Option trading zero sum game

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Download Firefox for Linux. Download Firefox — English (US) Your system may not meet the requirements for Firefox, but you can try one of these versions: Download Firefox — English (US) Your system doesn't meet the requirements to run Firefox. Your system doesn't meet the requirements to run Firefox. Please follow these instructions to install Firefox. Zero-Sum Game. What is a 'Zero-Sum Game' Zero-sum is a situation in game theory in which one person’s gain is equivalent to another’s loss, so the net change in wealth or benefit is zero. A zero-sum game may have as few as two players, or millions of participants. Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling are popular examples of zero-sum games since the sum of the amounts won by some players equals the combined losses of the others. Games like chess and tennis, where there is one winner and one loser, are also zero-sum games. In the financial markets, options and futures are examples of zero-sum games, excluding transaction costs. For every person who gains on a contract, there is a counter-party who loses.

BREAKING DOWN 'Zero-Sum Game' In game theory, the game of matching pennies is often cited as an example of a zero-sum game. The game involves two players, A and B, simultaneously placing a penny on the table. The payoff depends on whether the pennies match or not. If both pennies are heads or tails, Player A wins and keeps Player B’s penny if they do not match, Player B wins and keeps Player A’s penny. This is a zero-sum game because one player’s gain is the other’s loss. The payoffs for Players A and B are shown in the table below, with the first numeral in cells (a) through (d) representing Player A’s payoff, and the second numeral Player B’s playoff. As can be seen, the combined playoff for A and B in all four cells is zero. Most other popular game theory strategies like the Prisoner’s Dilemma, Cournot Competition, Centipede Game and Deadlock are non-zero sum. Zero-sum games are the opposite of win-win situations – such as a trade agreement that significantly increases trade between two nations – or lose-lose situations, like war for instance. In real life, however, things are not always so clear-cut, and gains and losses are often difficult to quantify.

A common misconception held by some is that the stock market is a zero-sum game. It isn’t, since investors may bid share prices up or down depending on numerous factors such as the economic outlook, profit forecasts and valuations, without a single share changing hands. Ultimately, the stock market is inextricably linked to the real economy, and both are powerful tools of wealth creation rather than zero-sum games. ‘Zero-Sum Game’ Theory & Background. Game theory is a complex theoretical study in economics. The 1944 groundbreaking work “Theory of Games and Economic Behavior,” written by Hungarian-born American mathematician John von Neumann and co-written by Oskar Morgenstern, is the foundational text. Game theory is the study of strategic decision making between two or more intelligent and rational parties. The theory, when applied to economics, uses mathematical formulas and equations to predict outcomes in a transaction, taking into account many different factors, including gains, losses, optimality and individual behaviors. Game theory can be used in a wide array of economic fields, including experimental economics, which uses experiments in a controlled setting to test economic theories with more real-world insight. In theory, zero-sum game is solved via three solutions, perhaps the most notable of which is the Nash Equilibrium, put forth by John Nash in his 1951 paper “Non-Cooperative Games.” The Nash equilibrium states that two or more opponents in the game, given knowledge of each others’ choices and that they will not receive any benefit from changing their choice, will therefore not deviate from their choice. ‘Zero-Sum Game’ & Economics.

When applied specifically to economics there are multiple factors to consider when understanding a zero-sum game. Zero-sum game assumes a version of perfect competition and perfect information that is, both opponents in the model have all the relevant information to make an informed decision. To take a step back, most transactions or trades are inherently non zero-sum games because when two parties agree to trade they do so with the understanding that the goods or services they are receiving are more valuable than the goods or services they are trading for it, after transaction costs. This is called positive-sum, and most transactions fall under this category. Options and futures trading is the closest practical example to a zero-sum game scenario. Options and futures are essentially informed bets on what the future price of a certain commodity will be in a strict timeframe. While this is a very simplified explanation of options and futures, generally if the price of that commodity rises (usually against market expectations) within that timeframe, you can sell the futures contract at a profit. Thus, if an investor makes money off of that bet, there will be a corresponding loss. This is why futures and options trading often comes with disclaimers to not be undertaken by inexperienced traders. However, futures and options provide liquidity for the corresponding markets and can be very successful for the right investor or company.

