Tuesday, July 01, 2008

Remember: Futures Trading is Zero-Sum

For every trader betting on higher prices, another is betting on lower prices. These trades are matched. In the stock market, all investors (buyers and sellers) can profit in a rising market, and all can lose in a falling market. In futures markets, one trader's gain is another's loss.

~Robert Samuelson

In the world of futures speculation for every long there is an equal and opposite short. That is, unlike the world of equity trading where there needn't be equal numbers of longs vs. shorts, in the world of futures dealing there is. Money is neither made, nor lost, in futures; it is simply moved from one pocket to the next as margins are swapped at the close of trading each day. Thus, every time there is a buyer betting that prices shall rise in the future, there is an equal seller taking the very opposite "bet," betting that prices will fall.

~Dennis Gartman, in "The Gartman Letter"


At 7/01/2008 3:56 PM, Blogger Malachi said...

Of course, but that's not quite the whole story, is it?

Wouldn't it be more accurate to say, if there are more buyers than there are sellers at a particular price then the price rises until they're the same?

At 7/01/2008 5:21 PM, Anonymous Anonymous said...

The question is can the oil market be out of a condition of equilibrium with its intrinsic value. Does price always have to reflect intrinsic value? Can buyers, in the case of oil, overwhelm sellers and move price away from intrinsic value? I think that is hard to accept that there is at all times in all markets enough conviction on the other side of the trade to force a market to equilibrium. Oil sellers have gotten run over here and are cautious, they are only going to trade if induced to do so by much higher prices. The volume of trades and the fact that it is a zero sum game are irrelevant.

At 7/01/2008 5:30 PM, Blogger Unknown said...

Remember: Zero-sum game means nothing as far as price discovery.

Sophist, In CARPE DIEM blog

What matters in futures trading is price concession. Prices move up when buyers concede to higher sell offers. Prices go down when sellers concede to lower buy offers. Like in any other market.

This is an excerpt from the book by a well-know futures trading professional.

Also, all kinds of trading, even stock trading, is zero-sum when returns are measured with respect to an appropriate benchmark and no external benefits are taken into consideration.

Furthermore, in commodities there is contango and also backwardation, hedgers that are willing to lose in futures, recreational speculators, professional traders, commercials, etc.

This is not an easy subject to try to summarize in one and two lines with the objectives of creating a straw man.

Remember: futures zero-sum game means nothing to price discovery.

More importantly, you can manipulate spot prices by manipulating futures prices. This has been done many times in the past, many people have been prosecuted for doing it, and however now denies it can be done in the case of oil prices, is ignorant of the facts.

Sophist, CARPE DIEM blog

P.S. Juandos, please do not jump in here. A man should know his limitations.

At 7/01/2008 6:21 PM, Blogger juandos said...

"Juandos, please do not jump in here. A man should know his limitations"...

Coming from you sir, that's beyond hilarious...

Please sophist pull your head out and come up for a breath of fresh air...

You've still have yet to answer the question sophist, tell me the difference between someone buy stock for their portfolio and someone who is into futures trading?

At 7/01/2008 7:08 PM, Blogger OBloodyHell said...

> intrinsic value?

There is no such thing as "intrinsic value".

If you're walking, naked, through the middle of the Sahara, how much value does a sack of diamonds (minus the sack) have for you? A barrel of oil (minus the barrel)?
(in case it's not obvious, the exclusion of the containers is because the containers's potential ability to shield you from the sun is more than the value of the contents).

I bet a dozen bottles of Perrier would have a great value to you. I bet you'd sign a check for a whole year's wages for that water. Yet, standing in the middle of NYC, I suspect the "value" it has would be a whole lot less.

Yes, this is an extreme case, to show a particular point. There is no such thing as "intrinsic" value.

THIS is the economic truism:
"The value of a thing is what that thing will bring"

And what anything will bring depends on the situation at the moment.

As noted elsewhere on this blog, the purpose of the futures market is to smooth the price-curve for those things traded. In essence, the current high price represents a "bringing forward" the future high price -- the expectation that demand, over the next year, will be greater than the supply will provide.

The purpose of the high prices is two-fold.
a) It encourages conservation. People won't waste gas "because it's cheap".
b) It encourages (well, to everyone except the US Congress) the the search for additional resources and development of more existing known resources.

Without those price signals, such events would not be proceeding with anywhere near the current alacrity. Instead, everyone would be acting like Congress is, and sitting on their fat asses.

At 7/01/2008 7:13 PM, Blogger OBloodyHell said...

> Coming from you sir, that's beyond hilarious...

Juandos, ignore his bloviating. Let him bask in his imagined grasp of everything, showing how much wiser and smarter he is than everyone else -- including people who have spent decades refining their own knowledge.

Once in a while, when he does post a question worthy of attention (as the saying goes about a busted analog clock), address that, while ignoring his part in it.

At 7/01/2008 10:54 PM, Anonymous Anonymous said...

“I bet a dozen bottles of Perrier would have a great value to you. I bet you'd sign a check for a whole year's wages for that water. Yet, standing in the middle of NYC, I suspect the "value" it has would be a whole lot less.”

I agree. Let’s say it is you and me stranded in the Sahara and I have the dozen bottles of water. As you say, the value is worth a year’s wages. Suppose I decided to just hand you a bottle. Does that bottle lose all of its intrinsic value? Are the remaining 11 bottles then worthless. Here the intrinsic value is high the price paid is low. Do you see the potential disconnect between price and value?

High prices do temper demand – I’m not sure they are purposeful. Demand is not tempered from conversationalists, they were going to conserve anyway. Demand is tempered from those who can least afford to pay the higher price for gas (i.e. the Kinko’s worker who lives 20 miles from work).

At 7/02/2008 8:44 AM, Blogger Unknown said...

here is some info for the bashers, obloody hell and Juandos:

Story link

Of course, they will claim they know the oil market better than OPEC ministers. This is ebcause they have placed a backet of oil underneath their webTV.

At 7/02/2008 8:46 AM, Blogger Unknown said...

Juandos asked"

"You've still have yet to answer the question sophist, tell me the difference between someone buy stock for their portfolio and someone who is into futures trading?"

It will be a waste of time since you know everything.

Wikipedia has made everyone a genious.

At 7/02/2008 9:00 AM, Blogger Unknown said...


I heard that your theory that:

"Pricing is kind of opposite to quantum mechanics." From this post

is not anyylonger considered crackpot stuff and you are on your way to Stockholm.

Good luck mate. While you there, we will all pray loud:

"Pricing is kind of opposite to quantum mechanics."

At 7/02/2008 9:50 AM, Anonymous Anonymous said...

In fact, futures trading is a negative sum game. For a given transaction if one party gains $100, the other side of that trade loses $100, but both pay transactions costs.

Futures trading is no more a zero sum game than the roulette wheel is a zero sum game. Execution brokers (transaction costs) serve the same function in futures trading as the green "00" serves in roulette, assuring those involved will lose all their money even if they have an evenly balanced sum of profitable and losing trades.


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