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After reading this, it seems like way too much complexity exists in the market. Me and my naive thoughts of "it's just simple buying and selling, right?" How l

After reading this, it seems like way too much complexity exists in the market. Me and my naive thoughts of "it's just simple buying and selling, right?" How long has it been like this?

lmm 14y ago
Since the mid 17th century. It's still perfectly possible to be a fundamentals trader/value investor and make a decent income. Look for undervalued companies or those everyone is selling, buy their stocks, hold them for the long term and be prepared for a bit of up and down. But there people who want to buy and sell these complex derivative contracts (well actually an option is pretty much the simplest derivative contract there is), and so the market will join them up with each other.
jwegan 14y ago
Futures and option contracts have been around for hundreds of years and there is some evidence that ancient societies also had similar financial instruments.
wutbrodo 14y ago
To be fair, options/futures are pretty simple and have uses that most people would count as legitimate. A farmer buying oil futures to mitigate the cost of a potential spike in fuel prices (and thus his costs) is basically just him buying insurance; trying to smooth out any crazy volatility his business may face is a fairly legitimate and straightforward application of finance. This is, of course, in contrast to a lot of financial instruments (particularly in the last couple of decades) that are needlessly complex (where at least some of the value for the issuer is in obfuscating the actual implications of the security from the buyer).
cschneid 14y ago
Options are really cool since they are so well named. They really do give you a ton of options to adjust your risk to exactly what you want. On one hand, you can have infinite risk strategies, on the other, you can lock in a stock price almost exactly, with little market risk. And then everything in between (ie, you can easily build something that's like: "I think this stock will go up a few bucks, but nothing crazy", or maybe: "I'm worried about a horrible plunge, but a minor decline is fine, I'll buy a put out of the money and have coverage for the plunge".) And really, it's fairly simple, a lot of the stuff I said about "time value" and such was related to how you value options, not the actual complexity of the thing itself. "How much is this worth" is always tricky, even for something as easy to understand as a bond. Organized markets, and bubbles, and derivatives are all old. And they aren't inherently bad either. You have to look at futures & options as a way to sell or buy risk. If you're willing to pay somebody, they'll take your risk away. And the other way, if you want to take on some risk in exchange for money, you can do that. (note, that last thing sounds scary, but how about this: sell a put [ie, promise to buy a stock at a certain price] right near where you want to buy the stock anyway [with a traditional limit order]. If it gets to below that level, you get 'assigned' the stock, which you wanted anyway, at the price you wanted anyway. If it doesn't hit that, then you wouldn't have bought the stock anyway. The counterparty gets insurance against their stock dropping. You take on the "risk" of it dropping, but you've set yourself up so that it works out for everybody involved). (note that last strategy doesn't work if the stock temporarily dips, then pops back up. You probably won't get assigned in that situation, where a limit order would have triggered. That risk is what you get in exchange for getting paid for selling the put).

After reading this, it seems like way too much complexity exists in the market. Me and my naive thoughts of "it's just simple buying and selling, right?" How long has it been like this?

lmm 14y ago

Since the mid 17th century. It's still perfectly possible to be a fundamentals trader/value investor and make a decent income. Look for undervalued companies or those everyone is selling, buy their stocks, hold them for the long term and be prepared for a bit of up and down. But there people who want to buy and sell these complex derivative contracts (well actually an option is pretty much the simplest derivative contract there is), and so the market will join them up with each other.

jwegan 14y ago

Futures and option contracts have been around for hundreds of years and there is some evidence that ancient societies also had similar financial instruments.

wutbrodo 14y ago

To be fair, options/futures are pretty simple and have uses that most people would count as legitimate. A farmer buying oil futures to mitigate the cost of a potential spike in fuel prices (and thus his costs) is basically just him buying insurance; trying to smooth out any crazy volatility his business may face is a fairly legitimate and straightforward application of finance. This is, of course, in contrast to a lot of financial instruments (particularly in the last couple of decades) that are needlessly complex (where at least some of the value for the issuer is in obfuscating the actual implications of the security from the buyer).

cschneid 14y ago

Options are really cool since they are so well named. They really do give you a ton of options to adjust your risk to exactly what you want. On one hand, you can have infinite risk strategies, on the other, you can lock in a stock price almost exactly, with little market risk. And then everything in between (ie, you can easily build something that's like: "I think this stock will go up a few bucks, but nothing crazy", or maybe: "I'm worried about a horrible plunge, but a minor decline is fine, I'll buy a put out of the money and have coverage for the plunge".) And really, it's fairly simple, a lot of the stuff I said about "time value" and such was related to how you value options, not the actual complexity of the thing itself. "How much is this worth" is always tricky, even for something as easy to understand as a bond. Organized markets, and bubbles, and derivatives are all old. And they aren't inherently bad either. You have to look at futures & options as a way to sell or buy risk. If you're willing to pay somebody, they'll take your risk away. And the other way, if you want to take on some risk in exchange for money, you can do that. (note, that last thing sounds scary, but how about this: sell a put [ie, promise to buy a stock at a certain price] right near where you want to buy the stock anyway [with a traditional limit order]. If it gets to below that level, you get 'assigned' the stock, which you wanted anyway, at the price you wanted anyway. If it doesn't hit that, then you wouldn't have bought the stock anyway. The counterparty gets insurance against their stock dropping. You take on the "risk" of it dropping, but you've set yourself up so that it works out for everybody involved). (note that last strategy doesn't work if the stock temporarily dips, then pops back up. You probably won't get assigned in that situation, where a limit order would have triggered. That risk is what you get in exchange for getting paid for selling the put).