
Ask HN: Why be an option/futures/day trader when it is zero-sum? - hashtable
Many very intelligent people whom I admire, such as Nicholas Taleb, are speculators. But isn't it very irrational considering that it is provably zero-sum?  I also would have moral qualms about doing it as well considering that I am not using my energies to produce wealth in any meaningful way.<p>Nicholas Taleb talks about jobs that "scale well". But isn't it more important to have jobs that are non-zero sum? If you have a job that is zero-sum, you have to keep working to stay ahead, whereas if you have a job that is less competitive you can relax. There will always be jobs available even for bad programmers because they at least create some wealth, whereas bad speculators would quickly lose their money and bad baseball players would starve in the streets.<p>I think it is as a rule irrational to enter a zero-sum game. When you enter the game, you are assuming that you are better than at least half of the other players. But everyone else is thinking the same thing. Clearly someone has to be wrong, and is going to be sorry. Is there any reason to believe that it is not you?<p>What do you think about this? I have been thinking a bit about getting into option trading, if you have any experience with it, please share.
======
getp
The irrationality you are referring to is called the self-serving bias (SSB).
I wrote a thesis on overconfidence for my master in behavioral economics, and
the two are related. SSB is a well-documented bias. For instance, 90% of
American drivers think they are in the top 50%. It's hard for people to fully
appreciate this fact. Allow me to illustrate. Do you still consider yourself,
even after reading this statistic, to be in the bottom 50% of drivers? If so,
then you're a minority, my friend ;-) (10%, to be exact)

~~~
nostrademons
90% (actually, about 98%) of American drivers _are_ above average, owing to a
statistical quirk. There are 6 million car accidents in the U.S. each year,
out of roughly 240 million vehicles. At a minimum, that means that 97.5% of
drivers get in _no_ accidents that year. They join the big bulge of people who
are "average", having perfect driving records or only an accident a decade or
so.

Accident frequency is a power law distribution - a large percentage of crashes
are caused by a small number of drivers who habitually violate traffic laws,
drive drunk, or otherwise engage in risky behavior. One of the distinctive
features of power law distributions is that there's this long tail of people
with very small values, and then a few people who make up most of the curve.
So (made up numbers) you might have 60% of the population who has _never_
gotten in an accident, then 35% who has gotten in one, then a tiny fraction of
1% who's been in a dozen. Over an 80 year lifetime, that 6 million
accidents/year results in 480 million accidents, or 2/person, so with the
hypothetical percentages above, 95% of people are above the mean and 60% are
above the median.

Just goes to show that you can't assume everything is a Gaussian. ;-)

A similar phenomenom occurs in many, many other fields. The average (median)
wage-earner actually makes below average (mean) wages, because the existence
of Bill Gates and Carl Icahn skews the distribution upwards. The median sale
price for a startup is $0, because over half of them fail. The average test
scores in Palo Alto or Weston, MA or Hunter College High School really _are_
above average, because those places already preselect for bright kids. It's
quite possible for Lake Wobegone to exist: you just need to compare _your_
kids with _someone else's_ average.

And none of this invalidates SSB, but you picked a bad example to illustrate
it. When 90% of drivers think they're in the top 50%, they're right.

~~~
paulgb
Sure, but that only works because you've chosen a discrete measure of how
"good" a driver is. If you defined a "good" driver by some other measure (say,
a function of risky behavior and fuel consumption), then 50% of drivers would
be above the median and 50% would be below, by definition.

~~~
breck
All 3 of you are right.

~~~
wlievens
Lies, damn lies and statistics :-)

------
ctkrohn
Speaking as a trader at a major Wall Street firm... if you want a job that
will allow you to relax, or if you aren't interested in "working to stay
ahead," it's best to stay away from trading. Seriously. The hours aren't quite
as bad as the investment banking/corporate finance guys, but I work 13+ hours
a day, and my hours are not atypical for a junior guy. If you aren't going to
work as hard as the competition, you'd better find some way to be smarter than
them.

