The Difference between Stocks and Options (zero-sum games)

Check out my discussion of Game Theory and Options…

VIDEO SUMMARY

In this video we are going to talk about the biggest difference between stocks and options. It is pretty easy to trade both stock and options on most trading platforms today. Now there are lots of differences between stocks and options, but there is one concept that is so significant, and I am shocked that I find a lot of people don’t understand this concept. I think it is so important that I wanted to dedicate this entire video to just this one idea…. And it has to do with “game theory.”

So game theory is the study of strategy, where you look at your actions, and the actions of the competition like pieces on a chessboard, and the goal is to optimize your outcomes. Under the framework of game theory, the activity of trading options represents what is known as a zero-sum game.

This is the most important thing to realize about trading options versus trading stocks. Trading options is a zero-sum game and trading stocks is NOT a zero-sum game.

Let me explain what that means. In every single option contract, one party wins, and one party loses. When you purchase an option, you are taking a position. If you are right, you get the benefit. If you are wrong, the other party gets the benefit. So with every option, you will either win or lose.

This is different from trading stocks. If you give your money to a company, and the company does well. Everybody wins. That is called a win-win situation. Now with stocks it is also possible for everyone to lose also. The point is that trading stocks and trading options fall under two very different strategic frameworks.

So let’s talk about how this plays out. If you are thinking of purchasing an option, you are generally expecting to make money from the transaction. Now you have to realize, there is someone sitting across the table from you selling the option you are about to buy. That person is also expecting to make money from the transaction, and that is why they are willing to sell the option. So here you have two people, thinking they are going to make money, and only one of them can be right. What is it that makes you smarter than the person selling you the option? Why are you going to be right and they are going to be wrong? That is a very deep question you need to ask yourself.

So that’s it. I just wanted to talk through this very important concept that differentiates stocks and options. It is the idea that options are a zero-sum game. In the next video we are going to continue to talk about options, and cover the basics on how they work.

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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.