What I meant by a zero-sum game

Someone asked me off board why I called an option trade a zero-sum game. Here’s the answer:

What I meant by a zero-sum game is that there is no money made or lost in sum in an option contract. If you buy a contract, someone else is short that contract, and vice versa. If at some point you are ahead $342.67, the other person is losing exactly $342.67. When the contract is finished if you are behind $93.27, the other person is ahead $93.27. There is no creation of wealth, or loss of wealth, in sum. At the end of the contract everything balances out with a sum of zero. That makes a zero-sum game. And, you are competing against real experts most of the time.

I know that some people use options for insurance or hedging, and those are valid uses, but that’s different than thinking you are going to get rich trading options. As I said above, there is no wealth created or lost in an option contract (except the commissions paid by both parties).

Hope this helps,

Saul

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Characterizing options investing a a “zero-sum game” is not only misleading, but incorrect.

Any simple investigation will put this “urban legend” to rest.

Here’s one from the folks that take options education to the beginner level (if you desire a more advanced treatment of this topic, I’ll leave it to you to ferret it out).
https://www.tastytrade.com/tt/shows/market-measures/episodes…

Peace and grace!

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Characterizing options investing a a “zero-sum game” is not only misleading, but incorrect.

Any simple investigation will put this “urban legend” to rest.

It seems there is a discrepancy between what Saul is referring to as a zero sum game and what the Tasty Trade link described.

Saul’s zero sum game is referencing a single trade and focuses on the fact there is always a loser on the other side of the trade in options. There is no value or wealth creation. What one person makes, the other person loses for any given trade.

Companies on the other hand actually create value/wealth. Shareholders of a company may benefit while there is no loser on the other side. Well, there may be losers that have short positions, but they aren’t a requirement for money to be made on the other side. Theoretically, there could be a company with zero short positions while shareholders happily make money.

Regards,
A.J.

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https://www.tastytrade.com/tt/shows/market-measures/episodes…

Looking a bit closer at what Tasty Trade is saying here, this is a theoretical exercise about market pricing efficiencies. It concludes the market isn’t perfectly priced all of the time.

Essentially, they examine the same trade over many years. For instance, a strangle on SPX where the parameters (call strike percent away from underlying, put strike away from underlying, time to expiration, etc…) are the same. In an efficient, perfectly priced market, the theory says profits will be zero. All the Tasty Trade folks are showing is the market is, in fact, not perfectly priced.

I hope this helps and let me know if anyone sees this differently than I do.

Take care,
A.J.

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Thanks Phoolio, Yes, it’s amazing how so many people use the expression zero-sum game without any understanding of what the term means.
Best
Saul

I won’t challenge the mathematical assumption being used about a zero sum game means. (I’ve studied such things in grad school to a fair degree and don’t think that the math behind it is relevant here.)

Instead, I’ll make a comparison. Are insurance policies zero sum games? I would say not, in that from a different perspective, if one person wishes to reduce risk by “overpaying” for coverage because a loss to that one individual could be financially catastrophic, that person is willing to “overpay” for that insurance. I view options from the same perspective. Some people are willing to overpay for insurance (in the case of buying puts) or gambling on possible upside gains (in the case of buying calls), and other people are willing to take the other side of those contracts.

In the case of insurance, large companies take the side of the sellers. In the case of options, a market disperses that risk. On average, the sellers of options make money, but it can be extremely volatile and the gains distributed very unevenly, so that many lose and many win, as is the case on the side of options buyers. But if both sides know what they’re doing (and I admit that they don’t always), then it can be a rational market.

That doesn’t mean that everybody can nor should play this game. But for those well-informed individuals that do, I for one won’t dissuade them. (After all, I trade lots of options.) For Saul’s investing style, it doesn’t fit. That’s fine by me. And since this is “his” board, I don’t feel that it is appropriate to discuss options here. But for those who are interested in options, I would strongly suggest that you don’t do so unless you are willing to educate yourselves about the theory and that you’re sure about your temperament and risk tolerance. It is absolutely not appropriate for everybody. In fact, it’s not appropriate for most people, IMHO.

as always, i am full of carp

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