A few years ago, the options trading market was considered “convoluted, esoteric, and ineffable”.
The words used to describe it were even more complicated than the concept itself. The media claimed that options trading was reserved to a covert group of “sophisticated professional investors”.
However, in recent times, the rumor has been dispelled and the average man can now take part in options trading.
Despite the presence of this opportunity, a lot of people are of the opinion that options trading is a zero-sum game.
A zero-sum game as in, your gain translates to someone else’s loss and vice versa.
In a way, just like a game of poker. Professional options traders find this claim laughable.
You’re not wrong if you also do!
The argument does not even hold water. Neither does it hold beer, nor juice.
There are many ways to debunk the claim, however, this article would explain it from the bottom upwards, explaining what options trading is, and why it isn’t mere gambling.
What is Options Trading?
An option is a contract which gives the buyer (owner of the option) the right, but not the obligation to buy or sell an asset at a specified date and specified strike price.
Let’s say you are the buyer, before you can have access to this privilege, a non-refundable deposit is paid. This payment gives you a form of security.
There are certain buzzwords associated with options trading, the right to sell is called “Put option” and the right to buy is referred to as “Call option”.
Is stock trading really a zero-sum game?
Since stock trading bear notable similarities with options trading, it’ll be a good place to start our analysis of the nature of the game. When you buy or sell stock, a value is created.
By buying a company’s stock, capital is provided to the company which is then used to fund projects and to ensure growth and expansion.
In a way, you are creating value for the investors. To the buyer, this value comes in terms of potential earning over time in terms of dividend, and high returns if you decide to cash out at a later time.
Now, you be the judge, is it still a zero-sum game?
Even when everyone can be a winner?
The answer is evident.
How about Options Trading?
Since options are more complicated in a way they operate in comparison to stock trading, it can be quite difficult to see how it is also far from being a zero-sum game. To help in understanding better, an analogy with auto insurance is presented.
Auto insurance functions just like options trading. You pay a premium to get protection against financial loss in an event of an accident or other physical damage to your vehicle or yourself. The premium you pay is the value you provide to the insurance company.
On the other hand, the insurance company must remain profitable for it to cover your loss in case of an unplanned eventuality. Here you see that there are no winners or losers.
You might argue that in a situation where you don’t encounter any misfortune, you’ve lost your premium. However, a counter-argument is that the premium paid has been used to buy you the rest of mind you’ve enjoyed.
Similarly, by trading options, you pay a premium for the right to lock a price for a stock you currently own or are looking to purchase at later times.
This helps to protect your stock in situations where the market moves contrary to what you believe. And if the options expire, at least you’ve enjoyed the rest of mind just like the person in our analogy who never had an accident.
By engaging in options trading, the following benefits are guaranteed.
It is possible to make significant profits by just investing a comparably smaller amount of money.
Elimination of Risk
It offers huge benefits while minimizing/eliminating any inherent risk.
Ease of Transaction and Flexibility
Options are very flexible and versatile in nature, making it possible to use them as an active or passive investment tool.
In a nutshell, it’s funny how critics make fallacious claims with certainty, even when they know that they’re 100% wrong.
Now that you’ve truly known what options trading is and how it isn’t a zero-sum game, it is normal if you want to learn more about those buzzwords and how you can start using them to your advantage.
— The Option Specialist