are options really ZERO SUM GAME ? i don't think so

Discussion in 'Options' started by chanakya, Sep 10, 2009.

  1. chanakya


    Lets assume there are two people
    One is john and the other carl

    john is 65 years old and is holding 100 intel stocks.
    He does not want to take too much risk with his stocks and is happy with guranteed premium than a unguranteed increase in stock price so he writes calls on the intel stock.

    carl purchases the call options.

    lets assume intel stock went to $40 before expiration.

    carl and john both made why is it a zero sum game ?
  2. MTE


    John made money on the stock and not on the calls. On the calls he lost money, and his loss on the calls is Carl's gain. The fact that John made money on the overall position does not contradict the zero sum game concept in options.
  3. chanakya


    But he got the premium on the calls he wrote ...?
    If somebody is just happy with the premium it not enough for them.

    I don't want to go into technicallity of this but at the end of the day, i see both john and carl having more money in thier hands than they started off with. i am not able to get how does it end up bieng zero sum game.

    I though zero sum game is something where the sum of money of all participants never change.
  4. sakhter


    if he wants guaranteed profit, y not exit at market for the profit instead of writing a call and waiting till expiry?

    For example, if you bought stock at $40, and when you are writing $45 strike call, you are loosing money after $45. that $5 profit is not considered because you did not make that $5 from the option transaction. Yeah you have a spread, but you have to remember options is all about making spreads that the counter-party is unaware of.
  5. jj90


    Utility doesn't matter, but payoff does.
  6. gkishot


    Maybe because stocks are not 0 sum game they both end up with profits.
  7. chanakya


    completely agree, the stock holder is just passing on the risky game of speculation to the options trader.
  8. I don't see how you cannot understand the concept of zero sum. You introduced someone who owns stock, so you are no longer just considering the options. Yes, they both made money at the end of the day but the one who sold the covered call made money due to appreciation on the stock. He lost money on the calls, money which would have been his had he just had the stock position.

    If you own 100 shares of intel at 30, and you sell a $1 call at strike 40 and the stock goes to 45, what happened? Well if you just had the stock you made 100x15 = 1500 dollars. But you sold the call, which is now most likely trading north of $5 due it having intrinsic value from being $5 in the money. You lost at least $4 on the call, which is $400 that comes out of your pocket. You are a net winner only because you owned the stock as well, but you no longer realize the full 15 points that you would have from just owning stock. The option essentially "caps" you at 10 points since you sold the 40 strike. Even if intel goes to $200, your profit does not increase because any gains on the stock past 40 simultaneously become losses on the option.
  9. chanakya


    Well what happens if the stock does not go to $45 ?
    The fact is that you don't know ahead of time where the stock will go. There is huge difference between a guranteed $5 versus a speculative $100
    The stock holder is passing on the risky game of speculation to the buyer of the call's in return for a premium.
    I see the whole thing as two people sharing the initial investment for buying the 100 stocks and then sharing the returns based on the risk they are taking.
  10. Let us for a second imagine a world where people only traded single equity options positions. If this were the case, one person wins and one person loses - zero sum game. The payoff function for a vanilla call is max(S-k,0) where S is the terminal value of the underlyer.

    Now I can see where you're coming from when you introduce more positions, then we get payoffs where both parties can make money depending on how they hedge their positions. However, what you're saying is akin to that blackjack is not a zero sum game if you're winning on some sports bet elsewhere simultaneously.

    If you break down the trades individually and assuming the market you're looking at is zero sum (equities are not), you should see that options are in fact a zero sum game!
    #10     Sep 10, 2009