August/September 2021

life. money. probability.

THINKING

BETS

AUGUST/SEPTEMBER 2021

PLUS

YOUR GUIDE TO SMARTER DECISIONS ANNIE DUKE EXPLAINS RISK THE KELLY CRITERION: BETTOR BET-SIZING IS GAMBLING MEDIA THE NEXT HOT SECTOR? WHY BOOZE & BETTING DON’T MIX

IN

the control freak's guide to life, money & probability

Higher, faster, further.

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August/September 2021

THINKING IN BETS 12

14 Luckbox Leans in with Annie Duke

The author, scholar and gambler dishes on trading, bet-sizing, prospect theory, outcome bias and the fine art of quitting.

19 Two States of Gambling

New Jersey surpassed Nevada’s online sports betting handle every month so far this year—but what does that mean for the future?

20 Game Theories

Two experts on the power of poker explain how the game prepares players for the world of finance.

22 The Kelly Criterion

Two keys unlock success in professional gambling, trading and investing: identifying opportunities, and the hard part, sizing the wager.

26 The Short Side of Kelly

The mathematical simplicity of the best-known bet-sizing formula obscures real dangers in its application. Besides, sometimes it’s fun to go for broke, a contrarian maintains.

28 Gambling Media: Bet On This Growth Sector Companies that take bets on sporting events are cementing alliances with like-minded media outlets. Investors should take notice.

33 Market Intelligence

IMAGE CREDIT TK

Bloomberg’s Larry Tabb assesses the recent surge in retail investing activity, speculative trading and financial literacy, while noting the one thing every trader should know about the markets.

ILLUSTRATION BY SATOSHI KAMBAYASHI

August/September 2021 | Luckbox

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editor in chief ed mckinley managing editor yesenia duran associate editors mike reddy kendall polidori editor at large garrett baldwin technical editor mike rechenthin contributing editors vonetta logan, tom preston creative directors katherine bryja tim hussey In the last five years, bitcoin’s value has gone up from $400 to $30,000. p. 54

trends

trades

life, luxury & the pursuit of happiness

actionable trading ideas

LIQUID ASSETS

35 Imbibing and Bet-Sizing

BOOK VALUE

37 The Luckbox Bookshelf

NORMAL DEVIATE

38 Trading with a Casino’s Edge

THE POKER TRADE

40 Bet Sizing & Implied Odds TRADERS

42 Meet Chris

Vecchio;

Kayla & Errol

THE PREDICTION TRADE 44 What Gamblers Can Learn From Superforecasters CALENDAR

45 Vinyl & SALT

CHERRY PICKS

51 Naked Puts for the Risk-Averse FOREX

52 Yen Trends as Fed Eyes Rate Hikes CRYPTO

54 Bitcoin Bets & Game Theory

DO DILIGENCE 56 Lucky Gambling Stocks

THE TECHNICIAN 58 Cryptocurrencies: Gambling or Investing?

FUTURES 62 Lighting up Cannabis Futures

tactics

contributor’s guidelines, press releases & editorial inquiries editor@luckboxmagazine.com

CHEAT SHEET

IN SERT The Trading

advertising inquiries advertise@luckboxmagazine.com

Game

subscriptions & service support@luckboxmagazine.com

INTERMEDIATE

47 Betting on

the Fed

media & business inquiries publisher: jeff joseph jj@luckboxmagazine.com

ADVANCED

49 Three Ways to Play Long Odds

Luckbox magazine, a tastytrade publication, is published at 19 N. Sangamon, Chicago, IL 60607

FAKE FINANCIAL NEWS

08 Gambling to a 1,925% Return

editorial director jeff joseph comments, tips & story ideas feedback@luckboxmagazine.com

essential trading strategies

contributing photographer garrett roodbergen

Editorial offices: 312.761.4218 ISSN: 2689-5692 Printed at Lane Press in Vermont

THE LAST PICTURE

luckboxmagazine.com

64 Big Bets & Bad Beats

Luckbox magazine

On the cover: Illustration by Satoshi Kambayashi

@luckboxmag 2019 & 2020 Best New Magazine Folio Award for Custom Content

Luckbox magazine content is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities and futures can involve high risk and the loss of any funds invested. luckbox magazine, a brand of tastytrade, Inc., does not provide investment or financial advice or make investment recommendations through its content, financial programming or otherwise. The information provided in luckbox magazine may not be appropriate for all individuals, and is provided without respect to any individual’s financial sophistication, financial situation, investing time horizon or risk tolerance. luckbox magazine and tastytrade are not in the business of executing securities or futures transactions, nor do they direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. luckbox magazine and tastytrade are not licensed financial advisers, registered investment advisers, or registered broker-dealers. Options, futures and futures options are not suitable for all investors. Transaction costs (commissions and other fees) are important factors and should be considered when evaluating any securities or futures transaction or trade. For simplicity, the examples and illustrations in these articles may not include transaction costs. Nothing contained in this magazine constitutes a solicitation, recommendation, endorsement, promotion or offer by tastytrade, or any of its subsidiaries, affiliates or assigns. While luckbox magazine and tastytrade believe that the information contained in luckbox magazine is reliable and make efforts to assure its accuracy, the publisher disclaims responsibility for opinions and representation of facts contained herein. Active investing is not easy, so be careful out there!

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Luckbox | August/September 2021

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THE ISSUE WITH GAMBLING I’ve been to the table, and I’ve lost it all before I’m willin’ and able, always comin’ back for more ...

If I’m bettin’ on a loser, I’m gonna have a devil to pay But it’s the only game I know to play, it doesn’t matter anyway —A Good Run of Bad Luck, Clint Black (1993)

Luckbox is devoting this issue to gambling, even though the magazine’s annual survey recently indicated that nearly 43% of readers hadn’t placed a bet in the last 12 months.

It’s not that they’re tight-fisted or inactive—71% indicated they trade the financial markets at least once a week.

But in the last year, nearly half hadn’t stepped inside a casino, pulled a chair up to a poker table, dabbled in the online prediction markets or gone online to play a game for money. They hadn’t even bought a ticket to a lottery or a raffle.

Yet, that didn’t stop Luckbox from producing a gambling-oriented issue. In fact, this edition is graced with a five-page report on sports betting—even though the survey found that 84% of the readership hadn’t wagered a penny on sports in the last year.

So what’s going on here?

Well, it so happens that the cognitive tactics,

discipline and bet-sizing techniques that can turn an amateur gambler into a pro can also transform a neophyte trader into a market wizard. Many examples of what optimized strategies for gambling and investing have in common come from the game of poker.

Traders and poker players have to make rapid repeated decisions based on incomplete information. That’s why members of both groups should learn to recognize and act upon probability instead of emotion.

Whether they’re playing cards or playing the market, anyone hoping to succeed should review the quality of his or her decision-making processes when faced with a variety of potential outcomes. They should realize that good choices can have bad results because of randomness and luck. And they can truly learn all of this by thinking in bets.

Poker and investing intertwine for many of the authors, academicians, gamblers and

Thinking Inside the Luckbox

Luckbox is dedicated to helping active investors achieve skill-derived, outlier results.

1 Probability is the key to improving outcomes in the markets and in life.

4

2 Greater market volatility brings greater opportunity for traders and investors.

3 Options are the best vehicle to manage risk and exploit market volatility.

4 Don’t rely on chance. Know your options because luck smiles upon the prepared.

investors who contributed their thoughts to this issue of Luckbox. Some began as gamblers and turned into investors. Others took the opposite path.

However they arrived at their destinations, hyphenated gambler-investors advocate playing poker as a foundation for making better decisions with money and in life in general.

Some of the contributors write books about intermingling the two pursuits, while others go so far as to teach young women to play poker as preparation for college and the world of business.

So, this Issue with Gambling serves as another lens Luckbox can use to view the preoccupations of probability, bet-sizing and luck in financial, professional and personal pursuits.

Ed McKinley Editor in Chief

Two ways to send comments, criticism and suggestions to Luckbox Email feedback@luckboxmagazine.com Visit luckboxmagazine.com/survey A new survey every issue.

Luckbox | August/September 2021

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Luckbox Readers are

Accomplished Say their financial literacy is above average ������������������� 55% Are owners, partners or executives at their firm ������������� 27%

Engaged ...

Trade at least once a day ����������������������������������������������������� 39% Trade at least once a week ��������������������������������������������������� 70% Consider themselves very active investors ��������������������� 33% Use tastytrade as a financial resource ����������������������������� 65% Trade cryptocurrencies ������������������������������������������������������� 38% Trade futures ������������������������������������������������������������������������� 36%

Your thoughts on this issue? Take the reader poll at luckboxmagazine.com/survey

… and looking to Luckbox for more coverage on ...

Specific trade ideas ��������������������������������������������������������������� 62% Prediction and forecasting markets ��������������������������������� 48% Financial scams ��������������������������������������������������������������������� 46% —Luckbox Annual Reader Survey

Amazon: Which side are you on?

It’s a hard call. Amazon is engaging in predatory trade practices but provides some real consumer benefits. I am inclined to agree with those who favor antitrust action. I just don’t trust Congress to be intelligent enough to consider the law of unintended consequences when they address it. Anyway, too many members are owned by large tech companies for that to happen.

—Richard McConnell, Arlington, TX

I love the convenience of Amazon but definitely find myself at a moral crossroads in terms of its predation on small businesses. However, it has inarguably delivered value to the consumer and efficiency to the American economy, making our economy and country stronger.

—Travis McBride, Jax, FL

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There’s more to Luckbox than meets the page.

Look for this QR code icon for videos, websites, extended stories and other additional digital content. QR codes work with all cell phones and tablets with cameras.

Open Outcry

Unregulated markets result in disaster. Libertarians like to pretend the invisible hand solves everything, but there are numerous examples where that isn’t true. Capitalism does not account for negative externalities, such as pollution and wealth inequality.

There is a healthy balance of regulation that allows capitalism to flourish and supports the middle class. Enforce the laws, protect the middle class or let unchecked capitalism run amok and destroy the backbone of our economy.

—Trevor Davis, IL

Take our reader survey!

Educated Bachelor’s Degree ����������������������������������������������������������������� 42% Graduate and/or post-graduate degree ������������������������ 40%

SCAN THIS

1 Open your camera

2

Amazon is a net negative for consumers but inevitable.

It has too much market share, squeezes out smaller sellers, uses dubious employment and compensation practices, and has serious quality-control problems with counterfeit and cheaply made items that are not being addressed. However, there is no doubt that they are the easiest retailer for a consumer to use and are the leading innovator in internet sales. We just need to make sure they don’t become the ONLY option in the future, as the negatives will only grow.

—Ryan Standefer, Prairie Village, KS Amazon has helped this country tremendously. It’s a shame that the editors of Luckbox feel inclined to assume that it owes others for its success. Too bad Luckbox does not get what the object of free markets is.

—Eric W Simpson, McLean, VA

Hover over the QR code

3 Click on the link that pops up

4 Enjoy the additional content

7/21/21 10:31 AM

SHORT INTEREST

THINKING IN BETS

“Hedge funds always blow up for the same reason— they traded too big.

Trade small.

Trade often.”

“I believe in bitcoin. I’m not too caught up in the value of the coin, because I’ve been around long enough to see things go up and go down, and I know it’s here to stay. The future is unfolding right before “Despite the popular wisdom us. I don’t see it as a that we achieve success pandemic fad. The through positive visualization, it turns out that incorporating pandemic just puts negative visualization makes us more likely gas on the fire.” to achieve our goals.”

SEE PAGE 54

— Tom Sosnoff, options trader and tastytrade co-CEO

SEE PAGE 22

SEE PAGE 14

— Snoop Dogg on crypto, April, 2021

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— Annie Duke, Thinking in Bets

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“Under the influence of alcohol, people choose the option less certain but more SEE PAGE 35 attractive when it comes to potential outcomes.”

— Frontiers in Psychology, Jan. 15, 2015

“BETTER COLLECTIVE ACQUIRES ACTION NETWORK FOR $240M” — SportsHandle, May 5, 2021

“DRAFTKINGS BUYS VSIN SPORTS BETTING VIDEO BROADCAST COMPANY” — SportsPro Media, March 31, 2021

“We forecast a $15 billion market for sports betting and internet gambling by 2025, an increase of 27% over current levels.

As much as $10 billion of that is likely to come from sports betting.”

—Morgan Stanley

$30 billion by 2030 —Macquarie Research

SEE PAGE 28

“For reasons mathematical, psychological and sociological, it is a good idea to use a money management system that is relatively forgiving of estimation errors.”

— William Poundstone, Fortune’s Formula (2005)

August/September 2021 | Luckbox

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FAKE FINANCIAL NEWS

A first-time gambler hits the road for one week of mobile wagering and a +37% return—annualized to 1,925% for this clickbait headline

By Vonetta Logan

What if this is a gateway to becoming my own Lifetime movie: Never Bet the Under: The Vonetta Logan Story.

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W

PHOTOGRAPHY: VONETTA LOGAN

Gambling to a 1,925% Return

orking for a group of traders is sometimes like starring in your own version of a musical. Not that traders break out in choreographed dance moves or sing songs of yearning, but mostly because a lot of time is devoted to trying to get the “square” character to take a chance on risky things like gambling, gin or (gasp) jazz.

I’m reminded of the iconic 1955 movie Guys and Dolls, where a dapper Frank Sinatra as Nathan Detroit tries to convince an uptight missionary from the Salvation Army to loosen up and fly to Havana.

In fact, the only thing I actually know about gambling is in the Guys and Dolls opening number, Fugue for Tinhorns, where three guys sing about their horse race picks.

“I got the horse right here, his name is Paul Revere, and the guy says if the weather’s clear, can do, can do...”

