What is a Zero-Sum Game?
In finance, a zero-sum game refers to trades orin which one investor when another investor loses.
How Does a Zero-Sum Game Work?
Futures and options trading is generally a zero-sum game; that is, if somebody makes a million dollars, somebody else loses a million dollars. The downside is unlimited.
Let's say IBM is trading at $100 per share. Now let's say Investor A purchases a call option on IBM from Investor B. A few weeks later, IBM is trading at $105 a share. The call option gives Investor A the right to purchase shares of IBM at $100 per share from Investor B. In this scenario, the buyer could use the option to purchase those shares at $100, then immediately sell those same shares in the for $105. Investor A wins, because he gets to buy something for $100 and immediately resell it for $105. Investor B loses by the same amount, because he has something worth $105 but has to sell it for $100. The $5 that Investor A is $5 that Investor B loses.
Why Does a Zero-Sum Game Matter?
Zero-sum games are essentially bets. In the financial markets, for instance, speculators essentially place bets on the future prices of certain commodities. Thus, if you disagree with the consensus that wheat prices are going to fall, you might buy a . If your prediction is right and wheat prices increase, you could make by selling the futures contract (which is now worth a more) before it expires (this prevents you from having to take delivery of the wheat as well). Zero-sum games have a bigger purpose in the markets, however; they provide a of liquidity to the and help companies find a way to stabilize their prices and thus their operations and financial performance.