sup guys, i actually think that zero-sum is valid if you consider every position marked to market from one moment to another.....it is true that counter parties can and do hedge themselves, but all that means is that risk is dispersed further down the line. without a doubt, however, a 1 dollar gain in any options position results is a 1 dollar loss _on that position_ to the other side. if the other side is hedged, then the _next_ guy sees the loss, or the next guy or the next guy. the joy of derivatives is that the individual risks are hedged, repackaged, resold, dispersed, rebundled and resolded again, ad nauseum, until the aggregate risk becomes systemic in nature. wee
Wee, I don't really disagree but would say that your emphasis underplays the fundamental insurance-like characteristic of options. We might consider the case where an owner of a stock buys an OTM put as down-side protection. The stock rises to expiry and the put expires worthless. Both the buyer and the seller of the put are happy because both positions made money. Seems like "positive gains from trade" to me. To say that the buyer lost may be true from a narrow dollar optimization perspective but is not true from a broader a "utility" perspective...the buyer bought peace of mind and that's worth something. Yours for the "joy of derivatives", TF
i hear you, but put aside the economic purpose/value of options and merely consider the zero-sum aspect. in your example the put buyer lost his insurance premium. the put writer banked it. the risks were not symmetrical -- they never are with options -- but the transfer of dollars-at-risk from one party to another is zero-sum, minus the nicks taken by both brokers, and/or intermediate mm's. wee
Consider an short gamma trader selling the XYZ 100 straddle at 50% volty. The buyer may buy the 50% volty expecting to gamma trade the position, operating under the assumption that the implieds are cheap, conversely, the seller thinking volty will fall... Fast-forward to expiration day -- spot volty to expiration turned out to be 55% in the intervening period, earning a profit for the straddle buyer, while the straddle seller also(possibly) seeing a profit, potentially large, as volty is moot at expiration, the return is simply a function of the price of the shares on expiry. Simply an example on what weewilly was referring to when mentioning deferring risk. In this example, the risks were transferred to another asset class. riskarb
Straddle buyer seeing a hedging gain thru his gamma-trade in spot greater than the loss on decay on the long straddle. Not to infer he had a gain to expiration on the straddle itself. riskarb
ah your second message clarified things for me riskarb. certainly the straddle buyer/seller cannot both profit equally at expiration --with no other activity taking place. in your example one of the parties was "working the straddle" by gamma scalping. no long arguments from me on the subject! wee
btw did you ever hear the joke about the efficient market theory economist walking down the street with his wife? she sees a dollar on the sidewalk and says "look, there's a dollar on the sidewalk." the economist says "no, there can't be a dollar on the sidewalk because someone would have picked it up already." so much for theories.... wee
I'm not sure what part of this thread I am suppose to respond to. As for the zero sum part, this is obviously not correct for the reasons risk arb pointed out. I could buy a straddle from risk arb and we both could trade the gamma, I from the long side and he from the short side. If I am a better underlying trader then he is I might make more money then him on this trade even if I was wrong on the straddle purchase and vice versa. The option gains and losses are never absolute. Most traders that trade large option positions trade the gamma in some form. And even in that case, you have to keep in mind that a trader may have on a portfolio of positions in which some positions lose money in the same group in which others make money. So while Trade A lost money, it lost money at the expense of Trade B making money. Another angle I would like to throw out there. Insurance companies, when you buy health insurance or car insurance, do you consider this a zero sum game? Obviously if you never have to use it, you might see it as the insurance company winning and you losing the premiums, but did you really lose? Your goal here was to lose was it not? Surely, you don't buy health insurance in the hopes of getting cancer, or buy car insurance with the hopes of driving your car into a brick wall. So in this example, you actually pay the premiums and hope to lose. Well the same can be said of options. Say a large hedge fund owns a million shares of stock XYZ at $100 a share. The stock is reporting earnings next week. The stock has had a huge runnup going into earnings and the hedge fund is scared that if the company disappoints the stock could fall maybe 10 or 20 pts. So the hedge fund buys insurance, in this case, maybe some slightly out of the money puts. Now think about this. In this case, the hedge fund actually wants to lose money on the puts. Then why would they buy them you might ask? Because, in this case, the cost of being wrong is too great. So they buy the puts in the hopes that the company announces good results and the stock goes higher. The puts then expire worthless and the hedge fund could not be happier. They wanted to lose! This is sometimes a hard concept for people to grasp because it goes against our intuitive nature. Why would anyone want to lose? For the same reason that none of want to get cancer or get into a car accident. Because of this paradigm, options have a special innate value that the underlying does not have. That is, no one buys or sells the underlying in the hopes of losing. If someone buys stock, they expect the stock to go higher, they are not buying it for defensive reasons. Even with arbitrage, the trader is hoping to make gains on both sides. So what the underlying trader has to live with, is the fact that every time he buys a stock or future, there is another guy on the other side of that trade that thinks exactly the opposite of him. With options, this is not always the case, therein lies the edge. Anytime you can take money from someone that actually wants to lose it and give it to you, well, you probably should provided that you understand the risks that you are taking. For these reasons, I think trading options is much more profitable then trading the underlying. There are built in profits for you to take. Here is another way I look at it. With options buying and selling in terms of laying off risk, I always look at it from the standpoint that someone wants to sleep better then me. If I am willing to accept his risk for him, I can make money at the expense of not sleeping as well. He has shifted his risk to me and I was willing to accept it. In this situation, the cost of me being wrong may not be as destructive as the cost of him being wrong. Here, both parties win. That's my two cents.
zero sum and "utility" are not the same thing...........i may be overjoyed to have purchased any insurance premium and have it expire worthless. that has nothing to do with the zero-sum of dollars-at-risk given no other trading or economic activity. scalping against a position introduces more trading....if i win on a gamma scalp against a straddle, there are now other parties involved (ex. the straddle parties) whose dollars-at-risk have to be marked into the zero-sum equation. i'm late now. bb in the eve. cya fellas................... wee