I had never gambled in my life. Wait, does eating gas station sushi count? I’d never bought a lottery ticket, never put $50 on black (always bet on black), or even put down $20 on the pass line, whatever that is.

I don’t have a moral objection to gambling.

You do you. I am just the cheapest person I know. If I have $20 in my hot little hands, I’m not going to gamble it away on something with 50/50 or worse odds. I can tell you down to the spring roll how much food $20 will buy at Panda Express.

So, does this story end up with some me and some dapper fellow gazing longingly at each other while drinking caipirinhas?

Nope. But it does have gambling, quasi-legal fireworks, a lot of hot dogs and a somewhat accurate clickbait headline.

So when my editor called and told me my assignment was to spend the next week as a degenerate gambler, I had concerns. What if I hate it? Oh, man, what if I like it? What if this is a gateway to becoming my own Lifetime movie, Never Bet the Under: The Vonetta Logan Story. But I downloaded the DraftKings app and linked my bank account.

Luckbox funded my account with $200, and now all I had to do was place some bets.

I reached out to two of my coworkers who are degenerate gamblers and asked them for advice. Mike Butler, host of Options Trading Concepts Live on the tastytrade network, said this: “Bet small so you can do it sustainably, and if your strategy is sound you have a good chance of eventually hitting, which will wipe

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PHOTOGRAPH: JASON GETZ/USA TODAY SPORTS/REUTERS

away tons of losing days. DFS (daily fantasy sports) is very much like buying long calls on the money in investing—many of them miss, but when you hit you can make 1,000 times your investment or more.”

Nick Battista, who’s also on OTCL, chimed in with this: “Life’s too short to bet the under.

With multi bets, all you do is pay the juice, i.e., if you are going to take the moneyline favorite and the over, you should parlay them for one unit rather than betting them separately for one unit each.”

Was this even in English? Ugh, I could feel myself craving Kung Pao chicken and wanting to be done with this already.

Helpfully, DraftKings has an FAQ section with a bullet point called “How to bet.” So my new online gambling persona, Vonnie the Newb, had to decide whether to bet on Sportsbook or Daily Fantasy, which is what Mike was trying to explain about winning daily fantasy pools.

OK, I chose Sportsbook. I learned that a moneyline bet is just a straight-up bet on who I think is going to win the game.

I also had the option of betting over or under on total points or I could just bet the spread. These three options were consistent for baseball, basketball and hockey. So I crossed my fingers and tried to place a moneyline bet on the Milwaukee Bucks to beat the Atlanta Hawks in the playoffs.

But my bet was denied! It’s totally legal to use online gambling sites in the state of Illinois, but a rule change in April 2021 meant that all bettors must register in person at the Casino Queen in beautiful East St. Louis, Illinois. During the pandemic, online registration was allowed, but Gov. J.B. Pritzker didn’t extend those permissions. The Casino Queen is 300 miles from my house.

I called my editor, and he told me to bring back some BBQ for him. (Um, thanks, Jeff).

So, I started Googling. Turns out, as long as your phone is pinging in the state of Indiana you can place bets there even if you’re not a resident. The Indiana state line is 20 minutes from my house, and that’s better than 300 miles. This is pretty common in states that are near urban areas

Here’s Khris Middleton setting up a shot. I don’t follow sports, but I bet on the Bucks to beat the Hawks. It’s only money.

with a patchwork of gambling laws. A recent survey found “at least 25% of the bets placed in New Jersey are from people driving over from New York.”

So, I grabbed my keys, jumped into the car and headed south on Lake Shore Drive to cross into Indiana. Northwest Indiana is a sinful melange of drive-thru cigarette depots, year-round fireworks stores, bulk liquor shops and casino “boats” in the loosest interpretation of what constitutes a boat. I settled on the Walmart parking lot in Hammond, Indiana, in the shadow of the Horseshoe Casino. Could I bet without actually setting foot in a smoke-filled casino?

This time when I opened the app and placed my bet on the Bucks it went through.

Because I was a new bettor, DraftKings kept throwing me what they call “Odds Boosts,” and all I had to do was opt-in. For this experiment, all of my bets were $20. I was employing my own “bet small, bet often” strategy. I should also mention that I don’t follow sports all that closely. I enjoy football and watch that the most, but baseball I reserve for watching in-person. I never got

I couldn’t tell you the difference between a sweeper and winger, but I made money betting on soccer.

into basketball that much. And hockey?

Well, I’m Black, so there’s that.

That’s why my initial strategy was just straight-up guessing. I took the Bucks because I got the “odds boost” raising the line from -375 to +100, which put me at 1/1 fractional odds. My $20 bet (which was correct) turned into $40.

And that’s how it went for the next five days. Then one blessedly sunshiny Sunday I hopped on my motorcycle and rode to Indiana to gamble, buy some fireworks and get some cheap smokes. I mixed up my bets among moneyline, over/under and the spread. I even tried Nick’s advice to do a parlay bet and got a parlay “odds boost” from DraftKings.

My Hawks/Clippers parlay didn’t work, but I was having fun trying to figure things out. I even tried out the DraftKings live in-game betting feature. So, in the middle of a baseball game, you can try to get a feel for how the rest of the game is going to play out. I bet a mid-game under of 6.5 runs in an Oakland versus Giants game. Who am I? That pick lost, but hey, I’m still learning.

The next day I tried to do some research before I placed my bets, so I checked out some sportsbook sites. One guy wrote that the Yankees had a hard time hitting off the Angels pitcher because he was left-handed.

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the limits of his gastrointestinal system!

So, after starting with $200 I ended my week of gambling with $274.83, a rate of return of 37%. Honestly, driving all over creation just to gamble made me want to trade more options. Yes, it was fun, and it did make me watch way more sports than I normally would. Can Trae Young not hit a free throw?

But there are a lot of similarities. As trading legend and tastytrade co-CEO Tom Sosnoff preaches, “Once you reach a certain level, it doesn’t matter what the product is.

You’ve flipped the switch and moved from the passive world to the active world.”

He’s right. I may not know what the heck a GeForce RTX 30 is, but it’s fun to trade Nvidia. And I couldn’t tell you the difference between a sweeper and winger, but I made money betting on soccer—which throws the whole stodgy era of finance and “trade what you know” out the window.

So is this the dawn of the Vonnie the Newb

Joey Chestnut recently won the Nathan’s Famous Hot Dog Eating Contest. You can bet on events like that.

era? No. I’m cashing out my DraftKings winnings and I’m headed to Panda.

Vonetta Logan, a writer and comedian, appears daily on the tastytrade network and hosts the Connect the Dots podcast. @vonettalogan

PHOTOGRAPH: KYODO VIA REUTERS CONNECT

I thought the poor guy must have a hard time finding scissors. Anyway, this “analyst” didn’t think the over of 10 runs was in danger, so I took the under.

The two teams scored a combined 16 runs that game. Analyst, my butt! So I went back to just randomly picking, and I started winning! I bet on Switzerland to go through in the Euro finals, the Hawks to cover the spread at -6.5, and Tampa Bay to beat the Canadiens.

On the third of July, I got an alert from DraftKings about the Nathan’s Hot Dog Eating Contest. So far, the most exotic thing I had bet on was soccer, but I had no idea you could bet on Major League Eating! I optedin and took Joey Chestnut to eat more than 75 hot dogs. The over/under line in Vegas was 73.5, so DraftKings was kind of screwing me on the spread. (That’s a sentence I never thought I would type). But, hey, never fade a superstar. Chestnut at +125 means I won $45 on my $20 bet—all because a man stretched

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*When you open and fund your new account with $200.

TASTYWORKS, INC. IS A MEMBER OF NFA AND IS SUBJECT TO NFA'S REGULATORY OVERSIGHT AND EXAMINATIONS. HOWEVER, YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY OVER UNDERLYING OR SPOT VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS. Promotional cryptocurrency will be provided by Zero Hash Liquidity Services LLC, MSB # 31000181510564, and/or Zero Hash LLC, NMLS # 169937, and deposited into a cryptocurrency wallet provided by Zero Hash LLC. Cryptocurrency trading and this promotional offer are not yet available for customers who reside in New York and Hawaii.

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POKER CAN MAKE PLAYERS BETTER ACTIVE INVESTORS. AN ARRAY OF EXPERTS INTERVIEWED FOR THIS SPECIAL SECTION ON THINKING IN BETS SAY THEY APPLY THE GAME’S DISCIPLINE, STRATEGIES AND MINDSETS TO THEIR MARKET RESEARCH AND INVESTMENT DECISIONS. THEY’VE ACHIEVED SO MUCH SUCCESS THAT GAMBLING-RELATED, BET-SIZING SKILLS HAVE BECOME HIGHLY VALUED IN THE FINANCIAL COMMUNITY. WALL STREET HAS EVEN MADE A PRACTICE OF HIRING CARD SHARKS AS HEDGE FUND MANAGERS.

THINKING IN BETS BUT SUCCESSFUL GAMBLING AND PROFITABLE INVESTING AREN’T JUST A MATTER OF DEVELOPING LOGICAL THOUGHT PROCESSES. OFTEN, THE THINKING THAT IMPROVES OUTCOMES REQUIRES SOME MATH, TOO. THAT’S WHERE THE KELLY CRITERION COMES IN. IT’S A FORMULA THAT CALCULATES THE BIGGEST LONG-TERM RETURN BY BETTING OR INVESTING EXACTLY THE RIGHT PORTION OF A BANKROLL. SOME INVESTMENT BILLIONAIRES SWEAR BY THE CRITERION, BUT SKEPTICS MAINTAIN THAT THE FORMULA CAN FALL PREY TO SUBJECTIVITY. MEANWHILE, CONTRARIANS CAN SIMPLY FIND THE CRITERION TOO RESTRICTIVE—SOMETIMES IT’S MORE FUN TO PLACE A BIG BET THAN A PRUDENT ONE.

14 / THINKING IN BETS WITH ANNIE DUKE 19 / TWO STATES OF GAMBLING 20 / GAME THEORIES 22 / BET-SIZING WITH THE KELLY CRITERION 26 / THE SHORT SIDE OF KELLY 28 / BET ON THE GAMBLING MEDIA SECTOR

BESIDES EXPLORING KELLY AND ITS DISCONTENTS IN THIS SECTION, LUCKBOX WEIGHS IN ON NEW JERSEY’S BID TO OVERTAKE NEVADA AS A GAMBLING MECCA AND WHAT THAT CAN MEAN FOR THE FUTURE OF WAGERING. LAST BUT NOT LEAST, THIS SECTION BEARS WITNESS TO THE EMERGENCE OF A NEW INVESTMENT SECTOR: GAMBLING-FOCUSED MEDIA. IT’S AN OPPORTUNITY OF THE MAGNITUDE THAT INVESTORS HAVE EXPERIENCED LATELY WITH LEGALIZED CANNABIS.

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ILLUSTRATION BY SATOSHI KAMBAYASHI

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ANNIE L U C K B O X

A: B E T S

People have used that word “pivot” in relation to me quite a bit. I’m going to use the word “quit.”

I quit things all the time. “Pivot” is a euphemism because we think that quitting is negative. Quitting is a very necessary part of poker. People talk about aggression as being a defining difference between great poker players and average ones. But the big defining difference is actually quitting behavior.

T H I N K I N G

I N

Do professional poker players quit more often than amateurs?

Amateur poker players play over 50% of the two-card (hole) combinations they’re dealt, while great players play between 15% and 25%. So what that means is that the pros are quitting a lot more early and a lot more often. I’m very happy to say that I’ve quit many things in my life.

Some people must be better than others at quitting.

One of the principles of being a great quitter is to understand that you always want to be exploring, not just exploiting. This is “exploit” in the game theory way, or the “algorithms to live by” way. It means you’ve got a good thing going and so you do it. But it’s really important to have other lines of inquiry open during your life. So what looks like a lot of quitting behavior is actually elevating certain things that I was exploring and deprivileging things that I had been exploiting. I’m moving between threads that I always have open.

Do you lose something when you quit?

The good news is you can go back to things that you quit, which is nice. I started off as an academic, which is where I’ve now ended up again.

And you were playing poker in the interim?

I did five years of Ph.D. work at Penn. And during the last couple of years there I played a little bit of poker that was exploratory. I was playing it with my brother,

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I N

W I T H

DUKE ON TRADING, BET-SIZING, PROSPECT THEORY, OUTCOME BIAS AND QUITTING

BY ED MCKINLEY

Howard Lederer, who was a world champion in his own right. It was kind of fun. He would take me out on vacations, and I would sometimes sit behind him or play a little bit myself.

Then at the end of graduate school I got sick, which forced me to take time off. During that year, I started playing poker and just really, really loved it. So I left academics.

The public identifies you with poker.

The amount of time that I was exclusively playing poker was actually only eight years. It’s not something people know because my public-facing self was as a poker player.

How did you move on from poker to become an educator and consultant on cognitive behavior and risk-taking?

In 2002, I was asked by a hedge fund to speak to their options traders about how poker might inform their thinking about risk. What I had been studying in graduate school was learning under conditions of uncertainty.

So, I didn’t talk about risk management in terms of the Kelly criterion (see p. 22) or anything like that.

I talked about the way that the path you’re on with losses and gains can distort your risk attitudes.

This conversation was edited lightly for style and brevity.

PHOTOGRAPH: COURTESY OF ANNIE DUKE

Q:

You’ve pivoted from professional poker to teaching and giving talks on the behavioral psychology of decision-making. How did that shift occur?

L E A N S

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Annie

Duke won the 2004 World Series of Poker Tournament of Champions and emerged victorious at the National Heads-Up Poker Championship in 2010. She’s written instructional books for poker players and two books on decision-making.

