Zero Sum games

[Directional]

But if the option isn't exercised in the money then the holder will eventually lose the full value of the option so it remains zero-sum.

even if it expires ITM, its still zero sum as far as I can see, because the ITM gain will be paid by the short writer who holds the other side at expiry...?

 

[arabianights]

Yeah, I was only talking about the cases of non exercise as they seemed to be where the objection was.

 

[arabianights]

Indeed, presumably every derivative is zero sum as no other assets are involved. Converesely anything involving trading actual assets cannot be zero sum unless said assets had no value...

 

[intradaybill]

Indeed, presumably every derivative is zero sum as no other assets are involved. Converesely anything involving trading actual assets cannot be zero sum unless said assets had no value...

I asked you before to show that trading equities generates extra cash so the game can be positive sum but you did not reply.

What you gain trading equities HAS to come from some other pocket. Where do you think the money comes from in your trading account when you have a realized gain? Do you think it is a present from the broker? I tell you that it is obvious it comes out from someone's pocket who lost money. Unless as I said before you can prove to me that trading equities generates more cash than the sum of the accounts involved. Forget about dividends and other tiny cash flows in comparison. That's peanuts compared to what is made or lost in trading.

I would like to see your answer to the magical cash generation that makes the game non zero-sum.

Bill

 

[Rhody Trader]

... I tell you that it is obvious it comes out from someone's pocket who lost money.

I understand the point you're making in general - trading - terms, but theoretically it's possible for no one to ever take a loss. Not likely, of course, but possible. That is contrary to the zero sum idea.

 

[fifty2aces]

I understand the point you're making in general - trading - terms, but theoretically it's possible for no one to ever take a loss. Not likely, of course, but possible. That is contrary to the zero sum idea.

I think you are confused about the meaning of zero-sum. Basically, it means that when you look at the profits and losses of all participants, they will add up to zero. In other words, the total money held by the parties remains the same, only the distribution between participants changes - the gains of winners are balanced by the losses of losers.

One person can keep trading forever without taking a loss (theoretically - this is unlikely in practice), without changing the fact that the game is zero sum - it just means that the person's gains are coming out of someone else's pocket.

 

[davidnmfarrell]

Hmm, I suppose you could call it zero sum if you removed the concept of value from trading and therefore, you are only exchanging numbers in some kind of mathematical game. Apart from that perspective, no trading is ever zero-sum because the underlying value of the instrument is derived arbitrarily - market price is simply the best price someone is willing to pay (which may or may not be a sensible price).

Basically, economics is not zero-sum as you can increase the efficiency of your employment of finite resources infinitely; therefore, it is possible for everyone to get richer - hence the fashion now to talk of 'relative poverty': the 'working' class have got good health, microwaves, cars and sky tv - but they're still poor!

 

[fifty2aces]

Hmm, I suppose you could call it zero sum if you removed the concept of value from trading and therefore, you are only exchanging numbers in some kind of mathematical game. Apart from that perspective, no trading is ever zero-sum because the underlying value of the instrument is derived arbitrarily - market price is simply the best price someone is willing to pay (which may or may not be a sensible price).

Even if the price is not sensible, this doesn't appear to affect the zero-sum nature - if you get something for "cheap", you make money at the expense of someone who pays you too much for it. Overall there is no gain or loss in value here - just a change in the distribution.

 

[davidnmfarrell]

Overall there is no gain or loss in value here - just a change in the distribution.

Ahh ok, but now we're back to numbers; I'm with you insofar as the equation still balances out (so to speak) - but the value of those numbers may be somthing completely different.

Cutting a cake; that's a zero-sum game. But economics is non-zero sum and ideas like comparitve advantage mean that we can all get richer - that is to say, the underlying value of our financial instruments can increase, without their price changing at all... That's why it's wealth creation right?!

What do you think?

 

[fifty2aces]

Ahh ok, but now we're back to numbers; I'm with you insofar as the equation still balances out (so to speak) - but the value of those numbers may be somthing completely different.

Cutting a cake; that's a zero-sum game. But economics is non-zero sum and ideas like comparitve advantage mean that we can all get richer - that is to say, the underlying value of our financial instruments can increase, without their price changing at all... That's why it's wealth creation right?!

What do you think?

Equities, yes of course, but options and futures are always going to end up with winners and losers. Some people (e.g. hedgers) may not actually care about making money on options, as they are merely managing risk in their other affairs. This is external though - it doesn't change the fact that the actual derivative trades are zero sum.

 

[arabianights]

I asked you before to show that trading equities generates extra cash so the game can be positive sum but you did not reply.

but then you say...

Forget about dividends and other tiny cash flows in comparison. That's peanuts compared to what is made or lost in trading.

... that's the whole point of equities and why they're not zero-sum!

 

[davidnmfarrell]

Alright, well Gordon Gecko called it zero-sum as well so I'll back off!

 

[intradaybill]

but then you say...



... that's the whole point of equities and why they're not zero-sum!

If dividend cash flow is what turns trading equities from a zero-sum to a positive-sum then you are at a contradiction, nobody should trade equities but only buy and hold for these cash flows.

I think you mix trading and investing. Investing in equities can be at times a positive or negative sum game. Trading equities is a zero-sum, including any dividends paid.

Given the 1999 bubble in tech stocks, one could argue that over the longer term specific sectors of the equity markets are a negative sum game due to diminishing returns or exuberant behavior of investors.