It is important to note that the stock market overall is often considered a zero-sum game, which is a misconception, along with other popular misunderstandings. Historically and in contemporary culture the stock market is often equated with gambling, which is definitely a zero-sum game. When an investor buys a stock, it is a share of ownership of a company that entitles that investor to a fraction of the company’s profits. The value of a stock can go up or down depending on the economy and a host of other factors, but ultimately, ownership of that stock will eventually result in a profit or a loss that is not based on chance or the guarantee of someone else’s loss. In contrast, gambling means that somebody wins the money of another who loses it. There are other such myths regarding the stock market, some of which include: falling stocks must go up again at some point and stocks that go up must come down, as well as that the stock market is exclusively for the extremely wealthy. Seven Options Myths Debunked. In theory, it would sound correct to say that every contract has a buyer and a seller, and where the buyer profits the seller loses (and vice versa). But that theory ignores something very important: market makers. Unlike buyers and sellers of options that are making their trades based on a notion of where the stock will trade in the future (up, down, or flat), a professional market maker does not make a directional bet. Instead, they take the other side of the trade simply to meet the demand of their customers, and will typically look to immediately hedge themselves into a neutral position, usually by buying or selling (or shorting) some amount of the underlying security, or buying or selling a different option contract.

Market makers also inherently work both sides of the order book, so they may be the ask that fills a buyer's order at one strike, and at the same time be the bid that fill a seller's order at a different strike. The bottom line is that you and a market maker can both make money, and therefore the outcome was not a zero sum game. Zero Sum Trading. Everything you need to learn the Zero Sum Trading method. A nightly watch-list, blog posts, frequent trade ideas, chatroom access and a tracked portfolio with trade alerts are included in the Gold Package. Billed Monthly. About Roberto Pedone. Roberto Pedone, based out of Delafield, Wis., is an independent trader who focuses on technical analysis for small - and mid-cap stocks, large caps, options and commodities. Roberto studied international business at the Milwaukee School of Engineer. Profile. Swing Trading Day Trading Stocks Options Momentum Technical Analysis Trend Trading Charts Short Selling Aggressive Biotech.

Product Features. Whether you have two minutes or two hours to explore, the chat room will give you easy access to discuss recent trade picks, market news, and community trading ideas. Keep up to date on everything going on in the product! Marketfy aggregates all of Roberto’s blog posts, videos, and trade alerts in real-time to give you one feed with all of the latest activity. Stay ahead of the market with Roberto’s insight and commentary. Stock market updates and outlooks have never been more accessible. Access a video library filled with education to help you succeed in the market. Now it’s easy to understand the method and know what stocks to watch each day. Track trading portfolio and real-time trade alerts via email or text message. Discover past trades and dive into charts of the method over time. What Members Are Saying. Excellent service!

I did very well quickly. Easily worth the investment. Roberto is well organized and easy to understand, even for rookies. The chat is very helpful as well. Money well spent, than. Good stuff! Waiting for those educational videos so you can teach me to fish. Thanks! Absolutely love this service after 2 weeks. Roberto is has been very helpful for a beginner trader. Also, the chat board is definitely my favourite feature. Are Options a Zero Sum Game? Charge takes simple approach to complex product. Most people consider options trading to be a zero sum game.

When you make a trade, someone takes the other side and when one of you gains, the other loses an equal amount. From that definition it&rsquos difficult to argue that the term &lsquozero sum game&rsquo does not apply to options, and to trading in general. However, I do make that argument. When a trader decides to sell a specific holding when it rises to $75 per share, the trader may make a mental stop, or enter a GTC (good &rsquotil canceled) sell order with hisher broker. When the stock is sold, the trader is happy with the result. Sure the stock may move higher, and one can argue that our trader &lsquolost&rsquo money by selling and that the &lsquobuyer&rsquo made money. With this point of view, trading is a zero sum game. I&rsquoll concede that the buyer earned money, but not at the expense of the seller. I prefer to look at it this way: Our trader earned the profit he hoped to earn, and when that happened, heshe willingly transferred ownership of the shares to another trader. Once the position is out of the account, the trader neither makes nor loses anything. Any change in the stock&rsquos value affects only the new owner. There is no corresponding loss on the part of the trader who sold the shares.