If you are interested in getting into option trading, make sure you understand
it cold. Know what delta, gamma, vega, and theta are. Understand the
relationship between these parameters and the price of an option: be able to
explain it intuitively, and be able to derive the relationship from an option
pricing formula. Understand implied volatility and the connection between vol
and option prices. Build a simple Black-Scholes pricer to allow you to compute
your own implied vol. Know why the vol surface has the shape it does. Make
sure you realize that volatility is directional: vol goes up when markets go
down. If you are playing index options vs. single-name options, make sure you
understand your correlation risk. The list goes on and on.

Options are interesting, though, because they allow you to trade volatility.
Vol is a more complicated thing than simple price movement, so if you
understand it well you could have an edge over your competition.

Finally... I think trading is a good job choice for young, ambitious, and
numerically minded people. Seems like there are a lot of readers like that
here... maybe I'll write a more detailed article about this sort of thing
later.

~~~
eru
Please do so. That would be interesting.

------
brentr
First, options and futures involve a sub-zero game. Money leaks out via
commissions.

Second, there are two types of players in this game. The first group is the
speculators. They play the game for profit from the game. The second group is
risk managers. They play the game for risk reduction. Speculators serve the
risk managers. The speculator's strategy is starkly different than the risk
manager's strategy. The speculator can profit by optimizing his strategy.

EDIT: The assumptions made by Black, Scholes, and Merton are highly idealized.
There is much research to still be done in the area of behavioral finance and
the game theoretic approach to derivatives pricing.

I've thought about conducting graduate research in this area because the
mathematics are truly fascinating in this branch of finance/economics. When
you start exploring this area from a game theory approach, you can start to
understand why John Nash won the Nobel.

~~~
muerdeme
My understanding is the "speculators" create liquidity for the risk managers,
thereby assuming their risk.

Why does the money leaking via commissions necessarily make the game sub-zero
sum? Is it because we aren't looking at the big picture where everyone wins?

It seems like the risk managers must have a positive incentive to sell their
risk on the marketplace instead of assuming it themselves. I.e. hedging
another investment like someone else said already.

~~~
brentr
I was thinking about how to better answer your question concerning the sub-
zero game statement I made. Let's remove ourselves from finance for a minute
into something that is more traditional in the game theory studies--namely
poker.

If the game is played where the players arrange transfers face to face such as
in a home poker game, then the game is zero-sum. Your losses are my gains. No
money is created. No money is destroyed. It stays inside the game. The minute
we go to a casino to play the same game, the game becomes sub-zero due to the
rake. You lose X to me and Y to the rake. I gain your X and lose Y to the
rake.

Your cash flows: -X - Y. My cash flows: X - Y. In a zero-sum game your cash
flows are the negative of my cash flows. This implies -(-X - Y) = X + Y. This
is a contradiction. Therefore, the game is not zero-sum.

~~~
muerdeme
I was thinking that, because the market created value, it couldn't be zero or
negative sum. Now I realize that it's negative sum within the scope of the
market itself, even though it may create value in a grander scheme of things.

~~~
brentr
To truly understand the implications of game theory applied to the financial
markets, you should look up the concept of Pareto improvements and Pareto
optimums.

~~~
muerdeme
Good call. My roommate and I are about to start an econ discussion site. Shoot
me an email if you're interested in helping us get conversation started or
just have any suggestions for us.

~~~
brentr
Email?

~~~
muerdeme
See profile, forgot that it doesn't show.

------
rrival
I have a Series 3 (futures/forex) license and worked in that industry for
about 6 months. It was like the bad parts of Boiler Room. I left when I
realized the shop I was working for had no problem ripping off retail clients
and allowing them to speculate with money they didn't have; clients had to
sell their homes to cover their obligations.

