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Comment by nissimk | Hacker News Reader

While cash securities markets (i.e. stocks and bonds) are not a zero sum game, derivatives markets (i.e. futures, options and all kinds of swaps) are zero or negative sum by definition. Also, derivatives markets are far larger in size [1]. There are always 2 parties to each transaction and one makes the money that the other one loses. The additional transaction fees that go to the banks and various other operations providers make it negative sum.

[1] http://www.isda.org/statistics/recent.html#2010mid

Also see:

http://www.nakedcapitalism.com/2013/03/worldwide-derivatives...

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My understanding of the original idea for derivatives was apportioning risks into pieces that could be independently valued by different experts/markets. For example, say a company wanted to finance an X factory in Y country. The original lender would have to be an expert at evaluating risk in the X market and the Y currency market, which is a small pool of investors. If derivatives could split the risk into X market risk and Y currency risk and sell them separately to specialists in each risk, then the factory was much more likely to find funding, at lower rates, etc. The "world" ended up with a factory that would not have been built, with all the associated wealth, which is positive sum. Am I missing something that makes derivatives negative sum in this case?

This is nonsense. With a future, for example, both sides lock in future cash flows and can lead to a reduction in risk for each party. Reduction in risk for each party can be beneficial for each party.

You might as well say that buying milk is a zero sum game, because the milk is either over or under priced. That's just wrong. Financial securities have more to them than just their price.

Can we stop quoting the underlying notional size when comparing size to equity markets? If you know how a derivative works, it's well understood that quoting the notional to represent size just doesn't make sense.

To put it simpler, a terminated CDS contract does not mean there is a loss of wealth equal to its notional, whereas a stock price going to zero in the equities market literally means you just lost the complete amount you invested.

Not to sound offensive, but I've heard this comparison way to many times and it just doesn't add up in terms of prices - most swaps, for instance, have their fixed leg in the single digits in relation to their notional.

That's certainly true for interest rate swaps, but credit default swaps are actually quite similar to stocks. For example when Lehman filed and the stock went to 0, the CDS settled at 91.375 [1] meaning that the protection seller had to send 91.375% of the notional value to the protection buyer. Yes, in most cases there is no credit event and even in many credit events the impairment to the debt is much less than 90%, but also most stocks don't go to 0. This case is a good example because the maximum market cap of Lehman stock was 60 bln [2], but the CDS market moved 270 bln in the credit event (see [1]).

[1] http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a...

[2] http://www.investopedia.com/articles/economics/09/lehman-bro...

That's a reasonable point. Obviously it's hard to talk about a term as broad as "investment" without running into exceptions.

"There are always 2 parties to each transaction and one makes the money that the other one loses."

Completely false. Wealth is not fixed. There can be two winners, which often happens.

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