She’s been a repeat guest on the Investor Hour podcast and teaches at the University of Pennsylvania’s Wharton School.

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Tell us about your writing career.

In 2012, I quit poker to focus on cognitive science full time. I’d written some books on poker, but I really, really wanted to write the books that I eventually wrote. I thought I had one book in me, but after writing Thinking in Bets I went on to write How to Decide. Now, I’ve got this new book coming out in about a year.

have a problem with cognitive bias. If we knew everything for sure, if there were no such thing as subjective judgment, if the world was really, really clear to us, we wouldn’t have these same issues in the same way.

The interaction between the two forms of uncertainty—luck and hidden information—creates a lot of noise and makes it really frustrating to try to get to any kind of good judgment. It’s the kind of problem that you’re living and

a table and losing, they won’t stop to go to a dinner date. There’s nothing that will get them out of their seat. If that exact same player is winning and you suggest going out to dinner, it’s like the Flash getting up from the table. What this shows is that your risk attitudes get distorted by the path you’re on.

It’s not about winning or losing over a long period of time. It’s about what has happened to you recently. We become very risk-averse when we’re in the gains and very risk-seeking when we’re in the losses.

THE TWO FORMS OF UNCERTAINTY— LUCK AND HIDDEN INFORMATION— CREATE A LOT OF NOISE AND IMPAIR GOOD JUDGMENT.

Now you’re in academia.

At Wharton, I co-lead a class with Maurice Schweitzer, and I’m interacting with Barb Mellers and Phil Tetlock, who work there on the Good Judgment Project that identifies and trains Superforecasters (see p. 44). I’ve found the sweet spot for the things that interest me and challenge me to become a more precise and better thinker.

The common element would be better decision-making?

The thread that’s pulling through all of it is decision-making under uncertainty.

If there weren’t uncertainty, we wouldn’t

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breathing when you’re playing poker. I like these problems that are intractable, where you peel some stuff off of it but you never really get to the core.

That’s what poker really is. You can get better at it, but you can’t solve the game. It’s just too hard, at least for a human being.

What would you tell options traders about how poker can help them think better about risks?

There’s deep risk in the way we behave when we feel that we’re in the red. Our risk attitudes change when we put a bunch of money into a house or a bunch of time into a relationship—or even just time standing in line.

If you have a poker player who’s sitting at

That’s not good.

It gets even worse because we will jack up the volatility to a level that would allow us to get even. This is true in options trading, and it’s true in poker. In poker, if I raise then I’m taking a higher volatility line to the hand than if I fold, which brings my volatility to zero. We have a choice about how big we want to bet—how swingy we want to play.

The more hands you play, the more you increase your volatility. So, if we feel like we’ve got a big loss on the books, we will actually start to jack our volatility. If the game we’re playing isn’t big enough because we’re constrained by the size of the bets, we will move to a bigger game to get enough risk that we could theoretically get our money back. And if that isn’t available

ILLUSTRATION BY SATOSHI KAMBAYASHI

Annie Duke quit playing poker full time (left) to deliver the message that the game can make people better risk-takers.

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o

RESULTING (a.k.a. Outcome Bias)

ne of the most controversial decisions in Super Bowl history took place in the closing seconds of Super Bowl XLIX in 2015.

The Seattle Seahawks, with 26 seconds remaining and trailing by four points, had the ball on second down at the New England Patriots’ one-yard line. Everybody expected Seahawks coach Pete Carroll to call for a handoff to running back Marshawn Lynch. Why wouldn’t you expect that call? It was a short-yardage situation and Lynch was one of the best running backs in the NFL. Instead, Carroll called for quarterback Russell Wilson to pass.

New England intercepted the ball, winning the Super Bowl moments later. The headlines the next day were brutal: > USA Today: “What on Earth Was Seattle Thinking with Worst Play Call in NFL History?” > Washington Post: “‘Worst Play Call in Super Bowl History Will Forever Alter Perception of Seahawks, Patriots” > FoxSports.com: “Dumbest Call in Super Bowl History Could Be Beginning of the End for Seattle Seahawks” > Seattle Times: “Seahawks Lost Because of the Worst Call in Super Bowl History” > The New Yorker: “A Coach’s Terrible Super Bowl Mistake”

Although the matter was considered by nearly every pundit as beyond debate, a few outlying voices argued that the play choice was sound, if not brilliant. Benjamin Morris’s analysis on FiveThirtyEight.com and Brian Burke’s on Slate.com convincingly argued that the decision to throw the ball

Seahawks coach Pete Carroll made a perfectly reasonable decision in Super Bowl XLIX, but he may never live it down.

was totally defensible, invoking clock-management and end-ofgame considerations. They also pointed out that an interception was an extremely unlikely outcome.

(Out of 66 passes attempted from an opponent’s one-yard line during the season, zero had been intercepted. In the previous 15 seasons, the interception rate in that situation was about 2%).

Those dissenting voices didn’t make a dent in the avalanche of criticism directed at Pete Carroll.

Whether or not you buy into the contrarian analysis, most people didn’t want to give Carroll the credit for having thought it through, or having any reason at all for his call.

That raises the question: Why did so many people so strongly believe that Pete Carroll got it so wrong?

We can sum it up in four words: the play didn’t work.

Take a moment to imagine that Wilson completed the pass for a game-winning touchdown.

Wouldn’t the headlines change to “Brilliant Call” or “Seahawks Win Super Bowl on Surprise Play” or

“Carroll Outsmarts Belichick?” Or imagine the pass had been incomplete and the Seahawks scored (or didn’t) on a third- or fourth-down running play. The headlines would be about those other plays. What Pete Carroll called on second down would have been ignored. Carroll got unlucky. He had control over the quality of the play-call decision, but not over how it turned out. It was exactly because he didn’t get a favorable result that he took the heat. He called a play that had a high percentage of ending in a game-winning touchdown or an incomplete pass (which would have allowed two more plays for the Seahawks to hand off the ball to Marshawn Lynch). He made a good-quality decision that got a bad result.

Pete Carroll was a victim of our tendency to equate the quality of a decision with the quality of its outcome. Poker players have a word for this: “resulting.” When I

started playing poker, more experienced players warned me about the dangers of resulting, cautioning me to resist the temptation to change my strategy just because a few hands didn’t turn out well in the short run.

Pete Carroll understood that his universe of critics was guilty of resulting. Four days after the Super Bowl, he appeared on the Today show and acknowledged, “It was the worst result of a call ever,” adding, “The call would have been a great one if we caught it. It would have been just fine, and nobody would have thought twice about it.” > From THINKING IN BETS: Making Smarter Decisions When You Don’t Have All the Facts

by Annie Duke with permission from Portfolio, an imprint of The Penguin Publishing Group, a division of Penguin Random House, Inc LLC copyright (c) 2018 by Annie Duke.

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WE BECOME VERY RISK-AVERSE WHEN WE’RE IN THE GAINS AND VERY RISK-SEEKING WHEN WE’RE IN THE LOSSES. to us, then you get people who will go out to the pit, which allows unlimited risk.

Is that prospect theory?

Yes, this is part of prospect theory, and I’ll give you the simple version of it. You owe me $100. Do you want to flip double or nothing? Or, I owe you $100. Do you want to flip double or nothing? Now everybody probably has the intuition that you’re totally flipping when you’re down $100, but you’re not flipping when you’re up.

So I say you’re down $100 and if you flip and lose, you’re going to owe me $220. But if you win, you’ll get to zero. So now you’re paying me $10 for the opportunity to flip, and you’ll say yes. You’ll pay me for the opportunity to take the gamble.

Now, what’s interesting is if I owe you $100, and you ask if I want to flip double or nothing. But it’s a little better than that. If I win, I’ll get to $220. If I lose, I’ll go to zero. People say no. So now you’re paying me $10 not to take the risk. This is incredibly irrational, and it’s what

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developed into prospect theory.

This happens across different situations— like what are the choices in terms of a play in a football game? How far down are you? Are you throwing some crazy 30-yard passes or are you running the ball? Obviously, those plays have different risks associated with them but also different gains.

Do investors need to understand base rates?

Most people probably aren’t going to use the term “base rates,” but they could say How does prospect theory how often a ball gets intercepted in a apply to investing? particular situation. We all feel it was a You should invest every single dollar with terrible call when it’s intercepted. And a positive expectancy, and I’ve just shown we all know it was a great call when it’s a that you won’t do that. You’ll invest in game-winning touchdown. And we think negative expectancy just for this weird nothing of it when it’s just accounting of trying to get incomplete. short-term even. This is not This is a problem we have as behavior that we’d like to see, decision-makers. We’re using but we see it all the time. And the one iteration to determine so the very first talk that I ever the quality of a decision. It’s a gave was on that topic. very bad substitution that we make. In fact, it’s the worst You’ve said that people More Duke cognitive error we make as tend to consider decisions Risk Schmisk human beings because it TED Talk good if they work and bad prevents us from learning. if they don’t work.

PHOTOGRAPH: COURTESY OF ANNIE DUKE

When she’s not instructing students at Wharton, Annie Duke teaches executives that poker can make them better decision-makers.

We have this intuition that we learn from experience. It’s how you figure out not to touch a hot stove. Oh, that burns!

The problem is that when we’re deciding under uncertainty, it’s difficult to look back and try to figure out why something happened.

Was it mainly because of skill—in other words, because of a decision we made? Or was it mainly due to things that were outside of our control, which could be information that was unknowable to us or just plain bad luck? Or just plain good luck, depending upon the outcome. The problem is that when we look back, our decisions aren’t transparent.

When we are changing behavior based on results, it’s called “resulting.” In the cognitive literature it’s called “outcome bias,” but I like “resulting” better because it’s a more intuitive name. If I know how a situation turned out— because I can see that very clearly—I can judge the quality of the outcome. And then you substitute the quality of the outcome for the quality of the decision itself. (See book excerpt on p. 17).

But to really understand the quality of a decision, we need to be thinking about a lot of math. We need to know some base rates for one thing, so that we can understand the probability of the different branches of a decision tree.

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TWO STATES OF GAMBLING

T H I N K I N G

I N

B E T S

NEVADA’S SYNONYMOUS WITH GAMBLING, BUT NEW JERSEY’S ON TRACK TO DOMINATE SPORTS BETTING BY MIKE REDDY

W

hat happens in Vegas generally stays in Vegas, but the past year revealed a notable exception: online sports betting.

New Jersey surpassed Nevada’s online sports betting handle every month between June 2020 and May 2021, according to gambling. com. New Jersey’s handle in May 2021 came to $814 million compared with Nevada’s $477 million—a difference of more than $300 million.

That’s no small feat considering Nevada had a big head start. Beginning in 1992, single-game sports wagering was confined exclusively to the Silver State by the Professional and Amateur Sports Protection Act, a federal law also known as PASPA. PASPA set out to define the legal status of sports wagering nationwide. In practice, it effectively outlawed the practice entirely with a few States With state exceptions—the most lenient of which were Legalized, in Nevada.

Operational But a 6-3 Supreme Court decision in 2018 Sports Betting deemed PASPA unconstitutional for disallowARKANSAS ing states from enjoying the privilege of legal COLORADO gambling on sports. The ruling opened the DELAWARE door for new opportunities.

ILLINOIS Wasting no time, several states INDIANA joined in on the sports betting IOWA MICHIGAN bonanza. Within the first year MISSISSIPPI after PASPA was overturned, MONTANA Delaware, Mississippi, West NEVADA Virginia, Rhode Island, PennsylNEW HAMPSHIRE vania, New York, Arkansas and NEW JERSEY New Jersey all hopped on board.

NEW MEXICO While some states allow only in-perNEW YORK son betting, more than two dozen have NORTH CAROLINA OREGON legalized some form of sports wagering.

PENNSYLVANIA The rush to embrace sports gambling shook up RHODE ISLAND one state in particular. “I think New Jersey is the TENNESSEE new king,” said Darren Rovell, senior executive VIRGINIA producer for The Action Network. “Nevada still WASHINGTON, D.C. has in-person sign-up if you want to sign up WEST VIRGINIA for a mobile sportsbook. Jersey has, I think, Source: americangaming.org 26 online sportsbooks that you can sign up for by yourself.”

Nevada vs New Jersey Sports Betting Handle Size

Dollars (in millions) 2500

Nevada New Jersey 2000

1500

1000

500

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Q1 2021

Source: usbets.com

$1.56

billion

NEW JERSEY SPORTS BETTING HANDLE

vs.

$935 million FOR NEVADA

— APRIL & MAY 2021, USBETS.COM

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T H I N K I N G

I N

B E T S

GAME THEORIES PROFESSIONAL POKER PLAYERS VANESSA SELBST AND ALEXIS ZERVOS BOTH FOUND SECOND CAREERS AS HEDGE FUND MANAGERS. THE SOUND MATHEMATICAL REASONING AND STRONG RISK MANAGEMENT SKILLS THEY LEARNED AT CARDS HAVE SERVED THEM WELL IN FINANCE. GENERAL MANAGER OF POKER POWHER ERIN LYDON AND SCIENCE AND TECHNOLOGY WRITER ALEX O’BRIEN HAVE ALSO FOUND THE LINK BETWEEN GAMBLING AND INVESTING. LUCKBOX SAT DOWN WITH LYDON AND O’BRIEN TO LEARN MORE ABOUT THEIR JOURNEYS BETWEEN THE TWO DISCIPLINES THAT SHARE SO MUCH.

ALEX O’BRIEN

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ERIN LYDON

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Alex O’Brien, a science and technology writer, is working on a book called The Truth Detective: Practical Tools for Everyday Critical Thinking that’s scheduled for publication in 2022. It’s about the mental upsides of playing poker and will offer strategies for analyzing information.