Bona fide hedging is a lucrative business for the companies involved, whether
that's hedging against currency or commodity price fluctuations. It's also
more "buy side" than "sell side" - you're dealing with companies rather than
'raising money' from new clients who get blown out over the course of 3
months.

I know a few successful options traders. It's highly lucrative (high 6 figs
base after a few years), you just need the pedigree and the intellect to pull
it off. If you're in a position to do that, though, you might try to get an
analyst job, get on a path to assistant portfolio management, portfolio
management, keep a good track record and start a hedge fund. That's all buy
side and would allow for some flexibility in the strategies you implement.

~~~
mattmaroon
Was the acting as bad?

------
utnick
Don't some people, especially big organizations buy options/futures as hedges
for another investment?... so it might not be a true zero sum game in the
sense that some of the players aren't really playing to win.. they are just
putting money in for insurance

~~~
chwolfe
Correct. There is a big difference in leveraging options when you own tons of
stock in a company vs. using options as a high class lotto ticket.

Example: Mark Cuban used options to guarantee he would be set for life no
matter what happened to Yahoo's stock after they bought Broadcast.com for $5
billion (in stock mostly).

~~~
llimllib
> Mark Cuban used options to guarantee he would be set for life no matter what
> happened to Yahoo's stock

Care to explain further, or point me to where I can read more?

Edit: I think the "equity collar" article linked below sorted me out.

~~~
chwolfe
<http://www.fastcompany.com/magazine/63/fasttalk.html>

"The basic worry that comes with having lots of money is no different from
what worries everyone else. Whether you've got $100 or $100 million, you don't
want to lose it. After we sold Broadcast.com, I hedged my stock with synthetic
indexes, in case the market cratered in the six months before I could hedge my
actual Yahoo shares. It cost me $20 million, but I protected what I had. Todd
Wagner and I had a credo: "Pigs get fat; hogs get slaughtered.""

------
greatreorx
"When you enter the game, you are assuming that you are better than at least
half of the other players."

I think the difference is - at what point does that assumption become atleast
somewhat provable. Shaquille O'Neal was probably an athletic 6'10" 280 lbs in
high school. Just because the game of basketball itself is zero sum, does that
make it irrational to think that he would become a decent professional
basketball player?

My favorite part of Taleb's book is when he describes the investing world as
if all player's had a random 50/50 shot of making money each year. There are
millions of investors, by random chance thousands will do really well, a
handful will do really, really well over the course of decades. How do you
know Warren Buffet is not part of that handful that is successful purely by
chance? It's been awhile since I've read the book, but I remember his
philosophy being something like if you have a logical investing/hypothesis
that gets proven results, then maybe we can say it's not by chance.

So to answer your question, if you think you have an objective
theory/algorithm/etc for option trading and have done blind historical tests
or have successfully paper traded for a year+, then you might be on to
something. If you think you are just smarter than everybody else, or maybe had
a couple successful stock trades, it's probably not a good idea.

------
menloparkbum
Competitive sports are also zero-sum games. Traders are banking "jocks." They
are traders because it is a zero sum game, and they think they have what it
takes to win.

------
andr
As a person that has been on both the positive and the negative side of the
sum, I can tell you that most people don't really think about this when they
get into the speculation.

1) Serious quant trader types are rarely good at anything other than
mathematics. Even if they are, if they are getting $500k+/yr it would be hard
to start as an entry-level engineer for $60k. So most people don't really have
an option once they get started in trading.

2) It's addictive. The top hedge fund manager in the US is paid to the tune of
$1.7 BILLION per year. On January 2nd the next year, he's back in the office.
Once you get in the quickpaced environment of trading everything else looks
very boring.

3) It's usually a collective game, so your particular performance is not as
important as the performance of the firm. You could do excellent, but somebody
else could tank the whole bank. Similarly, you could have a bad year, but if
the company is doing OK you'll still get a decent bonus.

After all, the same applies for startups. If you don't assume that you are
better than most people at what you do, there's hardly a point in doing it.

