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I would like to present two opinions by two different options experts, and let you to decide. Are Options a Zero Sum Game? - by Mark Wolfinger 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’s difficult to argue that the term ‘zero sum game’ does not apply to options, and to trading in general. However, I do make that argument. A Profit in Stocks 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 ’til canceled) sell order with his/her 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 ‘lost’ money by selling and that the ‘buyer’ made money. With this point of view, trading is a zero sum game. I’ll 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, he/she 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’s 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. Options are Different Most of the world looks at options differently. But I don’t. 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 $75/share, 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 — 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’s not my loss. In fact, it was my additional gain (in the scenario presented). Risk Transfer Options were designed to transfer risk. In the covered call example, the seller accepted cash to help reach the target profit. By doing so, he/she 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’t 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’s an oversimplification. Debunking the Option-Trading Myth of Zero Sum - by Rachel Koning Beals 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. Myth Buster One 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. Myth Buster Two 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. A Caveat 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, and/or 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. However, if you look at all the traders and investors out there in aggregate, trading does become a zero-sum game. When the market maker buys the stock as a hedge against her short call, someone else is selling that stock to her. If the stock goes up, the person who sold the stock misses out on the profits. 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 profit/loss ratios. You just have to worry about yours. Visit our Options Trading Education Center for more educational articles about options trading.

See, I’m an options nerd – I love the power, math, and flexibility of the instrument. Therefore, I get quite animated when I hear criticisms against options trading. Besides the risk, leverage, and incorrect blame for options causing the housing crisis, one of such statements is that options trading provides “no value – it’s a zero-sum game.” This bothers me and I hope it bothers you, my fellow options-trading enthusiast. Is options trading really a zero-sum game? Am I no better than a gambler or a pickpocket taking a fellow trader’s hard-earned money? Conventional wisdom might say it is zero-sum, but for this article, let’s discuss a non-conventional view premised on the question of: what value and utility options bring markets and society? What does it mean to be a “Zero-Sum Game?” A zero-sum game is one where there needs to be a loser for every winner. This interplay between winning and losing creates a net value of zero, a world where your chance to win is all or none. Las Vegas and sports betting books put this in terms of a pick ‘em bet, where you choose your team to win the game, regardless of points or spreads between the two competitors. If you bet on Team A and they win the game, you win. However, if you win, the counterparty (who chose Team B) loses. There’s no splitting earnings, no recompense for effort, no crying in baseball. You win or you don’t win. We’ll let this stand as our general understanding of zero-sum game and see if the rules explained above have any meaning or relevancy to options trading. Is Stock Trading a “Zero-Sum Game?” If we apply our general understanding of what the meaning of a zero-sum game is, then would traditional stock trading (buying and selling) fit the description? With stock trading, as in any type of trading, there is a buyer and seller and with each dollar the stock moves one profits while the other takes real losses (shorts) or opportunity losses (sellers). However, conventional wisdom would say no, stock trading is not zero-sum. When buying or selling stocks, you create value. You create value for yourself in terms of a potential for unlimited gains, additional income in the form of dividend, and capital growth over time. You also create value for the company by providing needed capital that is used for expansion and growth opportunities, the creation of dividends for other investors, and a way for the company to continue to produce, modernize, and be/become profitable. This type of value also creates a larger benefit for the community in the form of products and services, jobs, a taxable entity, corporate partner for social and charitable causes, etc. Stock trading is far from a zero-sum game. It is, in many respects, a value proposition that provides individual (micro) and societal (macro) benefits. Surely Trading Options is Zero-Sum? So, zero-sum is winning and losing in absolute states, if you continued to buy into the argument laid out so far. Accepting the value creation proposition of stock trading and the ripple effect it has, isn’t it logical to afford options the same opportunity to demonstrate value? Why must others peg them a zero-sum game of winners matched with losers? Let’s make an analogy of options trading with that of owning auto insurance. Insurance as we know provides assurance and piece of mind against the potential for loss based on pure risks. Pure risks are those that are unforeseen, accidental in nature, and not based on winning or losing. You buy auto insurance to protect against the financial loss associated with owning and operating an automobile, including financial loss for physical damage caused by you or to you by others, as well as bodily injury that may occur as the result of an accident that caused an injury to you or another person. You pay a premium, which is the exchange of value between you and the insurance company commensurate to the risk of the provided insurance. Under this scenario there are no winners or losers. In fact, the expectation is that the insurance company remains solvent and profitable in order to protect you against financial loss. Even if you never experience an accident or other insurable loss to your vehicle, the premium you paid is the price for the peace of mind you receive. That feels like you received something of value (protection) in exchange for something of value (premiums paid). Options operate in the exact same