In December, she won $10,000 by beating 1,666 other players in a poker tournament.

Erin Lydon, managing director and general

manager of Poker Powher, is pursuing the goal of teaching a million women how to play poker. She says the game’s professional and personal benefits include teaching players to “understand capital allocation and risk management.” Before joining Poker Powher, Lydon was the strategic advisor to Evil Geniuses, an eSports organization.

What are some of the complexities of poker and how can learning about them help us in other parts of life?

Bluffing is just a tiny element of the game. It has to be part of your arsenal, but poker is very much more than that. It is strategic thinking about probabilities, understanding risk and making risk assessments on the spot. It’s being disciplined. It’s being patient. The complexity comes from having to put together a lot of levels to make your decisions about a move or an action.

Tell us about Poker Powher.

Poker Powher is a movement. It started about 18 months ago—just before the pandemic, if we can all remember what that was like. It was the vision of the proprietary trading firm PEAK6. The bread and butter of PEAK6 is equity options trading, but they started Poker Powher to bring the skills and strategies of poker to young women.

The idea is to prepare them for college and as they step out onto the first rung of the ladder.

What can poker teach about trading?

Trading and poker playing are very similar. And that’s why you see the crossover between traders becoming poker players and poker players becoming traders. They’re already trained to think in probabilities and risk and are able to make those decisions even if they haven’t been trained as traders. They have that foundation of thinking that helps them with decision-making.

What does poker teach about bet-sizing?

As a player, you are always thinking about your chip stack.

“How many chips do I have left? How much is it going to cost me? How much do I have to raise your call to continue playing this hand? Where am I at the table?” If you’re the first to act, that’s called “under the gun.” You are in a weaker position because you’re forced to act, and you haven’t gathered any information from anyone else who’s played.

Now, the opposite of that is when you get to the ninth player, and they’re the last to act. They’ve seen eight people go before them, and they are able to make a better riskadjusted decision because they have more information.

How would you define probabilistic thinking?

Everybody will give you a different answer because we have different understandings of what probability actually means. There’s a general definition for probability: Something will or will not happen based on certain variables. To me, what that means is oftentimes we don’t have all the information we need. It’s not like chess— where you see your opponent’s position, you have your own position, you know what’s going on. In poker, you don’t. You always have something missing.

First of all, you don’t see your opponent’s cards, and you don’t know what cards are going to come. So, those are the basics. And much like in life, you oftentimes just don’t have all the information. You have to think about all the possible outcomes and the degrees of probability of all these outcomes.

What can you say about risk and bet sizing?

In poker, you have to make on-the-spot risk assessments all the time. You look at how many players are involved and the size of the pot. What are the stories everybody’s telling you at the table? When I play poker, that’s what I look for.

Then I look at my own position and my own hand, and I make a risk assessment based on everything I’m being told by my opponents and what I see. And then I calculate whether I’m willing to gamble or put more money into the pot based on my expected value.

These conversations were edited lightly for brevity.

What can readers learn from poker that will make them better investors right away?

The sunk cost fallacy is a big problem—certainly when you’re new to poker. Let’s say you have pocket aces. So that’s the best hand that you can have dealt. But pocket aces don’t win all the time, and the chances of being dealt pocket aces are less than half a percentage point.

When you put your chips into the pot—much like when you’ve purchased a stock or any other investment—and it’s time to fold, you should get out. But you don’t because you’ve already put some money in that pot. You think, “Well, I’m just going to wait for the next street of cards,” or “I’m going to wait for the next earnings report.” What tends to get you into trouble is that you are not getting out as quickly as you should. So you want to be booking that loss when it’s small versus letting it ride and ride.

What else should we be telling readers about why poker is important for hands-on investors?

If you want to negotiate better—and you’re negotiating with every decision you make—then play poker. Or, if you want to improve how you think and analyze, play poker.

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T H I N K I N G

I N

B E T S

THE KELLY C

HOW TO APPLY THE CELEBRATED BET-SIZING AND CASH-MANAGEMENT FORMULA IN TRADING AND WAGERING.

BY NICHOLAS YODER

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G

amblers and traders alike should get to know the Kelly criterion intimately.

The formula, developed in 1956 by Bell Labs scientist John Kelly, uses Information Theory to calculate how much to wager or invest to maximize long-term wealth.

But the criterion is often poorly understood, and its misuse leads to the ruin of many would-be traders. Their wealth skyrockets and then collapses to zero because they fail to grasp that the line between defeat and long-term profit is written in the language of mathematics.

Two keys unlock success in professional gambling and serious trading: 1. Identifying profitable opportunities

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Y CRITERION 2. Correctly sizing bets No. 1 is the easy part. No. 2 separates the professionals from the amateurs.

Trend-following “turtle” trader Michael W. Covel put it this way: Trading correctly is 90% money management and portfolio management.

A trader with a mediocre strategy and a great model for risk and bet-sizing will become fairly successful. A trader with a great strategy and a mediocre risk model will go bankrupt.

Examples abound. Think of a blackjack player deciding what percentage of his bankroll to wager on a given hand, a real estate investor who’s determining how much of her portfolio to commit to a new property or a cryptocurrency trader deciding what leverage to apply to a new strategy.

More of a gamble Bets of 15% or 25% of one’s bankroll can lead to bankruptcy.

EXPECTED VALUE Imagine a betting opportunity that offers positive expected value (EV) with known payouts and probabilities. A blackjack player, for example, knows that the current running count and true count imply a win/ loss probability for the next hand of 52% versus 48%.

A 52% chance of winning seems attractive, but how much of the gambler’s total net worth should he wager on it?

Deciding that requires balancing the competing forces of betting more to achieve greater profit and betting less to limit the chance of going broke.

Somewhere between those extremes there’s an optimal proportion of the total bankroll to bet such that long-term wealth is maximized.

SIZE MATTERS An uncomplicated experiment can test what happens when a card player makes bets of differing sizes on more than 1,000 hands of blackjack.

In one example, the gambler wagers 1% of his bankroll on each hand, plotting the course of his net worth over 1,000 simulated hands. The strategy makes a nice return over time, with a bit of volatility. After 1,000 hands, the

A GAMBLER WHO BETS TOO MUCH IS LOSING MONEY WITH WINNING BETS.

gambler has increased his wealth by 44% (see Bet 1% line in “More of a gamble,” above).

But what if a gambler risks a larger proportion of his net worth on each bet? The chart above shows his profit over time with bet sizes of 1%, 2% and 4% of net worth per hand.

It’s not surprising that as the size of the bet increases, the profit and the variance of the gambler’s net worth does likewise.

Cumulative winnings grow steadily as the bet size increases from 1% to 4%.

Yet, with larger bets, something counterintuitive creeps into the simulation. Take for example the following bets: 1%, 2%, 4%, 8%, 15% and 25%.

Bets of 8% can slow the growth of the gambler’s bankroll. Bets of 15% or 25% can lead to bankruptcy.

In fact, a gambler who bets too much is losing money with winning bets. Larger and larger wagers continually increase the variance of his net worth, but beyond a point,

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profits peak and then reverse.

But why would doing more of a good thing result in a worse longterm outcome?

How to bet a coin toss In 50/50 propositions, 10% bet sizes will yield the same outcome as 40%.

Bet Size

NEGATIVE GEOMETRIC DRAG 5% To understand this rise and fall 10% in returns, imagine an especially 15% good gambling opportunity: A 20% bet with 50/50 probability and a payout of 2:1 ($2 gain for $1 25% wagered).

30% Clearly, that’s a profitable 35% opportunity, but how much should a gambler invest in each 40% round of the bet?

45% In the first example, 1,000 50% rounds of betting were simulated.

This time, a more mathematical 55% approach can help.

60% Because the bet wins or loses 65% with equal probability (50/50), an 70% average round of betting produces an equal number of wins and losses. The simplest model of bets would be one win and one loss, and the order doesn’t matter.

As bet size (left column in “50/50,” above) increases, the size of the wins and losses increases, too. The total profit (right column) increases with bet size but then plateaus and falls.

A wager of 40% per round is as profitable

Initial Capital

Final

Profit %

$100

$104.50

4.5%

$100

$108.00

8.0%

$100

$110.50

10.5%

$100

$112.00

12.0%

$100

$112.50

12.5%

$100

$112.00

12.0%

$100

$110.50

10.5%

$100

$108.00

8.0%

$100

$104.50

4.5%

$100

$100.00

0.0%

$100

$94.50

-5.5%

$100

$88.00

-12.0%

$100

$80.50

-19.5%

$100

$72.00

-28.0%

as 10% per round. Yet, 60% actually loses money on average.

But why?

The losses are caused by negative geometric drag (NGD).

This drag on a portfolio’s profit results arithmetically from gaining and losing the same proportion of value. A gain of X% followed by a loss of X% (or a loss followed by a gain of the same amount), always results in a net loss.

A loss of 10% on an investment followed by a 10% gain results in having 0.99 of the original investment (0.90 x 1.10 = 0.99) or a 1% net loss. Profiting 20% then losing 20% nets a 4% loss from the starting point (1.20 x 0.8 = 0.96). The drag on an investment’s return is the square of the gain or loss.

EDGE + NGD = PROFIT As leverage is increased, the edge of a bet grows linearly with the amount of leverage, but the NGD grows as the square of the leverage.

At lower levels of leverage, the edge is the dominant force and the NGD is negligible. However, as leverage grows, the NGD becomes larger and eventually overwhelms the betting edge.

Shown graphically in “Kelly curve,” below, these figures create the familiar Kelly curve (blue).

Profit (red) is the sum of the ever-increasing leverage and the negative geometric drag (gray).

The green vertical line indicates where Kelly curve the two countervailing forces perfectly offset each other (marginal edge = As leverage grows, the NGD becomes larger and eventually overwhelms the betting edge. marginal NGD). This is the point of maximum profit (bet size = 0.25), and any additional leverage would result in lower profit.

To state this another way, on 50/50 outcomes, using this betting size (0.25 of net worth) would maximize the geometric growth rate wealth over time.

PUTTING KELLY TO WORK The Kelly criterion formalizes this logic in a single formula. It accepts known probabilities and payoffs as inputs and returns the proportion of total wealth to bet for maximum growth.

bp – q w= b

w= Wager b = Bet odds (2:1 etc) p = Probability (Win) q = Probability (Loss)

The example above would set b=2, p=0.5 and q=0.5. Wager size solves to 0.25, exactly the same value as the trialand-error table above.

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The gambler should bet 4% of his bankroll—exactly as predicted. But how do these principles hold up in the real world? A look at Ethereum (ETH) trading can help answer this.

Kelly Optimal +644%

4/5 Kelly: 520% Return 50% of Variance

Long ETH: 225%

KELLY ON CRYPTO Ethereum trading offers an excellent real-world application of Kelly. A particular ETH long volatility/trend-following strategy has the following returns from 2016 to the present in which the Y-axis is annualized return and the X-axis is leverage.

The long volatility strategy has a maximum (Kelly optimal) return of 644% per year versus 225% for holding 0 long ETH (2016 to present).

This optimal return used 1.7x leverage. Leverage of 1x, 2x and 4x would have returned +418%, +602% and -99% (total loss) annually. By using too much or too little leverage, the trader can easily miss out on an opportunity or even lose everything.

The Kelly-optimal bet is a fine line based on a solid understanding of the probabilities and returns.

KELLY ≠ GOAL KELLY = LIMIT

The Kelly criterion only defines the “optimal” bet to maximize return. It does not use caution or assign value to risk.

Kelly represents the limit to the range of rational investments. It is simply the largest bet that could still be rational assuming no value is placed on risk.

Betting even one penny more than Kelly would bring increased risk, increased variance and decreased profit.

However, bet-sizing anywhere near the Kelly-optimal amount is irrational by most standards.

As the bet size approaches the Kelly-optimal point, the ratio of additional risk to additional profit goes to infinity. Eventually, the investor would have to risk an additional $1 billion dollars to earn one cent more of expected profit.

Most people assign a negative value to risk. That’s why we pay a premium to insurance companies to haul away excess risk.

As a result, professional traders use leverage that is partway up the Kelly curve.

Never Logical

1 * 0.52 – 0.48 0.04 = 1

Professional traders use a leverage that is partway up the Kelly curve.

High Marginal Risk/Low Marginal Profit

Returning to the card counter from the introduction, b=1 p=0.52 q=0.48.

The Kelly optimal Ethereum bet

Optimal Sizing

What about a startup investment or ICO that has a 15% chance of success but a 30x payoff? A question like this is tough to work out intuitively, but the Kelly criterion advises an investment of 12% of total capital.

Suicidal

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3

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Kelly is not the goal but rather the boundary.

The ETH strategy had a Kelly optimal leverage of 1.7x, yielding 644% annualized return. But a leverage of just 1.3x returned 520% More Kelly annual profit with only half of the A deep dive with variance. tastytrade The Sharpe ratio (Return/ Variance) also improves with lower fractions of Kelly. In fact, the more modest leverage of 1.3x improves the Sharpe of the ETH strategy from 1.90 to 3.04.

As a rule-of-thumb, many traders use “halfKelly” which offers 75% of the maximum profit with just 25% of the variance. This is a 3x better risk-adjusted return.

As Ed Seykota, a pioneer of systems trading, once said, “There are old traders, and there are bold traders. There are very few old, bold traders.”

The Kelly criterion is an excellent tool for assessing the qualitative shape of risk versus reward and understanding the boundaries of rational bets.

While it does not assign value to risk, simple heuristics like ‘half-Kelly’ are enough for realworld application.

