Asymmetry Is Poison—We Want to Play the Whole Game

Some people assume that all the markets we trade are symmetric, that is, we can buy or sell assets with equal ease and the rules of trading are the same for all market participants.By the classical definition, a free market is a mechanism for the exchange of goods or services between an informed seller and an informed buyer,both operating independently and able to deal without external restraint.

In the practical world, though, this ain’t necessarily so. In fact, it isn’t so at all. While futures markets are almost perfectly symmetric, such is not the case in the stock and bond markets. This asymmetry is due to the rules governing these latter markets, and it constitutes a severe disadvantage for traders.Because the price of anything fluctuates over time, during some portion of the time the prices of any asset or class of assets will be going down.

If we trade assets during a falling market, we can generally profit only by selling an asset and repurchasing it later at a lower price, the tactic uniformly called selling short. If we cannot freely sell assets short when and as we wish in some market, this restriction directly implies that, some considerable portion of the time, we will have difficulty in making a profit trading in a downward moving market.

In stock and bond markets, the plain fact is that we cannot freely sell shares and bonds short as a means of initiating a trade. Selling short in these markets is actively discouraged by brokerages, unfamiliar to many (most?) brokers, restricted in practice by exchange and Federal Reserve rules, situationally impossible in too many cases, and all in all a major pain in the neck for anyone except very large traders.

For the ordinary trader, therefore, for you and me, stock and bond markets are not symmetric. These markets are becoming less asymmetric, slowly, as the popularity of “basket” products like SPDRs, Diamonds, and QQQs, which traders can readily sell short at will, grows over time. Single-stock futures, which debuted in the United States in the last part of 2002, have also reduced asymmetry, all to the good as far as stock market traders are concerned.

Asymmetry still persists, though, and is really very undesirable. We’ve all seen price bubbles, most recently in several different groups of U.S. stocks from 1995 through about March 2000, when we watched the prices of numerous stocks bid to astonishing levels. Such market action is, of course,wonderful when we own shares (provided we took our profit at some point),but when the bubble ends, if we cannot even attempt, in many cases, to profit during the long-lasting deflation of the bubble, we’ve little alternative but to step away from the market.

Regardless of whether now or any other time is or is not propitious for selling stocks or bonds short, the asymmetric structure of these markets is costly for us in terms of profit opportunities we must forego. The symmetry of futures markets, wherein we can sell short virtually whenever this tactic appears to be desirable, is a distinct plus factor for traders.Your Tax Dollars at Work—Governmental Event Risk In which broad market is event risk the highest? We’ve yet to consider the role of government regarding this question.

Which broad market can government tamper with most easily, and which does it they screw up most frequently?All the broad markets are distorted at times by arbitrary government action. We can take comfort only in that it is a little difficult for government 38 TRADING OPTIONS TO WIN to mess up the stock markets, because it must do so indirectly, at least in the United States. In stock markets, why look further for an example of political interference than the so-called antitrust prosecution of Microsoft Corporation?

I’m not particularly a fan of Microsoft products, and I’ve never owned a single share of MSFT, but I’m not bloody blind, either. “Trusts” or “monopolies” or whatever today’s fashionable misnomer may be, are in theory supposed to be engaging in practices that damage those who buy their products, the customer, the public. Well, I’ve designed computer systems for almost three decades, and I punch the keyboard in this pursuit for some hours every day.

All I can tell you from experience is that Microsoft, whether I prefer their products or not, has done nothing but decrease my costs and increase my little company’s productivity. If that’s “damage,” call me Oliver Twist. May I please have some more, sir? My preferences are irrelevant.

What is relevant is that it is indisputable that the government’s politically bought-and-paid-for prosecution of Microsoft immediately and adversely affected every participant in the stock markets, especially those who owned technology shares. If this were a solitary incident, we might shrug it off as hard luck. Of course it wasn’t, and we both know it.