One trader made a graceful exit, accepted a profit, and now a different trader has a new investment. Most of the world looks at options differently. But I don&rsquot. If I buy a call option and earn a profit by selling at a higher price, there is no reason to believe that the seller took a loss corresponding to my gain. The seller may have hedged the play and earned an even larger profit than I did. The thought that options represent a zero sum game assumes that all trades are standalone plays and that if you profit, the other person must have lost. Just as our trader above decided that transferring ownership of the shares to another investor would be a good idea at $75share, so too does the covered call writer. When I sell a covered call, I am thrilled when the stock rallies far above the strike price. It means I will earn my desired profit. Better than that &mdash if the big rally comes soon, I will be able to exit the trade with perhaps 90% of my cash objective. Why is that so good when the last 10% is sacrificed? Because of time. If there are still many weeks remaining before expiration day arrives, I can reinvest my money into another position and use the same cash to earn even more than that 10% left on the table.

It may be true that the person who bought my call scored a big win (if the trade was not hedged), but that&rsquos not my loss. In fact, it was my additional gain (in the scenario presented). Options were designed to transfer risk. In the covered call example, the seller accepted cash to help reach the target profit. By doing so, heshe willingly took cash to limit the profit potential of the trade. However, the point is that there was no potential profit to be sacrificed. The call seller would have sold stock at the strike price ($75) and earned less profit than the covered call writer, who collected $75 in addition to the option premium. The option buyer took on limited risk. If the stock did not rise far enough or fast enough, that buyer would have earned a loss. I don&rsquot see anything resembling a zero sum game in hedged options transactions. I understand that others see it as black and white: If one gained, the other lost. But that&rsquos an oversimplification. Article printed from InvestorPlace Media, investorplace.

com201104are-options-a-zero-sum-game. ©2017 InvestorPlace Media, LLC. More from InvestorPlace. More On InvestorPlace: Financial Market Data powered by FinancialContent Services, Inc. All rights reserved. Nasdaq quotes delayed at least 15 minutes, all others at least 20 minutes. Copyright © 2017 InvestorPlace Media, LLC. All rights reserved. 9201 Corporate Blvd, Rockville, MD 20850. Debunking the Option-Trading Myth of Zero Sum. There’s an urban myth in options trading that’s probably as old as the CBOE itself: It’s often said that options trading is a zero-sum game. In other words, if someone wins, someone else has to lose, right? Well, no. It’s true that the stock or option or future or whatever will go up or down, and only one of us can be right. But that assumes that each of us doesn’t do something else on the side.

Let’s look at a few scenarios in a typical options trade on an underlying stock. Say you buy a call, which means the market maker sells the call to you. If the stock goes up, you make money and the market maker loses money, right? Right. But there's more to it. When a market maker sells you that call, he or she might choose to hedge it immediately by purchasing the stock to hedge the short call. Now, you’re still long the call, but the market maker is short the call and now long the stock. Let’s assume the stock goes up, and your call goes up in value as well. The market maker who’s short that call is losing money on it, but is making money on the long stock. It’s possible for the profit on the long stock to exceed the loss on the short call. In that case, you make money on your position, and the market maker makes money on her position, too. In this case, you both can win.

Let’s say the stock goes down. The market maker is short a call, and makes money on that because she keeps the premium received when she sold the call. But she’s long stock, too, and loses money on that—probably more than what she made on the short call. You own that long call, and you lose when the stock goes down. In this case, you both lose. The difference is that the market maker started out with the opposite of the trade you had, but she changed it into something else. So, the options market isn't really a zero-sum game when you look at two independent traders taking opposite sides of a trade. Each can hedge or adjust their position without the other trader doing anything. The beauty of trading options is that you can make investment decisions based on market news, volatility, time to expiration, underlying moves, and so on, andor create different option strategies to hedge your initial trade or position at any point of time. If there's a hedge involved on the "loser" side of a trade, and the net result is a win, two traders can net out as winners, and the zero sum argument goes out the window. So, the zero-sum theory works for the grand scheme of the markets, but not necessarily on the trader-versus-trader level. Where does this leave you?

Pick your trades carefully and make sure they make sense to you. Consider proper hedges with your options trades, and let the other folks worry about their own profitloss ratios. You just have to worry about yours. Get Comfortable with Options. Trade Architect helps new options investors explore strategies with customizable streaming, charting, and more. Turn a Long Butterfly Spread into a Credit Spread? Break a Wing. A butterfly spread is a common choice among options traders who anticipate a move in a stock toward a specific strike price, in hopes it will expire right at t. Looking to Buy or Accumulate Stock? Consider Put Spreads. Stock traders and investors often enter orders to buy shares at a price that’s lower than the prevailing price. But did you know that certain options strategies can .