------
ad
Short answer: No, don't do it.

Long answer: For anyone interested in this stuff I highly recommend the book
Trading & Exchanges by Larry Harris. The book is about market microstructure,
and the knowledge applies to any market whether it's equities or options or
online gambling like intrade.com. It's a textbook, so not riveting reading,
but great information.

As other posters have pointed out, it depends on how you define zero-sum.
Trading is zero-sum, when you compare it against market returns. However, as a
trader you are providing services such as immediacy and liquidity. My AAPL
stock is more valuable to me as an investor, since there is an active market,
and people are willing to sell it to me and buy it from me on short notice,
even though I am losing some money to them through the bid-ask spread and
execution costs. The other comments about options being useful for spreading
out risk are true as well.

As far as the rationality goes, it's rational if you're an expert, you have
better information than the market, if reading the above textbook kept you up
late at night, etc. Your intuition about the odds are correct, though, so keep
your pessimism handy.

So why is my short answer 'no'? Well if you don't have the patience to read
the whole post then you definitely shouldn't do it, since learning all the
math behind it is going to be way more boring. You've read Taleb which is a
good sign. Now that you're at the end the answer is 'maybe', but your wording
concerns me: what do you mean by "getting into" options trading? If you're
going to get some intensive training and learn from professionals working at
reputable investment firms, then great. If you're going to read a few articles
off the internet and then dive in, then that is definitely not a good idea.
Trading is all about having an edge against the person you're trading with, so
a few articles don't improve your odds much.

~~~
hashtable
I'm just a undergrad college student. I read a few articles online and decided
to try the options trading simulation at cboe.com

------
jaydub
I think it has to do with the "superstar" phenomenon that Taleb discusses in
Fooled by Randomness & The Black Swan. Being a dentist, you are not likely to
see a multi-million dollar salary - yet you can definitely live comfortably.

What I believe Taleb's philosophy _was_ (he now remarks in bold text: "Finance
is for philistines!" on <http://fooledbyrandomness.com/> ) that by exploiting
the random nature of markets he could "swing for the fences" by placing many
small extremely risky bets that if they paid off -- even infrequently -- would
guarantee him a lot of money.

From the little that I know/think I know: Options are a good way to leverage
small amounts of capital into potentially large gains. If the price of the
underlying security doesn't behave as you expected you can let your option
contract expire worthless - meaning you have a defined risk which is what
appealed to Taleb. Even in the worst case he knew how much was at stake.

~~~
eru
That changes when you start to write options i.e. be the counter-party which
does not have the right to buy/sell but the obligation.

------
daniel-cussen
In theory, a good speculator allocates money more efficiently. In 2004 this
might have meant shorting Bear Stearns and buying stock in Google. Google
could then sell stock to raise money, or take out a loan with its own stock as
collateral, to pursue projects with the money. In theory, a good trader lends
money to the companies that deserve those resources the most. So, as far as I
can tell, it isn't a zero-sum game.

If the entire stock market does its job like this, money gets to googles more
easily than it gets to pets.com. The economy uses capital more efficiently,
and grows more than it would otherwise.

Of course, that's all in theory. In practice, being an investment banker is
rough.

~~~
ca98am79
This is exactly right. By making money day trading in the market, you are
creating very needed services - adding efficiency and liquidity. Without these
things, the markets wouldn't exist.

------
dfranke
Options trading is not zero sum because the utility of money is not linear.
When a rich person gives money to a poor person, the net gain is positive
because the poor person can use the money to satisfy more basic needs that the
rich person has already satisfied, and thus would otherwise have spent the
money on something with a smaller return.

As brentr already pointed out, some people trade options for risky gains (such
as selling an uncovered call), and some people trade them to offset risk (such
as buying an underwater put). Acting in the latter category is like buying
insurance: even though your expected return on money is negative, your
expected return on utility might still be positive. Acting in the former
category is like selling insurance: you run the risk of taking a big hit, but
your expected return is still positive.

------
mattmaroon
It's not uniformly irrational or unprofitable to enter a zero sum game. I made
a great living for over 5 years playing a zero sum game, and know lots of
people who have done it for far longer. Not options trading though. That one
in particular I can't speak to.

It's often not that hard to prove within a reasonable certainty that you are a
winner (or at least were one), depending on the variance. I haven't looked
into the coefficient of variation of options trading though. I might one day.

Also, whether or not something is competitive has nothing to do with whether
or not it is a zero sum game. It is generally just a factor of how much money
can be made. The software industry is not zero sum, but is highly competitive.
Low stakes poker tables are zero sum, but are not competitive at all.