manner. You pay (or receive a premium) in exchange for the ability to either lock in a price for stock you own or are looking to purchase, or to protect the value of the stock (or your portfolio) in the event the market moves contrary to how you believe. If the option expires worthless, you don’t lose if you paid premium, in the case of an options holder, and certainly do not lose if you receive a premium, in the case of an options writer. The Origins of Options as a Risk Transfer Tool We will further develop this notion of options as an insurance tool by looking at the history of options. The origin of both options and futures begins with speculators taking bets on various harvests more than two thousand years ago in both Greece and Japan. Options came to America in 1872 via OTC puts and calls introduced by Russell Sage. However, the matching of buyers and sellers was a laborious manual process and struggled with manipulation. Russell Sage Portrait Then sprung up “bucket shops,” where traders would bet on the movement of stock prices without owning the shares. This, basically illegal activity, of course, does not bode well for the argument that options are more than zero-sum, but bear with me. The activity of these bucket shops attracted regulatory authorities and, finally, some control over OTC options markets came down from the SEC. However, trading didn’t grow until the 70’s when the Chicago Board of Trade saw a significant decline in commodity futures and decided to create an official, regulated exchange (CBOE) for options in 1973. The exchange opened with call contracts only. The put contract came 4 years later. The new exchange, run by those with extensive futures experience, meant options could be used not only as a speculation tool but as a risk transfer tool. With a strong exchange and renewed market confidence in a fungible financial product, finance saw the rise of options as not only a trading vehicle but also as a risk transfer tool. What I mean by “Risk transfer” is that of taking potential for loss and transferring it to another party for the exchange of value – in legal terms this would be a consideration. Yes, the same consideration which is necessary for insurance policies to be legally binding contracts. Alas, we’ve finally come back to the insurance company example where a consideration (premium) for the insurance company to insure the risk for potential financial loss (a reduction in value), not based on the actual experience of the loss but the potential for the loss. Options operate in a similar manner. You pay or receive a premium based on a desire to protect value, peg profitability at a certain level, or increase income based on the current or future market sentiment. An insurer takes the opposite side, in this case being the options seller via the matching powers of the Options Clearing Corporation (OCC). The OCC creates binding contracts and provide a liquid, orderly, and efficient marketplace by which the exchanges operate. If exercised, you meet the terms of the contract and the transaction ends. If the option expires worthless, you benefited from the protection provided. If the contract moves in a direction counter to your intuition, you can enter in to a closing transaction prior to expiration for a resulting limited gain or loss. Everything described about the nature of options in the case of their use as a risk transfer tool makes them far from a zero-sum game, with its absolutes on winning and losing. Options are very much a value proposition that provides intrinsic and real value, regardless of the way they’re utilized. Hedgers vs. Speculators: The Counterparty Interaction Between Profit-Protection and Profit-Seeking The OCC creates an offset for options trades, matching buyers and sellers to create a counterparty relationship and increase the efficiency of the marketplace. Hedgers tend to be buyers, seeking to protect a position against adverse bullish or bearish moves, and generally hold for the duration of the contract. Speculators seek profit and can remove themselves from an unfavorable position with a closing transaction. This means that the counterparty interaction between those seeking to protect profit (buyers or hedgers in most instances) and profit-seekers (sellers or speculators) provide tremendous value to the marketplace. The counterparty in many options trades are hedgers who are “paying for insurance” as opposed to directly competing in opposing positions. Speculators tend to move in and out of positions more rapidly as well as close their positions before expiration. This all stands to reason; a trader has a higher risk for loss taking a speculative stance should the position move even $0.01 in-the-money before expiration. Closing a position protects the trader and further preserves the balance between profit and protection, with a nice byproduct of liquidity along the way. The Price Discovery & Stability Argument Finally, let’s briefly discuss what is the price discovery and stability argument as it relates to market supply and demand in determining the price of an option. The price discovery argument is one that is applied to trading futures contracts and used to determine spot prices for such commodities as corn, wheat, oil, and cattle. The close relationship futures and options have make the argument just as much relevant to options, and more specifically their pricing and hedging capability. Options pricing, being based on implied volatility (IV),creates a voting machine of sorts between buyers and sellers. The IV can be translated to expected price moves in the underlying stock, which helps prepare both traders and the underlying before an event. These signals allow traders to buy protection and put on hedges, which takes us back to the “insurance value” argument. Closing Thoughts Despite a bumpy history, options demonstrate a significant value proposition to modern markets and modern traders. It’s unfair to say that options trading is a zero-sum game only suitable for gamblers and market makers and unsuitable for the at-home, retail options trader. So take pride the next time you sell that valuable put because you may have just provided someone extremely valuable security and peace of mind – and if you make a little money in the process, then even better. Drew Hilleshiem is the Co-Founder and CEO of OptionAutomator, an options trading technology startup offering a free options screener that leverages Multi-Criteria Decision Making (MCDM) algorithms to force-rank relevancy of daily options opportunities against user’s individual trading criteria. He is passionate to help close the gap between Wall Street and Main Street with both technology and blogging. You can follow Drew via @OptionAutomator on Twitter.