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Be sure to understand all risks involved with each method, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading. TD Ameritrade, Inc., member FINRASIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2017 TD Ameritrade. finance. 195 . Nefarious - Gordon Gekko MrTacoMan Corporate method AutoModerator wreckingcru VP - Private Equity throw-it-out Analyst - Hedge Fund » the front page of the internet. and subscribe to one of thousands of communities. . . Want to add to the discussion? –Zigxy Equity Research 0 1 2 3 (0 ) mod guidelines . Reddit for iPhone Reddit for Android mobile website . , . © 2017 reddit .

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Your password has been reset. We have made changes to increase our security and have reset your password. We've just sent you an email to . Click the link to create a password, then come back here and sign in. Options Trading a Zero Sum Game? I just received my thinkMoney from ThinkOrSwim. In addition to being wonderfully quirky, ThinkOrSwim also provides some very insightful educational material through their website as well as through the print periodical they send out to their clients. Yes, I am a Swimer. What got me blogging this evening was a short article found on page 40 of the Winter 2010 edition of thinkMoney. The article, written by Tony Battista, tackles the idea that the options market is a "zero sum game." What is a zero sum game, you ask? A zero sum game is one where for every winner you must also have a loser. In the context of trading it means that for every person who turns a profit someone else must suffer a corresponding loss.

By way of example, if I sold a call option to you and the market rallied wildly higher, you would have made a tidy profit and I would have suffered a demoralizing loss. True? Well, let's consider what Mr. Battista has to add to the discussion. Tony Battista presents three myth busting scenarios. The first is a situation similar to the one I just offered, and Mr. Battista suggests that perhaps I would not suffer a demoralizing loss despite having sold that call option. If I was a market maker I would immediately buy stock to hedge the risk I took on when selling the option and would have suffered no loss as a result of the market rally. As a retail investor I may have sold that call option as part of a covered call trade i. e., I bought stock, too. If this were the case we both could make money, no? What if the market falls? You would certainly lose money on your long call, while I make money on the opposite side of that position. But, I also bought the stock and the losses on the stock may quickly exceed the premium I received from the call sale. In that case, you and I would both be holding our hand in the shape of an "L" on our foreheads. We could also both be winners if I owned I profitable long call, sold that call to you to close the position and lock in my profit, and then you enjoyed a profit from a continued market rally. But, what of the fella who sold the call to me? Well, if that fella was a market maker she, or he, would likely have immediately hedged that short call position to offset their risk. From market maker, to me, on to you.

Who lost money? Well, that's not the entire picture and true to his floor trader roots, Tony Battista does hedge his thesis a bit. But, it was an interesting quick read that I thought I would share with my readers. If you would like to read the original story, it is on page 40 of the current thinkMoney magazine and is available in electronic form on ThinkOrSwim's website. Founder and Managing Member of an international association of options traders providing access to educational content both "in house" and through affiliated providers and sponsors, including a free options mini-course that has been utilized by thousands of traders across the globe. 3 replies to "Options Trading a Zero Sum Game?" well, Chris, you probably know my perspective already but i really hate when folks continually dredge up the fantasy that somehow options are NOT a zero-sum game. that point of view can only ultimately be that of a charlatan or - what is the same thing - a spokesperson for the options (or brokerage) industry. saying that hedging changes the whole zero-sum game is misleading, dishonest and disingenuous. you might just as well say that the person who sells an option and uses the proceeds to buy a bushel of grapefruit can win on the net combination. zero-sum is irrefutable and, to me, fundamental to understanding options. hedging does nothing but alter your position synthetically or carry the zero-sum logic one, two, or more steps out.

if e=mc^2 in the physical universe it would be more than a bit odd that somehow that law is broken in the fictive world of derivatives. Buying the stock doesn't change the zero-sum nature of the option transactions themselves: Something + Zero = Something. For example, you might tell me not to play the roulette wheel at the casino because each bet has a negative expectation, and the more I bet, the more I can expect to lose. The nature of that expectation doesn't change just because I claim I have a 9-5 job that pays me more than I lose at the roulette wheel. I'm just playing a second financial game, where the sum of the two is positive. Glad to see someone is reading this blog! I guess I'll keep writing. I did allude to Battista hedging his position in this article, which he does in it's conclusion. He writes. "Now, if you look at all the traders and investors out there in aggregate, trading is a zero sum game, minus commissions and fees and all that. " I guess even the occasional industry spokesperson has to maintain some credibility.

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