~~~
hashtable
But wouldn't the lose leave the game, leaving the previous winners to battle
amongst themselves?

~~~
mattmaroon
Nope. Any game involving variance allows one to chalk up bad results to bad
luck for a very long period of time. And new losers join every day.

------
icey
I'll save someone the task of googling Nicholas Taleb. I think this link has
been here before, but even so, it's a good one:

<http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm>

------
byrneseyeview
It isn't zero sum, any more than manufacturing is zero sum because all you did
was expend energy rearranging the same old atoms.

Trading well requires you to synthesize information that other people will act
on. If oil is too cheap, you buy oil, this raises the price and alleviates the
problem. The fact that this causes some people to lose money is material, but
it just means that trading is a way to redistribute wealth from people who are
usually wrong to people who are usually right. I do not see how anyone could
believe that this isn't socially useful.

~~~
mattmaroon
That doesn't make sense. Manufacturing is not zero sum because you're taking
things people don't want (raw materials) and turning them into things they do.
It's a zero sum game at the atomic level, but not at the wealth level.

Options trading is zero sum because every dollar made by one options trader is
lost to another (or to a commission). There's no net wealth generation.

~~~
byrneseyeview
Of course it makes sense. Trading options takes something people don't want (a
particular exposure to a particular set of cash flows) and turns it into
something they do want (a different kind of exposure to a different set of
cash flows). If people they were indifferent to sets of cash flows, markets
wouldn't work.

Here is one incredibly obvious way that you're wrong: if you ran an airline,
you might be worried that a sudden spike in fuel prices would bankrupt you.
They could use futures to speculate that prices would go up, so they'd be
indifferent to price changes -- an increase of $X in fuel costs would give
them an increase of $X in futures profits. Suddenly, they are a more stable
company -- people are more willing to work for them, banks are willing to lend
them more money, passengers are more likely to participate in frequent flier
programs, airports would be more likely to consider them for long-term spots,
etc. Somehow, everyone on that side of the transaction benefits. And lo! The
speculator on the other side, betting that prices will go down, is able to do
so directly, rather than by indirect means such as buying stock in an unhedged
airline and exposing himself to the vagaries of that industry. Even if he
loses money in the end, he has what he wants when he makes the trade. However,
I needn't restrict myself even to people making business decisions through the
futures markets: even a compulsive gambler trading pork bellies is not a
compulsive gambler getting drunk at casinos or playing illicit card games. In
short, it's a very sanitary sort of gambling (this was not always the case --
in the 1920's, traders at the then-outdoor American Stock Exchange drank
constantly to keep warm. This explains a lot).

It is trivial to declare that some business is zero-sum or negative sum. Even
retail is a series of zero-sum transactions: I had $5 and the restaurant had a
burger, now I have $5 worth of burger and the restaurant has $5 worth of cash.
Even, minus time and taxes. And yet, for the most part, our bias is to quite
correctly assume that when people voluntarily hand over billions of dollars,
some of them becoming poorer and some of them become quite richer in the
process, they may be doing something rational. The fact that rich countries
develop stock exchanges, and that the development of stock exchanges
correlates with future wealth, is not a coincidence.

------
bdr
Has anyone else read "Nonzero" by Robert Wright? It's one of two nonfiction
books that have noticeably improved my understanding of the world, with almost
daily benefits. (The other is The Black Swan.)

------
aaronblohowiak
Being a quant has a certain appeal, but nothing (to me) is as appealing as
creating tools that people use to accomplish things.

Gambling on anticipating/creating the future is not an easy way to make money.
However I agree that there is no wealth creation resulting from this (the
increased liquidity of the market due to new kinds of derivatives may increase
the efficiency of the market, but I think you are talking about "simple"
trading.)

------
davidmathers
Zero-sum depends on your perspective. Speaking strictly in theory here: a
successful speculator creates value in the same way a hunter creates value
when he sharpens his spear. By taking decision making power (money) away from
people who make wrong decisions he "sharpens" the market and makes it a more
useful tool when other people use it to create value.

