Market theory only says that the aggregate effect of market activity is to allocate capital efficiently. The claim is that it does so by broadly rewarding investors whose decisions maximize value creation, encouraging more such decisions in general over the long term.
It does NOT say that any individual investment decision that produces a reward for the investor must necessarily have improved the allocation of capital to maximize value.
Options trading in particular has only indirect market-making effects on how the primary capital allocation market works. The existence of the options market helps the primary market discover efficient allocations (the theory goes). Participating in the options market has a side effect of increasing efficiency, but the way the options market allocates rewards is less connected to the information value that your trades contributed to the market.
There’s an investment product some governments sell called a ‘lottery bond’. People buy the bond, then periodically, rather than every bond being redeemed for a small premium over its value, one randomly selected bond is redeemed for a much higher value.
As a thanks for participating in that bond market and letting the government use your capital, instead of a predictable investment return the government offers a chance of a life changing lottery win.
This isn’t better or worse than a traditional bond offering, it just offers a different strategy for allocating the rewards for investing some capital in that government.
The person who wins a lottery bond didn’t do anything better or different than a lottery bond loser - both of them contributed the same value to the market in terms of increasing capital allocation efficiency. But the rewards were distributed unevenly - which is by design and both of them knew that going in.
Options traders take the same deal. Playing the game has the chance of winning big; participating in the game has a side effect of producing value. And the way the rewards are allocated for playing... don’t matter too much.
> the way the rewards are allocated for playing... don’t matter too much.
Of course they matter. If they didn't matter, then participants wouldn't participate. ...and if they didn't participate then the market would have less liquidity. ...and higher liquidity is ALWAYS a good thing.
The health of a market can be characterized by the persistence of liquidity.
If there are only two traders trading against one another, you are correct.
...but there is an ecosystem of traders intertwined and many of them are primary market participants, so the market does care, because the "gamblers" are providing liquidity to the legitimate participants.
It does NOT say that any individual investment decision that produces a reward for the investor must necessarily have improved the allocation of capital to maximize value.
Options trading in particular has only indirect market-making effects on how the primary capital allocation market works. The existence of the options market helps the primary market discover efficient allocations (the theory goes). Participating in the options market has a side effect of increasing efficiency, but the way the options market allocates rewards is less connected to the information value that your trades contributed to the market.
There’s an investment product some governments sell called a ‘lottery bond’. People buy the bond, then periodically, rather than every bond being redeemed for a small premium over its value, one randomly selected bond is redeemed for a much higher value.
As a thanks for participating in that bond market and letting the government use your capital, instead of a predictable investment return the government offers a chance of a life changing lottery win.
This isn’t better or worse than a traditional bond offering, it just offers a different strategy for allocating the rewards for investing some capital in that government.
The person who wins a lottery bond didn’t do anything better or different than a lottery bond loser - both of them contributed the same value to the market in terms of increasing capital allocation efficiency. But the rewards were distributed unevenly - which is by design and both of them knew that going in.
Options traders take the same deal. Playing the game has the chance of winning big; participating in the game has a side effect of producing value. And the way the rewards are allocated for playing... don’t matter too much.