MISUSE OF THE KELLY CRITERION LEADS TO THE RUIN OF MANY WOULD-BE TRADERS. THEIR WEALTH SKYROCKETS AND THEN COLLAPSES TO ZERO.

Nicholas Yoder, a hedge fund manager and former firefighter, studied mathematics and machine learning at Carnegie Mellon University. @nickyoder86

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Leverage

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B E T S I N

T H I N K I N G

THE SHORT SIDE OF KELLY BILLIONAIRE INVESTOR WARREN BUFFET MAINTAINS THAT THE KELLY CRITERION TEACHES ESSENTIAL LESSONS FOR DECISION-MAKING. BUT IS IT REALLY ACTIONABLE? LUCKBOX OFFERS TWO CAUTIONARY TAKES.

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BY JASON PIPKIN

any regard the Kelly criterion as the best sizing formula for bets or investments, but its mathematical simplicity obscures real dangers in its application.

To use Kelly, traders or gamblers plug several parameters into an equation. For it to work, they have to have a good idea of the real probability of the underlying event—but most of the time they probably won’t. For instance, if gamblers think it’s 75% likely that Horse A will win a race but the real odds are 20%, no bet-sizing formula is going to save them.

They also need to know the expected return on the bet. If they’re betting on an evenmoney line, the expected return is 100%. That’s what any number of online Kelly criterion calculators suggest, but this ignores several other important considerations: What’s the likelihood that bettors will reduce the risk prior to the event? Say they’re planning to cover a bet by buying the other side at some other book. Should the line move in their favor, that reduces their expected return on the initial bet. That, in turn, reduces the fraction of the bankroll that they’re supposed to bet.

Naively applied, Kelly assumes infinite liquidity on the part of the bookmaker or betting market, and that’s not the case in reality. Even if the bettor got everything else right, there’s no guarantee of getting down the amount Kelly says they should unless they’ve modified how they calculate the expected return parameter to account for that.

What’s the likelihood that the price the market is offering is the best a bettor can get? This is a very real

consideration—obviously, one wants to buy at the time when their price differs from the market’s by the largest amount possible, but that means knowing something about both the likelihood of the event and how the price is going to move over time, which any experienced trader knows isn’t easy.

What’s the likelihood that sinking money into one bet will reduce opportunities in others? Kelly doesn’t know what gamblers are betting on. Plugging the formula into a market where one’s odds are 99% and the market is offering 97% will suggest that bettors dump a rather substantial fraction of their bankrolls on the bet. But gamblers should properly parameterize the equation with the expected lost earnings from the bets they can’t make while they wait for their sure thing to come through.

When does the event take place relative to when the bet is made? If gamblers are betting on a sure thing that happens a year from now, they need to make sure they seriously discount their expected return to account for the opportunity cost of having that money tied up for that time and thus unavailable for other bets or trades.

While the equation is simple, applying Kelly is not—unless one’s an excellent handicapper and is betting on frequent events that resolve on a short time scale. So when using it to get a sense of how much to bet, remember not to take shortcuts when calculating the expected return.

THE KELLY CRITERION’S SIMPLICITY OBCURES ITS DANGERS.

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Jason Pipkin, a neuroscientist, is a semi-pro prediction market trader and frequent guest on The Prediction Trade podcast. @jipkin

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BY ANTON KULIKOV

he Kelly criterion, a mathematical concept that supposedly pinpoints how much of a bankroll to wager or invest, can maximize profits over time.

Say someone offers an even payout on the flip of a coin, but the player knows the coin is weighted ever so slightly to favor heads 51% of the time.

Now suppose the player has $100 in his pocket. The Kelly criterion tells him how much to bet.

In this case, the Kelly-efficient bet is $2 per flip.

Now, put the math aside. If someone really did offer this bet, would a gambler really want to risk just $2?

Mathematically, that’s the bet that will grow the biggest bankroll over time. But let’s face it—some people (like myself) would bet $20 or even $30 per flip for the thrill of it. Others would bet only 50 cents because they simply enjoy the game.

The point is that different people bet differing amounts even if they all understand the Kelly criterion.

Does that mean they are irrational or that they simply have different preferences?

One relatively recent phenomenon in the field of economics—during the last 100 years or so—is the attempt to find a single correct mathematical solution to fundamental economic concepts. This sterilization of the field leaves out the most important feature of economics: human choice and individuality. In other words, just because someone developed a technically correct way to bet on a favorable outcome doesn’t mean that it’s the right way.

The right way to do X depends upon the subjective value system of the individual performing the

task. Is it correct to have five cups of coffee if the recommended serving size for one’s body type is two?

Of course not, but it may make sense when trying to finish 10 hours of work in three hours to spend seven hours with the family.

The Kelly criterion is no different in the world of gambling and finance. Sure, it may yield the correct bet size to maximize a bankroll over a stretch of time, but unless that’s the only factor one cares about, it pays to consider betting the amount that provides the most satisfaction with playing the game.

Everyone wants the single correct answer for everything from investing to choosing a college major, career, car, house, spouse, diet, exercise routine, etc. But when someone gives them a reputedly universal answer, they don’t ask why.

Humanity could prevent bad outcomes if only people were walking vessels of infinite wisdom. But they’re not. So, embrace that fact and stop suffering because of a stupid decision. Take some unneeded stress off of those shoulders.

So, what’s the point? Next time someone offers a “sure thing”, use the Kelly criterion to find the most efficient bet size and then completely ignore it.

Instead, bet whatever brings joy. After all, winning a $50 bet on a $100 bankroll sure feels a heck of a lot better than betting $2 just because it’s the “correct” bet.

Think of the Kelly criterion as just another tool to help make better decisions. It’s like a Top 10 restaurant list. Ultimately, each diner has to choose a personal favorite.

Anton Kulikov is a trader, data scientist and research analyst at tastytrade. @antonkulikov97

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B E T S I N

T H I N K I N G

GAMBLING MEDIA BETON THIS GROWTH SECTOR

PARTNERSHIPS BETWEEN SPORTS-BETTING OPERATORS AND MEDIA COMPANIES THAT COVER SPORTS BETTING ARE CREATING A FULL-BLOWN INVESTMENT SECTOR WITH LOADS OF OPPORTUNITY

C

ompanies that take bets on sporting events are cementing alliances with like-minded media outlets, and investors should take notice. Sports wagering companies haven’t just entered the mainstream, they’ve entered the mainstream media. The goal: Create a mania for wagering and a big source of revenue in the years ahead.

Some of the media outlets involved have been around for a while despite the illegality of betting on games until about three years ago. That’s when the Supreme Court overturned the 1992 Professional and Amateur Sports Protection Act, also known as PASPA. (See p. 19.) The ruling struck the gambling industry like a tidal wave.

For 16 years, that federal law had limited legal sports gambling to the state of Nevada, keeping most of the industry offshore or driving it into the shadows of the black market. Then, suddenly, the court’s decision allowed the gambling industry to step into the light and begin offering any number of investment opportunities.

The newfound freedom contributed to a boom in sports-betting journalism, surpassing the small boom in cannabis-related journalism that occurred with the legalization of cannabis at state and local levels.

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COURTESY OF VSIN

BY GARRETT BALDWIN

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SPORTS WAGERING COMPANIES HAVEN’T JUST ENTERED THE MAINSTREAM, THEY’VE ENTERED THE MAINSTREAM MEDIA. Musburger

Musburger

VSiN Follows the Money Vegas Sports Information Network, a gambling media company launched in 2017, was acquired by DraftKings in March 2021. The network, known as VSiN, produces 18 hours of sports betting content every day, said its CEO, Brian Musburger.

“Out of the gate, we assumed that the audience was ready for a more sophisticated conversation,” Musburger said. “It was critical for us to have credibility with professional sports bettors.”

To achieve and maintain that credibility, VSiN employs journalists with strong track records, he maintained. The roster of reporters includes Musburger’s uncle, the legendary sports analyst Brent Musburger, and Matt Youmans, a former betting columnist at the Las Vegas Review-Journal who helped establish guidelines for VSiN’s coverage.

VSiN also works hard to teach its audience how to understand what drives a change in betting behavior ahead of an event. A gambling line can shift leading up to a sporting contest for a number of reasons, Musburger said. The most important include weather, injuries and the flow of money—particularly large “whale” bets.

“To me, that’s one of the most interesting discussions, and the advantage that VSiN has with studios on the floor of important sportsbooks,” he said. “We will hear when somebody comes in and makes a seven-figure bet. A lot of people follow those big bets. Casinos and operators will need to adjust their positions sometimes.”

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Rovell

A Gambling Journalist Finds Action New Jersey-based Darren Rovell, a sports memorabilia collector and a bold former CNBC and ESPN gambling analyst, has found a home as senior executive producer at The Action Network.

Rovell had eight months on his deal at ESPN when he departed for the new gambling media outlet, recently acquired by Better Collective. He wrote between 40 and 60 articles on gambling and recognized that he could expand his gambling coverage as legalization began to sweep the country.

“Here I am sitting in New Jersey and being blessed with basically seeing what things will look like before they go down,” he said. “How many businesses can you look at and say, ‘I am in the epicenter of this business that will sweep the nation. I am in the state that sued the government to make it happen.’”

Rovell, who covers gambling from all angles each day, says he’s found his perfect job. “I needed to go to a place that was not a sportsbook,” he said. “I still wanted to be a journalist. I wanted it to be a stat-based place, a product-based place. And operated on the idea that there was something that made you a better gambler.”

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Before that, High Times, a cannabis-focused magazine first published in 1974, was nearly alone in covering the weed industry, culture and related politics.

Cannabis experienced a huge investment boom a few years ago, and sports wagering could easily surpass it. Plus, sports gambling had a head start over cannabis in capturing the imagination of the American public. With these new media mergers and alliances, the sky could be the limit.

Second, Sinclair Broadcast Group made a deal in May 2019 to purchase Disney’s regional sports networks, which present 4,500 live sports matches each year.

Sinclair branded its 19 regional sports networks, or RSNs, with the iconic name of Bally’s, which owns or manages 11 casinos in seven states and holds multiple off-track betting licenses. Bally’s paid Sinclair $88 million for a 10-year naming rights plan.

Then, Penn National Gaming, which owns casinos, invested $163 million in a 36% stake in Barstool Sports, a network that produces daily betting content. Barstool, founded by media executive Dave Portnoy, will have its own branded sportsbook in 10 states this year.

The 800-pound gorilla, however, is Walt Disney, which has evolved on gambling as well. The company owns 80% of ESPN Networks and has long walked a fine line around sports gambling because of its family-friendly reputation. Through ESPN, it now hosts its own gambling shows, like Daily Wager, which is shot in a studio at The LINQ Hotel + Experience in Las Vegas.

The effort by ESPN differs greatly from the company’s attitude in the past, said Darren Rovell, a former ESPN analyst who left the sports network to become senior executive producer at The Action Network, a gambling

CANNABIS EXPERIENCED A HUGE INVESTMENT BOOM A FEW YEARS AGO. SPORTS WAGERING COULD EASILY SURPASS IT.

GOLD IN THE SILVER STATE Following Nevada’s legalization of sports gambling in 1949, Las Vegas began reaping a reliable crop of cash on major events like the Super Bowl.

Even a 10% tax on all sports bets by the U.S. government—imposed in 1951 and later lowered to 2%— couldn’t deter public fascination with sports wagering.

Americans bet roughly $4.76 billion on Super Bowl LII in 2018, according to the American Gaming Association (AGA). But about 97% of the bets were placed illegally through local bookmakers or offshore sportsbooks, the trade group estimates.

Legal or illegal, that’s a lot of money. Let’s examine some of the companies cashing in on the bonanza.

First, DraftKings and FanDuel went big with media coverage and legalized “gaming” to create the boom in fantasy football early in the last decade.

media group, in 2018. (See Sidebar: A Gambling Journalist Finds Action.)

“At ESPN, we had all these rules about gambling, and it was ridiculous,” Rovell told Luckbox. “Toward the end of my time at ESPN, my editor-in-chief was Chad Millman, who wrote one of the best books on gambling and was a total gambling junkie. He then became

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my boss at The Action Network. I think ESPN was clouded by being owned by Disney.”

Things have changed. ESPN’s flagship SportsCenter program now features a gambling-focused segment by Scott Van Pelt called Bad Beats.

During an April earnings call, Disney CEO Bob Chapek described gambling as an opportunity for his firm and as a “minimal risk to ESPN.” The sports network has signed agreements with Caesars and DraftKings, and it stands to benefit from new content on gaming on ESPN+. Some analysts speculate that Disney might consider its own sportsbook.

Deal-making also has accelerated. FanDuel inked media partnership agreements with Turner Sports, and sportsbook William Hill signed a partnership contract with CBS Sports. Even Verizon—just after divesting itself of Yahoo! and AOL—has established a deal with BetMGM—a joint venture between British gambling firm Entain and U.S. operator MGM Resorts.

Rovell’s firm also was recently acquired.

Better Collective, the sports media group behind VegasInsider and Bonus Code Bets, purchased The Action Network for $240 million.

Why all the action? Betting operators and media outlets expect a huge return.

$4.76

billion

THE AMOUNT WAGERED ON SUPER BOWL LII IN 2018

97%

THE PORTION OF THOSE BETS THAT WERE PLACED ILLEGALLY — AMERICAN GAMING ASSOCIATION

MARKETING THE MEDIA For the marketing model to succeed—and generate eye-popping revenue—industry advocates argue that a few things must happen.

First, the media must work harder to eradicate illegal sports betting, according to AGA CEO Bill Miller. He argues that the media and marketing outlets must help customers recognize the difference between legal U.S. operators and illicit offshore operators.