~~~
davidmathers
Of course I totally missed the point of the question. It strikes me as just a
matter of personal temperament. I, personally, have no interest in jobs that
involve going into battle againt other people every day. But if that sounds
appealing to you then I think you should go for it, even if probability says
you won't succeed. Passion > reason.

------
rrival
Wrt to the "why" of the market, without speculation, liquidity is far lower.
Take a look at the Chicago Climate Exchange's (CCX) price fluctuations
compared to a fall expiring wheat contract on the CME/CBOT - you can move the
CCX with a small amount of money.

------
Tichy
I am not sure that traders don't create value. Their job is to allocate money
to the most useful company, I suppose?

~~~
hugh
Except the companies don't see any of the money once the IPO is finished.

Of course, the only reason the IPO can proceed is because people who buy
shares know that they can sell them to other people later. So I suppose in
that sense they help. However, once the market already exists, no extra value
is created by an extra trader entering it.

As others have pointed out though, there genuinely is value created by the
options trading market, since the existence of options allows risk to be
spread.

~~~
yummyfajitas
Well, companies do sometimes make further public offerings.

Stock trading also provides a somewhat objective measure of the value of the
company. For instance, if MS wants to buy Yahoo, how much should they offer?
Without the stock market, it's tough to tell if they are lowballing or paying
a premium.

~~~
brentr
You're spot on that the market is a means of both creating information and
disseminating information. Information is key to game theory. That's where
sigma algebras and filtrations start to creep into theory.

------
mynameishere
Trading long is positive sum.

~~~
hashtable
For stocks, yes, but not for options/futures.

~~~
mynameishere
I am talking about stocks.

------
xlnt
speculation done right consists of creating knowledge about what resources
will be in what demand in the future, and then saving resources that are cheap
now but will be expensive later. doing this raises the price a bit now (b/c
you buy a bunch) and lowers it then (b/c supply is higher then). you make
money smoothing out price fluctuations. this is a valuable service -- price
fluctuations can really hurt people or companies that don't have spare money
at the moment.

there is a limit on how much total money can be made doing this. the more
people do it, the less price fluctuations are available to even out.

but anyway, there are good types of trading.

~~~
brentr
I'm guilty of not creating a distinction between speculation and investing.
Technically, investing done right consists of creating knowledge about what
resources will be in what demand in the future. A speculator plays a mere
hunch. The distinction lies in the amount of information processed in the
decision formulation. A good discussion of the dichotomy between a speculator
and an investor can be found in Graham and Dodd's Security Analysis.

------
johnrob
This is human nature. It happens everywhere, the most commonplace example is a
lottery ticket: that is a negative sum game. Venture capital is also a
negative sum game (EDIT: I'm actually not sure about this, the winnings of top
VCs might outweigh the losses of the majority).

Risk hungry people will pay a premium for increased upside. For example, they
will prefer a win 20-lose 30 game over a win 10-lose 0, because 20 > 10.

~~~
muerdeme
Venture capital is not an example of this phenomenon. VCs accept high
risk/variance in order to achieve high expected value, and it is not a
negative sum game.

