarding my strategy, I can become massively profitable vs. the same strategy you are running.

 

[billyjoerob]

My opening post wasn't clear . . .

I agree that the equity markets are positive-sum . . . with a rising stock, every buyer can theoretically sell for more than he paid.

However, in every options or derivative transaction there is a winner and a loser, no exceptions. I'm not looking at the effect on the portfolio, but at the individual transaction.

 

[sjfan]

But it's no zero sum. It's only zero sum when you only consider those markets in isolation. There's no reason to look at in isolation since not every participating within it is doing so in isolation of their wider context. In fact, it's the wider economic context that motivates a vast amount of transactions.

For example, an airline enters the futures market to buy oil futures. It's not doing so to speculate. If there were no need for future oil, it wouldn't be trading.

Quote from billyjoerob:



However, in every options or derivative transaction there is a winner and a loser, no exceptions. I'm not looking at the effect on the portfolio, but at the individual transaction.

 

[billyjoerob]

Quote from cgeorgan:

You're forgetting that a participant's cost of funds (or, more broadly, cost of doing business) is a major determinant of overall profitability.

You and I could be running the same set of strategies, but if I can borrow more cheaply, and face lower overall transaction costs, I can be profitable while you will not be. Furthermore, if I am in the position to benefit from economies of scale regarding my strategy, I can become massively profitable vs. the same strategy you are running.

Presumably any non-leveraged strategy has no cost of funds other than opportunity cost and transaction costs. Again, with a rising stock, even after transaction costs it's possible for every participant to be a winner.

 

[Scataphagos]

Quote from billyjoerob:

Presumably any non-leveraged strategy has no cost of funds other than opportunity cost and transaction costs. Again, with a rising stock, even after transaction costs it's possible for every participant to be a winner.

In the short run, may appear to be true. In the long run, all markets are "zero sum" (minus transaction and carry costs, of course)

 

[billyjoerob]

Quote from sjfan:

But it's no zero sum. It's only zero sum when you only consider those markets in isolation. There's no reason to look at in isolation since not every participating within it is doing so in isolation of their wider context. In fact, it's the wider economic context that motivates a vast amount of transactions.

For example, an airline enters the futures market to buy oil futures. It's not doing so to speculate. If there were no need for future oil, it wouldn't be trading.

What is the airlines cost basis?

It's true that derivatives can create value . . . but I'm not looking at the economic value. By definition, every derivative transaction has a counterparty that is going to pay up.

 

[sjfan]

In that case I don't under your premise.

You are of course right that within isolation each derivatives market is zero sum (net of t-costs). But that's not a particularly useful or relevant observation? So long as there are participants who gains real economic benefits from these transactions outside of these markets (ie, airlines hedging their fuel cost; I don't understand your cost basis question - what are you referring to?), these markets provide a legitimate value-adding service.

So I guess I don't under your original premise.

Quote from billyjoerob:

What is the airlines cost basis?

It's true that derivatives can create value . . . but I'm not looking at the economic value. By definition, every derivative transaction has a counterparty that is going to pay up.