Subject: Re: On Charlie Munger's centenary, and albatrosse
Engr27,

Thanks for helping me out. To be fair to me, though:

You wrote:
You were asked to imagine that all stocks were fairly valued.

Actually, Jim asked me to Imagine that every stock in the world were trading at fair value tomorrow

You wrote:
Instead, your premise is that the market is overvalued

Actually my "premise" was noting a fact with which I think Jim would agree, that in the past the stock market has been overvalued for years at a time.

****

But I think after reading your note I did figure out what Jim was getting at, and that is that the stock market rises in value due to retained earnings of companies, and that is an example of its non-zero-sumness, which is true and I agree with.

And what I wanted Jim or others to recognize was that:
1) The entire non-zero component of the stock market arises form transactions in which the issuer of the stock participates.
2) If the issuers of stock that write or redeem warrants and options were included as part of the options market, the options market would also be non-zero sum.

****

In one of the posts, Jim hypothesized that there may be a net transfer of cash from the buyers of options to the sellers (or writers) of options. A very interesting thing to contemplate and something that would NOT be true in a frictionless market with "properly priced" options. It would not be true because the definition of "properly priced" is a set of prices which statistically average to equal amounts won and lost by people on both sides of the options transactions. If buyers are systematically overpaying for options, it is either because they are on the wrong side of the bid-ask spread more often than sellers, or because the options are mispriced and us retail guys should be writing options more often than we are buying.


I will hypothesize that there should be a net transfer of cash to the buyers of calls from their sellers, and to the sellers of puts from their buyers. My reasoning is that stock prices rise over time, so "properly" priced options will win on the long side over time and lose on the short side over time. That to zeroth and first orders, "investing" in options is just a funny way to invest in stock and eliminating arbitrage opportunities means the long side has to make more money than the short side since the stock hedge of long options books is rising in value, on average, while the short stock positions that hedge short options books are falling in value over time. In fact, if I am right, there should be a systematically higher advantage to being on the long side of options trades when markets are rising and a systematic advantage to being on the short side of options trades when the markets are falling.

I hope at least someone besides me has been entertained by these considerations. Whether that is true or not, I will go back to thinking about more useful things like how many angels can dance on the head of a pin and whether the devil is real.

R:)