Media outlets, including The Wall Street Journal and Yahoo! Finance, have struggled to distinguish between the two forms of operators, Miller told SBC Americas, a trade news portal.

Journalists should stop using the term “offshore” to describe gambling operations, he said.

“If I had my way, the media wouldn’t write about these sportsbooks at all,” Miller told author Matthew Ramirez. “Responsibility for educating the public is shared amongst everyone in the sports betting ecosystem. Media organizations should do their part, too.”

The next challenge is distinguishing between journalists who viewers should follow from those they should ignore. The lack of accountability in the market worries Brian Musburger, CEO of Vegas Sports Information Network.

(See VSiN Follows the Money, p. 29.)

“We’re hitting a wave in the euphoria around sports betting where you’re now seeing people with quite questionable creden-

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Televising the Strip The consolidation of gambling and new media has created opportunities on the Las Vegas Strip. Sports gambling firms are starting state-of-the-art media studios that would make CNBC and ESPN analysts jealous. Those studios are cranking out hours of daily videos. VSiN has three of them, and they’re located at South Point, Mandalay Bay and Circa. The latter—billed as the “world’s largest sportsbook”— opened in late 2020.

Gamblers placed their bets at the FANDUEL sportsbook during Super Bowl LIII in 2019.

tials holding themselves up as experts,” Musburger told Luckbox.

“These people see the money that is flowing into sports betting media,” he continued. “This is the period where there will be missteps, and I think people will start to better appreciate the complexities of how to cover this phenomenon.”

investment trend, according to Chad Beynon, who’s deputy director of Macquarie U.S. Equity Research and also serves as the firm’s U.S. gaming, lodging and theaters analyst.

He forecasts a compound annual growth rate (CAGR) of 33% through 2030 for sportsbook and online gambling operators.

That growth is directly tied to their rela-

THE SURGE IN SPORTS GAMBLING HAS FUELED IMMENSE INTEREST IN SEVERAL COMPANIES THAT HAVE THE POTENTIAL FOR EXPLOSIVE GROWTH. Musburger raised concerns about touts (or handicappers) who engage in “east-westing.”

“They tell half their audience to bet Team A and the other half to bet Team B, and the ones who are wrong get a free pick the following week,” he said.

But Musburger isn’t calling for regulation.

The market will spur innovation and shed bad actors, he predicted.

FRUITS OF SELF-REGULATION Assuming the market can isolate bad actors and improve the flow of customers to legitimate operations, the revenue potential of recent agreements could prove massive.

In fact, the acceleration of deal flow in gambling media will create a significant

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tionships with media outlets and could bring total annual wagering revenue to more than $30 billion annually.

BEST BETS FOR THE SPORTS BETTING WAVE The surge in sports gambling has fueled immense interest in several companies based on their potential for explosive growth. Here are three that stand out in an increasingly consolidated field.

DraftKings (DKNG) got its start in the daily fantasy sports industry. With a market capitalization of $20.65 billion on July 6, it’s larger than established rival MGM Resorts International.

Plus, DraftKings continues to expand at a

breakneck pace and will benefit as more states legalize sports betting. Analysts project that year-over-year revenue will increase by 66% in 2021 and by 40% in 2022. It has an average price target of $68.13, representing a more than 32% upside from the closing price on July 6, 2021, according to TipRanks.

Another potential winner, Penn National Gaming (PENN), once operated video gaming terminals and racetracks. But the firm made a huge splash by transforming its media reach through its deal with Barstool Sports in early 2020.

That deal accelerated the gambling media arms race and brought a wider audience to Penn’s operations. At the height of the COVID19 crisis, PENN stock fell under $5 before a rebound and surge to $142 in March 2021.

Shares have since pulled back to the mid-$70 range, but Wall Street remains bullish. Macquarie analyst Beynon set a $113 price target in late June, and Wall Street has an average price target of $106.44, according to TipRanks.

With that in mind, shares have been volatile—one reason why Deutsche Bank analyst Carlos Santarelli has set a $31 price target.

Meanwhile, MGM Resorts International (MGM), an established player and host of multiple big-ticket prize fights and mixed martial arts events in Las Vegas, has taken sports gambling by storm.

The company continues to progress with its new internet gaming and media outlet BetMGM and had expanded into seven states in 2020. This year, the company opened operations in Iowa, Virginia and Michigan.

Nevertheless, Wall Street is less bullish on MGM Resorts, with an average price target of $48.22 based on TipRanks’ insight on July 6. However, Deutsche Bank gambling analyst Santarelli did set a price target of $54 in early July. That figure represents an upside of more than 30%.

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MARKET INTELLIGENCE

BLOOMBERG’S LARRY TABB ON THE RECENT SURGE IN RETAIL INVESTING ACTIVITY, SPECULATIVE TRADING AND THE ONE THING MOST MISUNDERSTOOD ABOUT THE MARKETS BY JEFF JOSEPH

You’ve said the pandemic revolutionized the public markets by “turning everyone’s kitchen table into a trading desk.” What other catalysts have increased trading activity?

The big ones are zero commissions and people being trapped at home with not a whole lot of other things to do. Subsequently, there’s been a big run-up in options trading. And that’s because of educational information put out by companies like tastytrade, and before that thinkorswim, as well as other folks. You’re also seeing increased content on CNBC. There’s a lot more idea generation coming out in the options market. The availability of greater amounts of information, increased leverage, lower commissions, better execution quality—as well as incentives such as zero payment for order flow—lead to more individuals trading options.

How many of the new entrants to the market are engaged in speculative gambling, as opposed to more thoughtful investing?

There is no definitive data on that, but I would estimate that approximately half of the zero-commission and pandemic-inspired trading has been theme- or meme-based speculation.

How important is education to traders entering the markets for the first time?

Education and improving user interfaces are critical to new entrants. First, it’s getting people involved, interested and educated.

Second, it’s helping them avoid burning out their capital. Thinkorswim was really good at it. That’s where education has evolved at firms like tastytrade, where [co-CEO] Tom Sosnoff is helping new traders learn to hedge and pick up some premium instead of just saying, “Hey, I think Tesla’s going to the moon.”

What do people fail to understand about the markets?

That the market is extremely efficient.

The technology and Growth of Retail Trading market participants that 2010 10.1% some critics claim are 2011 10.7% nefarious—like highfrequency traders—are 2012 13.3% not ruining the market.

2013 13.0% They’re actually upping 2014 15.3% the level of competition, and that’s generally a 2015 15.5% good thing for investors.

2016 15.0% When you look at 2017 15.2% the actual numbers, 2018 15.5% they’ve actually put a lot of money back into 2019 14.9% individuals’ pockets.

2020 20.0% The markets should 2021 (Q1) 23.8% be fair, but fair doesn’t necessarily mean 2021 (Q2) 20.00% equal. The movement —As a percentage of overall trading, Bloomberg that enabled zero commissions to payment for order flow actually helps retail traders and makes the markets much fairer.

Does any pending legislation worry you?

Transaction taxes would screw up a lot of things because that would add anywhere from a couple of cents to dollars to every trade. New Jersey is contemplating a tax on high-frequency trades that would add 25 cents a share. We haven’t seen a quarter per share spread in ages, probably 20 years.

So, a transaction tax could walk back 20 years of market efficiency.

Larry Tabb leads market structure research for Bloomberg Intelligence. Before joining Bloomberg, he headed research and consulting at TABB Group, which provided financial markets research and advisory services. @ltabb

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trends life, luxury & the pursuit of happiness

LIQUID ASSETS

Imbibing and Bet-Sizing Anyone who drives faster when the car speakers blast Radar Love should know how alcohol affects the decision to take risks

By Kendall Polidori

W

hether it’s Mark Wahlberg knocking back a drink before he goes all-in at the poker table in The Gambler or Ryan Reynolds and Ben Mendelsohn clinking glasses while betting on a horse race in Mississippi Grind, alcohol and gambling go hand-in-hand—or at least that’s how it’s portrayed in movies and other media.

But does alcohol change the way players behave in a game of chance? To find out, researchers study how alcohol consumption influences gamblers’ decision-making and risk-taking.

In a 2019 study at the University of British Columbia’s Centre for Gambling Research, scientists found that participants who were under the influence of alcohol placed higher bets following losses compared with the bets they placed after wins.

That’s called loss chasing and it’s “one of the hallmarks of problematic gambling,” said Luke Clark, director of the Centre for Gambling Research at UBC and senior author of the study.

The experiment included male student participants, who often show higher levels of risk-taking and higher rates of problem gambling than female students, Clark noted in an interview with Luckbox. The particLoss Chasing: Gamblers who are losing tend to place higher bets than when they’re winning. Alcohol doesn’t aid that decision-making process.

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trends

ipants, ages 19-30, were required to have some experience with gambling and alcohol. They were split into two groups: alcohol and placebo.

Those in the alcohol group were administered a 0.028-oz/lb body-weight-adjusted dose of alcohol, and the placebo group received tonic water with bitters. The researchers used that procedure because the placebo group could not tell whether they received alcohol, thus inducing alcohol expectancy in both groups.

It meant that a 180-pound test subject consumed the equivalent of eight cocktails in 30 minutes. (See Legal Limits.)

After drinking, participants waited 20 minutes before playing 110 spins of a roulette wheel in approximately 15 minutes.

“In our data, participants showed a ‘gambler’s fallacy’ effect in both the alcohol and the placebo condition,” Clark said. “The clearest effect of alcohol was that participants in the alcohol group placed higher bets after losses compared with wins, whereas participants in the placebo group did not show any such difference.”

That may have been loss chasing under the influence of alcohol because the participants seemed disproportionately sensitive to losses and were taking on more risk after losses, Clark noted.

Participants under the influence of alcohol persisted for more trials, or longer runs, and placed higher bets almost immediately after a loss compared with a win, the study indicated.

Alcohol vs. placebo The researchers didn’t say whether the gambler’s fallacy is a good thing or not, but it relates to the alcohol myopia theory—the tendency for alcohol to increase a person’s concentration on immediate events and reduce awareness of distant events, leading to short-sightedness.

Loss chasing is an attempt to recover past losses. In a game of roulette, for example, test subjects show a variety of irrational biases,

TASTES IN MUSIC One day in 2015, Felipe Reinoso Carvalho was asked to join the Brussels Beer Project to quantify the connection between sound and taste. The project’s administrators wanted to know whether a beer tastes better when paired with a specific piece of music.

Carvalho had studied sound engineering and design and explored the effects of sound on decision-making. He specializes in multisensory experiences—trying to understand how to use sound, touch and taste to create better experiences.

Carvalho and his fellow Brussels Beer Project researchers found that tasters rated beer as more enjoyable with music than in silence. He connected the study to synesthesia—a neurological condition where information meant to stimulate one sense instead stimulates several.tastingemotional reaction and decision-making.

When losing, gamblers under the influence of alcohol place larger bets than their sober counterparts.

It’s a bad decision. one of the most common being the gambler’s fallacy, Clark said.

“Where after a run of successive events of one color (e.g., three or four red in roulette), people often strongly believe that the other color (black) must be owed or due,” he noted.

The UBC researchers’ observation of loss chasing falls in line with a 1999 study by the Department of Psychology and Australian Institute for Gambling Research at the University of Western Sydney.

In the latter study, researchers studied the interaction of alcohol consumption and gambling behavior. It was designed with two familiar groups: alcohol and placebo. Participants drank either three alcoholic drinks, each containing approximately 10 grams of pure alcohol (beer or wine) or a non-alcoholic beverage.

Those who drank alcohol persisted for

twice as many gaming trials as the placebo group, with significantly more players who had consumed alcohol losing their original cash stake—50% compared with 15% of the placebo group.

Both groups chose black or red in line with the gambler’s fallacy.

So, where does alcohol come into play, and why does it affect people’s decision-making during a game of roulette?

Impulse control Gambling and alcohol are connected on a number of levels—phenomenological, clinical and neurobiological. Alcohol produces a range of disinhibiting effects, such as making people more impulsive, Clark said. That’s associated with reduced control by the frontal lobes, but it remains unclear how that would affect decision-making. Experiments in complex, real-world gambling settings have been inconclusive.

“Our findings strengthen the case for paying careful attention to alcohol availability in gambling venues,” Clark said. “In most jurisdictions, regulation does pay attention to those things, but given the rise of online and smartphone gambling, it’s also important that the public is aware of the risks of alcohol use when gambling in the home.”

Legal Limits: Participants in an experiment were required to wait until their blood alcohol concentration (BAC) was below 0.05% before they were permitted to gamble. In the United States, the federal legal limit for drivers is a BAC of 0.08%.

Gambler’s Fallacy: You’re on a winning streak betting on red at roulette, and it’s starting to feel as though it’s about time to switch to black. This is a gambler’s fallacy—the belief that if a particular event occurs more frequently than usual, it is less likely to happen in the future, or vice versa. But random events have no memory—past events do not change the probability that events will or will not occur in the future.

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BOOK VALUE

The Luckbox Bookshelf New and not-so-new books that captured our attention this month Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts

By Annie Duke

As a poker champion, Annie Duke knows all too well that good, thought-out decisions don’t always lead to good outcomes, and that poor decisions sometimes result in wonderful outcomes. In her book Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts, Duke offers examples from business, sports, politics and poker of people using simple tools to embrace uncertainty and understand how to make better decisions.

That process breeds confidence when it’s time to place a bet or make an investment decision.

It also reduces bias, tames emotions and banishes destructive ways of making decisions.

Modern Investing: Gambling in Disguise

By David Schneider

with an understanding of how to make index funds and exchange-traded funds work in their favor, how to avoid scams, how to recognize common risks, and how to apply the right practices to secure financial freedom.

Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street

By William Poundstone

Noise: A Flaw in Human Judgment

By Daniel Kahneman, Olivier Sibony and Cass R. Sunstein

Noise: A Flaw in Human Judgment, by Daniel Kahneman, Olivier Sibony and Cass R. Sunstein, addresses the negative effects of noise—which they define as variability in judgments that should be identical. In the classic example of noise, judges hand down widely differing sentences for the same offense. Noise intrudes upon a number of professions, including medicine, forensic science, law and economic forecasting. It undermines fairness and justice, wastes time and money, and imperils physical and mental health. “Wherever there is judgment, there is noise,” the authors write. They also make the distinction between noise and bias, defining the latter as systematic deviations from the norm. The authors offer remedies that reduce noise and provide advice on making better decisions in various situations.

Finance, investing and gambling might seem like wildly different pursuits, but they all require the ability to manage uncertainty, reduce risk and roll with the punches.

That’s the theme of William Poundstone’s book, Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street. The author recounts the story of how two former Bell Labs scientists, Claude Shannon and John L. Kelly, used information theory to make as much money as possible, as quickly as possible. In partnership with MIT mathematician Edward O. Thorp, Shannon brought what they called the “Kelly criterion” to Las Vegas and proved that it worked as a tool for sizing bets. The same holds true for determining the size of investments, according to Poundstone.

Both Shannon and Thorp became successful investors, but the formula still spawned controversy. In this book, Poundstone pushes back on the pushback in an effort to convince readers that the Kelly criterion deserves their trust.

In Modern Investing: Gambling in Disguise, author David Schneider skips the jargon and gets down to basics. The book serves as a guide for beginners who want to take the leap into independent investing. By laying out core principles and key strategies, the author teaches readers to distinguish between gamblers, speculators and investors—while also making the argument that Far too often, book reviews drive away readers. But reviews present just one stranger’s view, and taking them to heart investing aligns closely with leaves great books undiscovered. The Luckbox Bookshelf offers profiles instead of reviews. Don’t look to these pages for opinions. Think of Bookshelf as a place to discover books that educate, entertain and challenge entrenched beliefs. gambling. When readers close the book, they’ll walk away

August/September 2021 | Luckbox

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THE NORMAL DEVIATE

Trading with a Casino’s Edge Active investing isn’t gambling for traders who know the odds

By Tom Preston

W

hen someone’s interested in options trading but doesn’t know quite how to approach it, ask a question that provides context just about everyone understands. “Who makes more money, the casino or the gambler?” They always get the answer right.

Casinos make more money than the players. Even though a skilled blackjack player

who counts cards might make money over time, those winnings are dwarfed by the profits of a casino.

Why? Casinos are probability-based businesses. They determine game payouts by calculating the probability of a gambler winning and then paying out smaller amounts to winning gamblers than they theoretically should.

The difference between what the casino

actually pays out compared with what it theoretically should pay out in a completely fair bet is called its “edge.” In blackjack, for example, the casino has about a 0.5% edge overall.

That may not sound like a large amount, but over the thousands of hands of blackjack played in an hour in a casino multiplied by the dollar amount wagered, 0.5% equates to a lot of money. Nice work if you can get it.

Stay small What casinos don’t do is what gamblers hope to do: make a huge profit on a small bet. And sometimes inexperienced traders can fall into that same trap of trying to reap huge returns from a single lucky options trade.

But even though that might happen once, it’s hard to do that trade after trade, month after month, year after year. In fact, gambling with options is a good way to lose money.

Nobody wants that.

So, here’s the next question to pose: “Would you like to make money the way casinos do?

Legally?” Invariably, the answer is “yes.” That leads to an explanation of why traders can make money over time by selling out-of-themoney options.

The payout on the short option is greater than the probability-based theoretical payout should be. It’s not much, but like a casino, anyone making lots of small trades—each with a high probability of profit—can earn significant returns over time.

So, basing trades and investments on quantifiable probabilities is a logical choice for just about everyone—except, of course, Wall Street analysts and money managers. A self-directed trader can make many small bets that each have a greater than 50% probability of making money.

Calculating the edge But how can a trader figure out the edge of a short options trade, assuming that options are fairly priced? Casinos can calculate their edge because the rules of the games and all potential outcomes are clearly defined. But that’s not necessarily the case with options trading.

There is, however, a simple hack to esti-

Casinos determine payouts by calculating probabilities.

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A RISKY BET OR A SURE THING? You receive a guaranteed payment of $10, or you get to enter a lottery with a 50% chance of winning $24 and a 50% chance of winning nothing.

Which do you choose?

50.09%

Guaranteed Payment

49.91% Lottery Chance

Respondents to the annual Luckbox survey split 50/50 on which payment they’d take—one that’s certain or one that might pay off big. Why? Because they’re both right.

The risky bet with a 50% chance of $24 and a 50% chance of $0 has what’s called an expected value (EV) of $12. EV is the sum of the probabilities times the payouts.

The risky bet’s EV is 50% x $24 + 50% x $ 0 = $12.

Compare that with the EV of the guaranteed $10. That choice’s EV is 100% x $10 + 0% x $0 = $10. So, a $12 EV is better than a $10 EV. Right? It isn’t when someone really needs that $10 right now. In that case, the utility of the $10 is very high. People don’t want to risk not getting it. On the other hand, if they don’t need the money now but would like more money eventually, they’d choose the bet with the $12 EV. That will make more money over time even though there are times when there might be less money.

For example, the probability of the $24/$0 risky bet resulting in $0 winnings after five bets is 3.125%. Not huge, but not zero. The safe payment would have won $100. In the short term, the safe choice could outperform the risky choice.

It’s just not likely and almost impossible over the long term. With more than 1,000 bets, the payout of the risky bet would be close to $12,000 versus the guaranteed payment of only $10,000. Both have advantages, which explains why some people choose one over the other.

Luckbox Reader Survey

mate the edge in a short option. It’s the difference between a stock option’s individual implied volatility and the overall volatility for all the options on that stock, multiplied by the option’s vega.

As a refresher, an option’s implied volatility is the volatility that, when plugged into an options pricing formula, makes the option’s theoretical value equal to its market value.

The overall volatility of a stock’s options is a VIX-style weighted average, and it’s used to

determine the probability of a stock reaching some price in the future.

Vega is how much an option’s theoretical value changes when volatility changes.

The overall volatility is used to calculate an expected high and low range for a stock, and because it incorporates most of a stock’s options in its calculation, it’s often lower than the implied volatility of individual options.

The lower overall volatility means smaller potential price changes in the stock than the

Traders can make money over time by selling OTM options. prices of the individual out-of-the-money options with higher implied volatility indicate. That difference between the volatilities can be interpreted as an edge.

For example, a trader who’s bullish on Wynn Casinos (WYNN) might consider shorting a put. When WYNN was trading for $124.50, its overall volatility was 41%. The 95 put with 56 days to expiration was trading for 0.80, and it had an implied volatility of 50% and a vega of 0.06.

The difference between the 95 put’s implied volatility and the overall volume is 9% (0.09).

So, 0.09 times the option’s 0.06 vega equals 0.0054, or 0.54%. That’s very close to the edge the casino has in blackjack.

Multiply that 0.0054 by the option’s 0.80 price to get 0.00432. Multiply that by the $100 contract size of the option, and the actual dollar amount of that edge is $0.43.

That may not sound like a lot. But over the course of thousands of trades over the years, those small numbers add up, just like they do in a casino.

Does that mean selling options when their implied volatility is higher than the overall volatility is a guaranteed winner? Unfortunately, the answer is “no.”

Just like casinos sometimes lose bets no matter how small the probability.

And if some gambler walks in with $100 million of crypto profits and sits down at a blackjack table to make one massive bet, the payout on a winning hand could bankrupt the casino.

That’s why casinos have table limits. They know that while they might lose one bet, they’ll probably win the majority of 10,000 bets. Approach trading in the same way, with lots of small trades, none of which could bankrupt you.

So, don’t gamble. Look to profit the same way that casinos do. Keep the probabilities on your side and the edges positive.

Tom Preston, Luckbox features editor, is the purveyor of all things probability-based and the poster boy for a standard normal deviate. @fittypercent

August/September 2021 | Luckbox

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THE POKER TRADE

Bet Sizing & Implied Odds The proper size of a bet is often determined by the potential payout

By Jonathan Little

W

hen playing a hand of poker, consider the immediate risk, future potential risk and potential profit. Realize that some hands play better under certain situations. Sometimes it’s good to play speculative hands and other times it’s better to fold them.

Consider this example: Someone raises to two big blinds (bbs) before you, and you have a solid speculative hand like 8♥-6♥ on the button, which is the worst hand at the moment but has the potential to improve to a premium hand like a flush or a straight.

The amount you can potentially win from your opponent should be one of your main concerns. If you

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can only win a little bit from your opponent because he has a short stack of perhaps 25bbs or fewer, you should usually fold your speculative hand because the potential reward (25bbs) is not worth the risk (2bbs).

That’s expressed as 12.5:1 implied odds. You have to invest one unit to win 12.5. But if you are both deep stacked with 100bbs, you should usually play your hand because you will then be getting 50:1 implied odds.

As a broad generalization, to play a suited connected hand like 8♥-6♥ or a marginal suited ace like A♥-6♥ profitably, you ideally want to be getting 20:1 implied odds or more, assuming you do not expect to be able

to win the pot by bluffing too often.

That will often be the case in smallstakes games in multi-way pots.

With small pairs, you usually need about 10:1 implied odds. If you are not getting the correct implied odds—either because the stacks are shallow or the initial raise was large—you either have to fold or potentially use your hand as a re-raise bluff.

While small pairs, suited aces and suited connectors have implied odds, some hands have reverse implied odds, meaning you will usually either win a small pot or lose a large pot.

The hands that have the worst reverse implied odds are a big card with a small card that are not suited, such as K♥-5♠ or Q♦-7♣. Imagine you see the flop and make top pair, which is normally a strong hand.

If you bet and all your opponents fold, you can be confident you had the best hand, but you are rewarded with only a small pot. If instead you bet and someone calls or raises, they could have a better top pair than yours, or a worse hand, but you have no way of knowing which.

If you bet the flop and they call, if you continue betting on the turn and river, you will find that when you get called, it will usually be by a better hand, and you lose a large pot.

Because of that, hands with large reverse implied odds, like K♠-8♣ and Q♠-9♠, should not be played in most situations, especially in multiway pots or when the stacks are deep.

When you are likely to be against only one opponent, like when every-

In Texas Hold ‘em, the best hand you can be dealt at the start is known as “pocket aces.”

But how often can you expect that to happen?

The chance of being dealt an ace as your first card is one in 13, but the chance of a second ace drops because only three are left in the pack.

Assuming a wellshuffled deck, the chances of receiving pocket aces is one in 221 attempts. That’s almost the same as the chances of throwing three sixes from three dice (one in 216).

—Fergus Simpson, senior researcher at Prowler.io

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Takeaways As the stacks are deeper and the pots are played multi-way, you are incentivized to speculate with hands that are likely to lose a little or win a lot—primarily the small pairs, suited aces and suited connectors.

Folding the non-premium off-suit hands will keep you out of trouble and save you a lot of money.

CALL OR FOLD? 1

2

3

Playing 100 big blinds deep, someone in early position raises to 3bbs, the cutoff calls, and you are on the button with J♠-9♠.

Playing 50 big blinds deep, someone in early position raises to 3bbs, the cutoff calls, and you are on the button with K♦-9♠.

Playing 15 big blinds deep, someone in early position raises to 2bbs, the cutoff calls, and you are on the button with 3 -3 .

Should you call or fold?

Should you call or fold?

Should you call or fold?

Jonathan Little, a professional poker player and WPT Player of the Year, has amassed more than $7 million in live tournament winnings, written 14 bestselling books and teaches at pokercoaching. com. @jonathanlittle

J ♠

9 ♠

K ♦

9 ♠

3 ♠

3 ♣

Answers: 1. Call 2. Fold 3. Fold

one folds to you before the flop on the button, or when you are shallow stacked—such that you can be happy enough playing for your entire stack with a marginal top pair—these hands potentially become playable.

Listen Here Truth or Skepticism

Tom Sosnoff, entrepreneur, options trader and co-CEO of tastytrade, joins Dylan Ratigan, businessman, author and former host of MSNBC’s The Dylan Ratigan Show, for a weekly podcast covering everything from sports and investing to politics and monetary policy. One’s an iconoclast, and the other’s a contrarian. Tune in each week find out who is who.

It’s unscripted and unpretentious—some like to think of it as rants, but refined.

The Prediction Trade

If you can trade it, or bet on it, you can bet they will talk about it on The Prediction Trade—the only podcast for gamblers, traders, investors, math freaks, data geeks and superforecasters devoted to the intersection of probability, prediction and profit. Each episode features expert guests with proprietary forecasting models and insights into the outcomes of prediction market events. So whether you live to bet or bet to live, check out the next episode of The Prediction Trade.

Truth or Skepticism and The Prediction Trade are available on your favorite podcast platform.

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TRADER 1 Bloomberg terminal

1

2 Editing latest “The Macro Setup” with Guy Adami & Dan Nathan 3 Blue Yeti microphone

2

4 Moleskine classic hard cover (notes on macro research and trading strategies dating back to 2013) 5 Wooden pen made from old Shea Stadium home dugout benches

3

6 Moleskine notebook (planner & trading diary)

4

CHRISTOPHER VECCHIO Title Senior currency strategist, DailyFX Home/Office location Lower Manhattan

& Westhampton, New York Age 32 Years trading 17

How did you start trading? I was 14 years old and I wanted my first cell phone, so my mother told me that if I invested some money, I could earn it. She’s a trust and estates attorney and does some angel investing, so she’s always had a sharp eye for the markets. She gave me some money and some choices, and I invested in Baxter International, a biotech company. When it went up enough in price, I sold to cover the cost of the phone.

