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I find people who stand in disbelief of the markets often don't understand how they are working, and/or why they have and societal value. Skepticism is healthy

I find people who stand in disbelief of the markets often don't understand how they are working, and/or why they have and societal value. Skepticism is healthy, but in this case, it's closer to ignorance. The ability for corporations to go to the open market to secure capital is contingent upon a high liquidity of buyers and sellers present and actively participating. The market doesn't exist without "primary" buyers and seller acting on behalf of their company to issue new stock (raising capital) or buying back stocks (returning capital (or via dividends)). Between these two types of transactions, there are participants that are constantly estimating the value of these share. If the price of the share deviates too far from what the company thinks it's worth, it will actually trigger one of those two events. Options are just another more efficient mechanism to make these estimations on a specific timeframe. They allow traders to have a very specific thesis on what is mispriced and place a trade on it. Without these trades, the market would lack liquidity, and companies would see an increase in their cost of new capital - which is bad for everyone because it means companies wouldn't invest in growth, equipment purchases, new jobs, etc...

mbg721 6y ago
I guess I'm one of the ignorant; I'm still skeptical about derivatives. I get the need for hedging, but when you can construct something mathematically equivalent to a stock without actually putting money into the company, that seems like it could end very badly.
- koheripbal 6y ago
  Sorry if my comment came off as critical - probably could have been worded better. Derivatives are critical even to primary market participants. Farmers looking to secure their pay for future crop deliveries. Banks looking to remove interest rate risk on mortgages they've issued. Shipping companies looking to remove the risk of fuel fluctuations on their future transport costs. Fluctuations of cost inputs and uncertainty of future revenues can be a company death sentence as they cause cash flow shocks. They have real value to the economy. Often, they are only possible if there is a liquid market of people willing to take the other side of these transactions. Narrowing the spread between buy/sell prices on these derivative contracts allows more companies to be able to afford them, and that makes many low margin businesses able to exist at all. Despite all the hate on social media, these markets have material value. ...even if there are these anomalies like this Gamestop incident. I imagine the SEC is going to shut down that Reddit sub because these types if activities actually destroy liquidity but discouraging short sellers. Regulation plays an important role in keeping markets running smoothly.
- imtringued 6y ago
  Commodities have to be traded as futures because you cannot move commodities instantaneously. So what you do is you write on a piece of paper (its digital today) that you will provide X amount of commodities for price Y in Z days. You can then sell the contract for the total value of the commodities and when the contract is due you just send the commodity to the holder of the contract.
imtringued 6y ago
The primary value traders provide is liquidity and decreased volatility. There is a fixed need for these two services. Once you have served every customer the only way to make more money is to take customers away from other competitors, or grow the market as a whole. Traders do not influence the size of the market, they only increase efficiency, so the expectation is that you run into diminishing returns stays. There is more than enough liquidity in the markets. Any more liquidity is not providing any value. >Without these trades, the market would lack liquidity, and companies would see an increase in their cost of new capital - which is bad for everyone because it means companies wouldn't invest in growth, equipment purchases, new jobs, etc... The Fed is already taking care of that. The bigger problem is that there is no reason to invest the Fed money and grow the market.
- aeternum 6y ago
  Increasing efficiency is pretty critical. For the vast majority of markets, there's no such thing as 'serving every customer'. Companies can always serve customers more especially if they can reduce the price. However it takes capital to do this. It's not just about liquidity, investors basically influence the cost of capital for each company which has a big impact on how many customers each company can serve.

mbg721 6y ago

I guess I'm one of the ignorant; I'm still skeptical about derivatives. I get the need for hedging, but when you can construct something mathematically equivalent to a stock without actually putting money into the company, that seems like it could end very badly.

koheripbal 6y ago
Sorry if my comment came off as critical - probably could have been worded better. Derivatives are critical even to primary market participants. Farmers looking to secure their pay for future crop deliveries. Banks looking to remove interest rate risk on mortgages they've issued. Shipping companies looking to remove the risk of fuel fluctuations on their future transport costs. Fluctuations of cost inputs and uncertainty of future revenues can be a company death sentence as they cause cash flow shocks. They have real value to the economy. Often, they are only possible if there is a liquid market of people willing to take the other side of these transactions. Narrowing the spread between buy/sell prices on these derivative contracts allows more companies to be able to afford them, and that makes many low margin businesses able to exist at all. Despite all the hate on social media, these markets have material value. ...even if there are these anomalies like this Gamestop incident. I imagine the SEC is going to shut down that Reddit sub because these types if activities actually destroy liquidity but discouraging short sellers. Regulation plays an important role in keeping markets running smoothly.
imtringued 6y ago
Commodities have to be traded as futures because you cannot move commodities instantaneously. So what you do is you write on a piece of paper (its digital today) that you will provide X amount of commodities for price Y in Z days. You can then sell the contract for the total value of the commodities and when the contract is due you just send the commodity to the holder of the contract.

imtringued 6y ago

The primary value traders provide is liquidity and decreased volatility. There is a fixed need for these two services. Once you have served every customer the only way to make more money is to take customers away from other competitors, or grow the market as a whole. Traders do not influence the size of the market, they only increase efficiency, so the expectation is that you run into diminishing returns stays. There is more than enough liquidity in the markets. Any more liquidity is not providing any value. >Without these trades, the market would lack liquidity, and companies would see an increase in their cost of new capital - which is bad for everyone because it means companies wouldn't invest in growth, equipment purchases, new jobs, etc... The Fed is already taking care of that. The bigger problem is that there is no reason to invest the Fed money and grow the market.

aeternum 6y ago
Increasing efficiency is pretty critical. For the vast majority of markets, there's no such thing as 'serving every customer'. Companies can always serve customers more especially if they can reduce the price. However it takes capital to do this. It's not just about liquidity, investors basically influence the cost of capital for each company which has a big impact on how many customers each company can serve.