Zero Sum Game

06 May

yinyangThe point about zero sum game is that there are position holders on both sides of the trade, meaning that for every buyer (long position holder), there is an opposite seller (short position holder). A gain or profit for one participant represents a loss for the opposite participant. Forex (foreign exchange) and futures markets are examples of zero sum game markets. Stocks do not fall in this category.

Interestingly, there are some investors who avoid “zero sum game” markets (investments) because they mistakenly believe in their minds that these markets represent nothing more than a group of poker players sitting across the table from each other where, in order for someone to win, another player has to lose. They believe that smartest player will walk off with all of the chips. Nothing could be further from the truth. To begin with, not all participants in “zero sum game” markets, like futures or Forex markets, are investing to make money. Here’s an explanation:

One of the primary participants in the futures markets are hedgers. Hedgers are interested in transferring their risk to other participants in the futures markets because hedgers are interested in making money in their field of expertise. Hedgers are not in the business of forecasting price trends. Hedgers are only interested in being experts in their own fields, like farming, manufacturing, or corporate finance. Futures markets are extremely valuable instruments in our economy when it comes to the function of risk transfer.

Chiquita Brands International is one of the largest players in the banana market. They sell a substantial quantity of bananas to U.S. buyers, which include grocery store chains. Their business model involves growing and wholesaling bananas to international retail chains. When Chiquita negotiates the price (in advance of the actual delivery) of a banana shipment with a U.S. client in U.S. dollars, one of the first things that Chiquita does is to transfer their currency fluctuation risk to other futures markets participants, like speculators or scalpers. Chiquita is not interested in seeing their profit margin evaporate as a result of an unforeseen currency price move. Currency speculation is not their primary business. Thankfully, the currency futures markets offer Chiquita the perfect forum to transfer this undesirable currency fluctuation risk to other futures market participants.

In another example, some airlines have used the crude oil futures markets to successfully lock in lower energy prices because they feared that rising crude oil prices would significantly impact and potentially damage their future profit margins. Fortunately, Southwest Airlines, for example, transferred their energy risk before higher energy prices became a reality. By hedging in the energy futures market, Southwest Airlines become one of the most profitable airlines in the industry when crude oil prices finally spiked.

“Zero sum game” markets, like futures markets, are effective mechanisms for countless companies to transfer their unwanted price risks. Professional money managers, like Commodity Trading Advisors, are in the business of strategically accepting transferred risk when they believe that profits can be made. Don’t let the “zero sum game” misconception keep you from considering excellent investments in managed futures.

by Mark Helweg and Drew Day

Lexington Asset Management

Clifton House, 75 Fort Street

PO Box 1390, Grand Cayman

KY1-1108

Email: info@ LexingtonAM.com

Web Site: LexingtonAM.com

Phone: 239.273.0142

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