Jane Street barred from Indian markets as regulator freezes $566M

Anyone have any recommendations for books/papers/articles (math heavy is fine) that give a good steel man argument for why options and derivatives are beneficial?

I can wrap my head around why/how options for physical commodities give price stability for sellers and buyers. But at first glance I struggle to see how derivatives are beneficial in the equity markets. The argument is that derivatives increase market efficiency (more accurate pricing) over what just a simple buy/sell market would give you right? But how valuable is this increased efficiency? Obviously is super valuable to the people who work in finance, but how valuable is it outside of that context?

Puts let you hedge long positions, calls let you hedge short positions. Without that you'd have to liquidate much sooner so there would be more volatility.

More abstractly derivatives let traders in one asset pay premia to offload risk to other traders who are more able to absorb it. This way everyone has what they want and the market functions more efficiently. It's very similar to insurance (and you can actually model insurance like a portfolio of long/short put+call options with a probabilistic (event dependent) multiplier.)

They allow for more flexible risk management (ie hedging), especially when dealing with margins or not very liquid tickers because they give you exposure to 100 units (%δ * 100) without requiring you to buy or sell them.

If you own stock, you can sell calls against it — especially if premium is high to hedge against drops. If you are short stock, you can buy calls to hedge against short term movement.

I personally don’t think they improve price discovery because market microstructure through options and mm exposure affect pricing.

As a start, separate "derivatives" (a huge category of products) into two simpler categories: listed options and futures. For many underlyings, like interest rates or commodities, it is very difficult to trade the underlying directly, so you use derivs to trade them indirectly.

Related: My biggest concern: There should be more gatekeeping around allowing retail traders access to derivs markets due to the implied leverage in the contracts. That said I don't know a good way to gatekeep. How about an exam?

>Related: My biggest concern: There should be more gatekeeping around allowing retail traders access to derivs markets due to the implied leverage in the contracts. That said I don't know a good way to gatekeep. How about an exam?

In the US, investors need approval to trade options. https://www.investor.gov/introduction-investing/general-reso...

The idea that always felt at least tentatively compelling to me is that options prices themselves allow a way for people to express their sentiments about whether a security is under-priced or over-priced — while putting money on the line to do so.

I have gotten approval in a few different jurisdictions for retail derivs trading. The barrier to entry is pathetically low in all cases. Literally: Tick a box to agree if you accept risk and are "qualified".

Under-priced? Buy the stock. Over-priced? Long or short sell the stock. In your case, why do you need options? All are much lower risk than retail folks using options.

In equities for example, an option at a given strike let's you pay a little for insurance i.e. that you will have X amount of cash if SPX is at Y and so on.

This is very important for pension funds and so on because they have fixed liabilities like outflows.

All these things are is a way of moving risk around. Some people want risk, some people want to hedge — it's just as true for wheat as it is for bonds.

It's not so much price as risk.

Shorting the stock is much higher risk than using options. With options you can cap your liability at particular levels, whereas with traditional shorting your potential losses are theoretically infinite.

It’s all about being able to control the risk/reward profile of a trade. Options can be deployed cautiously or recklessly.

Shorting a stock is risky, buying puts has more constrained risk.

Honestly I bet it still helps.

IBKR makes you pass a quiz before you can trade derivatives

My broker presents a form with questions that I need to get right before they allow me to dabble in the leveraged and tricky instruments. Don't remember how many exactly, it's a combination of questions like 'can you lose all your invested money' and technical ones that reflect the type of instrument.

I assume it's a compliance requirement, they get a record of me having said the right things at one time and don't really know if I got someone else to tell me what to answer. Still, I think it's actually keeping some people out, judging from some forum threads where they try to get help to pass and seemingly fail even though others are telling them basically what to respond with.

Yes, this is the intuitive way to think about it.

It is wrong.

The insight that it’s wrong lead to an Economics Nobel price for the Black Scholes model for pricing options.

It's helpful to remember the history of how they got here. Commodity producers (farms, oil) need to make investments before production, but want to reduce their exposure to changes in the spot price in the future. Hence futures: the ability to sell oil or onions six months in the future at an agreed price, rather than wait until the day to find out spot. This is genuinely valuable to them in terms of shifting risk to the finance industry in return for a price. It's like insurance.

Options are then futures where you don't necessarily have to close out the position. They are a means of insuring against price changes .. or to get paid for providing such insurance.

However, in things like farming and oil exploration much of the risk is real and physical. The further away you get from that to derivatives of other financial instruments, the more it becomes just a mix of what the other market players are doing.

Then there's "we priced these risks as de-correlated but actually they're correlated", which blew up a lot of people in 2008.

Helpful comment, but it's also mildly amusing you picked one of the few agricultural underlyings you can't trade futures on (Onion Futures Act). Not sure if that was intentional or not!

It was - and illustrates the point that these markets are fine until someone tries to corner them..