Nevertheless, loot at GOOG. Dividends is noise compared to what made or lost in intraday trading. Same goes with ETFs like SPY and QQQQ. Add the numbers. Hundreds of millions of shares change hands daily. People may lose of gain 10K in a matter of few minutes. Where do you see the positive-sum, it makes me wonder.

Bill

 

[Directional]

do we have general consensus on options as a derivative instrument being zero sum from write to expiry?

the other question is therefore equities, which I dont know much about. I'm not sure dividends deviate from the zero-sum equation, because the stock is devalued by the value of the dividend at the time of payment, right? so the stock holder gains the payout in cash, but the stock value lessens by the same amount?

But i can see how the stock as an asset creates value, because from the date of first issue, the company takes the first "sell" and then each stock changes hands from there on at different values, there isnt, in principle, someone short for every long, just a seller who is passing the asset on.

 

[arabianights]

If dividend cash flow is what turns trading equities from a zero-sum to a positive-sum then you are at a contradiction, nobody should trade equities but only buy and hold for these cash flows.

I think you mix trading and investing. Investing in equities can be at times a positive or negative sum game. Trading equities is a zero-sum, including any dividends paid.

Given the 1999 bubble in tech stocks, one could argue that over the longer term specific sectors of the equity markets are a negative sum game due to diminishing returns or exuberant behavior of investors.

Nevertheless, loot at GOOG. Dividends is noise compared to what made or lost in intraday trading. Same goes with ETFs like SPY and QQQQ. Add the numbers. Hundreds of millions of shares change hands daily. People may lose of gain 10K in a matter of few minutes. Where do you see the positive-sum, it makes me wonder.

Bill

Where do company profits go to?

Answer: Shareholders.

Therefore equities are not a zero sum game.

 

[Rhody Trader]

I think you are confused about the meaning of zero-sum. Basically, it means that when you look at the profits and losses of all participants, they will add up to zero. In other words, the total money held by the parties remains the same, only the distribution between participants changes - the gains of winners are balanced by the losses of losers.

I know exactly what zero sum is. You didn't follow on the discussion I was engaged in when I made that response.

One person can keep trading forever without taking a loss (theoretically - this is unlikely in practice), without changing the fact that the game is zero sum - it just means that the person's gains are coming out of someone else's pocket.

I wasn't speaking in terms of one person, but the whole collective. If a whole bunch of people bought a new IPO at 10 and no trading took place until some buyout offer was made and they tendered their stock for 20, all those folks made 10 points of profit on their positions, but there was no one losing those points. Thus, it's not zero-sum.

Obviously, that's an extreme example, but the same sort of thing could not happen in futures, which are definitely zero sum. For those folks to gain their 10 points someone must be on the other side losing the 10.

 

[Rhody Trader]

If dividend cash flow is what turns trading equities from a zero-sum to a positive-sum then you are at a contradiction, nobody should trade equities but only buy and hold for these cash flows.

I think you mix trading and investing. Investing in equities can be at times a positive or negative sum game. Trading equities is a zero-sum, including any dividends paid

Since traders and investors operate in the same arena, you cannot seperate trading and investing. If traders were just trading with traders and investors just transactiong with investors, you could make a different arguement, but that simply isn't the case.

 

[Rhody Trader]

I'm not sure dividends deviate from the zero-sum equation, because the stock is devalued by the value of the dividend at the time of payment, right? so the stock holder gains the payout in cash, but the stock value lessens by the same amount?

That's a theoretical view and nothing more. The book value of a company by definition must decline by the amount of the dividend, but stocks are valued on much more than just book value, so you rarely see prices drop on a dividend payment - unless it's one of those one time extraordinary types.

 

[barjon]

I
................I wasn't speaking in terms of one person, but the whole collective. If a whole bunch of people bought a new IPO at 10 and no trading took place until some buyout offer was made and they tendered their stock for 20, all those folks made 10 points of profit on their positions, but there was no one losing those points. Thus, it's not zero-sum...............

.

Unlike futures, which as Rhody points out must be zero sum however much money is in play, the equity market is affected by overall net money flow and (ignoring the dividend element) and will only be zero-sum when the overall money in the market is static. When there is new money being added to the market (as in Rhody's example) prices must rise and there is positive expectancy. Conversely, when money is being lost to the market

good trading

jon

 

[intradaybill]

Unlike futures, which as Rhody points out must be zero sum however much money is in play, the equity market is affected by overall net money flow and (ignoring the dividend element) and will only be zero-sum when the overall money in the market is static. When there is new money being added to the market (as in Rhody's example) prices must rise and there is positive expectancy. Conversely, when money is being lost to the market

good trading

jon

Hi Jon,

IPO price is 10, 10 shares issued, 10 people buy 1 share each and someone offers 20 to take the company private and off the board. Now, 10 people make 10 each because someone pays them 20 to get their shares:

Investors: total gain = 100

Buyer: total cost = 200

Company owner = -100 because he sold the shares to investors.

Since the company is valued at 200, the amount the buyer paid, this means that the owners who issued shares lost 100.

Result: owners+investors = zero-sum

According to basic economics, the owners lost money because they sold something valued at 200 for only 100.

This will explain to you why recent IPOs are issued above market value. This makes sure owners never lose money in the zero sum game.

It is simple economics. I wonder why people still debate the obvious. When you measure trading gain/losses with respect to an underline value or index (in my example the value the buyer calculates) trading and investing is zero sum.

Bill