Favorite trading strategy for what you trade most? I don’t have the temperament to

sit around day-trading tight ranges. My academic background is degrees in political science and economics, as well as earning the CFA (Chartered Financial Analyst) Charter by passing an exam that tests the fundamentals of investment tools, valuing assets, portfolio management and wealth

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5

6

planning. That gears me toward longerterm perspectives. So, I’m either looking for significant turning points in markets for long-term value plays or finding a trend I have faith will continue for several weeks or months. While I use spot forex in the currency space, my activity in equities and commodities is explicitly vis-à-vis options, such as call and put spreads, straddles/ strangles and, when I’m very confident, longdated on-the-money calls/puts.

Average number of trades per day?

Approximately 20 per month, so fewer than one per day. I usually trade in batches and then sit around for days at a time.

What percentage of your outcomes do you attribute to luck? I typically outline my

FAVORITE TRADING BOOK Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein Wiley (1998) Paperback, 400 pages

strategy and expected returns ahead of time for each trade, going so far as to backtest the strategy using factor models to create an expected distribution of outcomes. If I find myself in a position where the realized outcome is in excess of three standard deviations of my average expectation (common practice for identifying outliers in Gaussian distributions), I attribute that to luck. There have only been two instances when that’s happened to me.

Favorite trading moment? My favorite

trading moment came when the Bank of Japan intervened in the yen on Aug. 4, 2011, sending the U.S. dollar/Japanese yen currency pair from ~77 to ~79 in a few minutes. I was fresh out of college and doing things by the book. And I recalled a professor in college just months earlier telling me about his experiences around White Wednesday, or Sept. 16, 1992, when the Bank of England’s peg broke and they exited the European Exchange Rate Mechanism, which is why the U.K. doesn’t use the euro. He noted that he had orders laddered among different British pound-crosses that day, and he basically made his year in one afternoon. On a hunch, I laddered in long U.S. dollar/yen orders and, sure enough, I hit it lucky. That single trading event confirmed to me that studying market history would be beneficial in the long term.

Worst trading moment? On Sept. 6, 2011, I was short the euro/Swiss franc currency pair. When I arrived at my desk at 4:31 a.m., the Swiss National Bank had raised the floor to 1.2000. This was my first margin call. It was a hard but tough lesson, and I haven’t run the risk of ruin since. It was formative in understanding risk management early in my career.

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TIKTOK DOUGH

Learning the Trade

(PART 2)

Two Gen Z TikTok influencers are learning the fine art of trading stocks and options from a seasoned pro—and they’re doing it in real time on the tastytrade network

I

n the April issue, Luckbox readers met Kayla Kilbride and Errol Coleman, the beneficiaries of mentoring by legendary trader Tom Sosnoff, co-CEO of the tastytrade financial network. Their adventures navigating the options markets are streaming Mondays and Fridays at 1:30 pm Central on tastytrade.

How is your education coming along?

Kayla Kilbride: I feel more and more

confident every day. I was reflecting on some of my very first TikToks this week and stumbled upon one where I made a joke about how I had no idea what people were talking about when they referred to IRA investments, equities and index funds.

With that said, I feel like my investment education is coming along very well!

Errol Coleman: My investment education is going very well because of being able to rewatch the previous Two Yutes episodes!

a few months back with the Small Exchange precious metals index, /SPREH21. I made $162.

Coleman: My biggest win thus far has been $338 on PayPal. I sold a put spread and closed the position six days later.

outcomes instead of narratives or technical patterns has certainly made me feel less like a “gambler.” However, I want more opportunities to test my prudence or discipline in my investments before I consider myself a “prudent investor.”

Coleman: I feel more like a prudent investor because I am trading off of probabilities— trading small, but trading often.

Do you feel more like a gambler or a prudent investor?

Kilbride: Trading based on statistical

Do you think absolutely anyone can learn options trading?

Kilbride: Oh my goodness, yes! If I can do it,

What’s been your biggest win thus far?

Kilbride: My biggest win was a trade I made

PHOTOGRAPH: (TIKTOK) DYLAN BRENNAN

Errol Coleman and Kayla Kilbride hang out with Tom Sosnoff at the tastytrade office in Chicago

More Kilbride & Coleman Watch The Two Yutes

anyone can. I am still getting terminology mixed up and backward all the time.

Nonetheless, I’m learning new things every week and getting better with every trade.

Coleman: Yes, 100%. Anyone can learn if they put the time in. After that, it’s rinse, wash and repeat.

Which investment vehicle do you enjoy trading most—stocks, options, futures

or cryptocurrencies?

Kilbride: I have had significantly more

success trading futures, but they scare me more than options, stocks and crypto combined. Ironically, because they have been my most successful trades, I enjoy them the most and keep going back to them.

Coleman: I am enjoying stock options the most, but I am looking forward to getting even more involved with trading futures.

What do you feel is your most valuable lesson from Tom Sosnoff to date?

Kilbride: Most of my confidence has come

from trusting the tastytrade mechanics and then committing to learning along the way, as opposed to the reverse of that statement (learning and then trusting).

Coleman: My most valuable lesson from Tom is that what happens on the market is not your fault. You cannot control the direction of the market, but we can choose to apply our mechanics and stick with them.

August/September 2021 | Luckbox

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THE PREDICTION TRADE

What Gamblers Can Learn From Superforecasters An understanding of an event’s base rate is a critical component of smart decision-making

By Warren Hatch

S

uccessful gamblers, like good forecasters, know how to translate hunches into numeric probabilities. For most people, however, this skill is not innate. It requires cultivation and practice.

In Superforecasting: The Art and Science of Prediction, a best-selling book co-authored with Dan Gardner, Phil Tetlock writes that “nuance matters. The more degrees of uncertainty you can distinguish, the better a forecaster you are likely to be. As in poker, you have an advantage if you are better than your competitors at separating 60/40 bets from 40/60— or 55/45 from 45/55.”

Good Judgment’s professional Superforecasters excel at this, but thinking in probabilities doesn’t come naturally to the majority of human beings. Daniel Kahneman and Amos Tversky, who studied decision-making under risk, found that most people tend to overweight low probabilities (e.g., the odds of winning a lottery) and underweight other outcomes that were probable but not certain. In other words, people tend to evaluate probabilities incorrectly even when making critical decisions.

Good Judgment training teaches that the first step in estimating correct probabilities is to identify the base rate—the underlying likelihood of an event. This is also the

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step decision-makers tend to ignore.

Base rate neglect is one of the most common cognitive biases that arise in training programs and workshops, and it generally leads to poor investing, betting and forecasting.

For those new to the concept, consider this classic example: “Steve is very shy and withdrawn, invariably helpful, but with little interest in people or the social world.

A meek and tidy soul, he has a need for order and structure and a passion for detail.” Is Steve more likely to be a librarian or a farmer?

A librarian or a salesman?

While the description, offered in Daniel Kahneman’s Thinking, Fast and Slow, may be that of a stereotypical librarian, Steve is in fact 20 times more likely to be a farmer—and 83 times more likely to be a salesman— than a librarian. There are simply a lot more farmers and salespersons in the United States.

Base rate neglect is the mind’s irrational tendency to disregard the underlying odds. Failure to account for the base rate could lead, for example, to the belief that participating in commercial forms of gambling is a good way of making money. Likewise, failure to factor in the house edge could lead to poor betting decisions.

Fortunately, the mind’s tendency to overlook the base rate can be corrected with training and practice.

Recognition of bias and noise,

and techniques to mitigate their detrimental effects, should be at the heart of any training for better decision-making. At Good Judgment workshops, debiasing interventions have consistently improved the quality of forecasting.

Another essential component is practice. On Good Judgment Inc.’s public platform, GJ Open, anyone can try forecasting—from predicting the next NBA winner to estimating the future price of bitcoin.

Unsurprisingly, those forecasters who use base rates and forecast on the platform regularly tend to have better results.

To stay on top, gamblers—like successful forecasters and professional Superforecasters—should seek out the base rate and mitigate other cognitive biases that interfere with judgment. While “thinking in bets” does not come easily to most people, better decision-making—in forecasting, investing and gambling alike—is a skill that can be learned.

With an awareness of cognitive biases, debiasing techniques and regular practice, anyone can acquire the mental discipline to handicap the odds more effectively.

Warren Hatch, a former Wall Street investor, is CEO of Good Judgment Inc., a commercial enterprise that provides forecasts and forecasting training based on the expertise and research of the Good Judgment Project. @wfrhatch

Most people tend to overweight low probability outcomes

Tune in to The Prediction Trade podcast from Luckbox for all-new ways to make money forecasting the financial markets, politics, crypto, sports and other events.

Luckbox | August/September 2021

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CALENDAR

AUGUST

July 29-Aug. 1 Lollapalooza

Chicago

5 OTCQB Venture Investor Conference Virtual

5 National IPA Day 12 National Vinyl Record Day

13-15 GAMEACON eSports Expo Rancho Mirage, CA

20-22 The Mid-States Poker Tour Larchwood, IA Aug. 30-Sept. 12 U.S. Open Tennis Championships Flushing, NY

PHOTOGRAPHY: (FESTIVAL) CAMILLE FINE/CHICAGO TRIBUNE/TNS; (RECORD) SHUTTERSTOCK

SEPTEMBER

2-5 Bonnaroo Music & Arts Festival Manchester, TN

6 Labor Day

10-12 Pitchfork Music Festival Chicago

13-15 SALT Conference New York

16-17 All American Sports Betting Summit San Francisco

17-19 Riot Fest Chicago

21 Financial Services Investor Conference Virtual

Summer Music Festivals Outdoor music festivals are returning after COVID-19 banished most of them last summer. The dearth of live shows during the pandemic left musicians without a source of revenue that had kept the music ecosystem’s heart beating. Cities that host the massive music gatherings also felt the economic impact. It’s estimated that the concert music industry lost $30 billion in 2020. And with the loss of Lollapalooza alone, Chicago lost out on nearly $35 million in sales for the city’s businesses and $9 million in earnings.

But now, Chicago will see the return of not only Lollapalooza but also Riot Fest and Pitchfork, albeit with rules, regulations and limits on crowd size for some venues. Lollapalooza, however, will kick off its events at full capacity (around 400,000 people) but will require proof of vaccination or a negative COVID-19 test each day. The concert industry and music fans seem ready for a comeback.

National Vinyl Records Day Sales of LPs and EPs decreased every year from 1981 to 1993, but vinyl records have made a comeback since then. By 2019, LP and EP sales volume reached 19.1 million units, an increase of 14.6% over 2018, according to the Recording Industry Association of America. As of February of this year, vinyl sales have continued to rise, increasing by 29.2% to $619.6 million, compared with $479.5 million in 2019, the association said.

SALT Conference The SkyBridge Alternatives Conference, also known as SALT, will convene in New York for three days of discussions concerning what organizers call “themes of alternative investments, bitcoin, fintech, healthcare, infrastructure and sustainability.” Although the event’s being held in person, it will include hybrid sessions. It’s important to bring the conference back at a time when New York could use an economic boost after a year of severe economic decline, said Anthony Scaramucci, who started the SkyBridge Capital hedge fund and the forum that bears its name. Scaramucci is also host of a weekly podcast, Mooch FM. Jeff Joseph, Luckbox editorial director, appears on episode No. 40 of Scaramucci’s podcast.

August/September 2021 | Luckbox

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tactics essential trading strategies

INTERMEDIATE

Betting on the Fed

Incorporating spread trades into a portfolio can open a whole world of opportunity

By Michael Gough

T

he once-sleepy interest rate environment is starting to awaken after a recent Federal Open Market Committee meeting. Following the Fed’s announcement at that gathering, U.S. 2-Year Treasury Yields jumped from 0.15% to 0.25% in a matter of days and then remained over 100% for weeks.

While the 2-Year yields have responded swiftly to the Fed’s decision, the opportunity extends beyond short-duration Treasuries with the whole yield curve shifting.

The U.S. Treasury market may be one of the largest and most actively traded markets in the world, but interest rates are still a nascent asset class for many DIY investors and traders. This is probably because of the market’s inherent legacy complexities.

While interest rates are quoted everywhere, trading products— such as the iShares 20+ Year Treasury Bond Exchange-Traded Fund (TLT) and CME Group 30-year Treasury Bond futures (/ZB)—are quoted in terms of price, which moves inversely to yields. Few traders, if any, can convert a Treasury bond price of 160 into an interest rate without a calculator (the corre-

Look to the past The price history of interest rates generates ideas for investors, speculators and hedgers.

7.0%

6.0%

5.0%

4.0%

3.0%

2.0%

1.0%

0.0%

Jan 2000

Jan 2004

Jan 2008

Jan 2012

Jan 2016

Jan 2020 dxFeed Index Services

sponding rate is 2.1%).

The Small Exchange offers an opportunity to engage in this market with a suite of treasury interest rate products quoted in yield. Small two-year, 10-year and 30-year interest rate futures remove the complexity of converting prices to yields. So, traders can execute on

Bullish (Bearish) on 10-year yields? Buy (Sell) /S10Y futures.

August/September 2021 | Luckbox

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tactics

How-to sheet Refer to this brief refresher for a reminder of how to structure yield curve spread trades.

get

lucky get

Yield Curve Spread Strategy

Action

Front Leg

Back Leg

Flattener

Buy Spread

Buy

Sell

Steepener

Sell Spread

Sell

Buy

their ideas as quickly as possible.

Bullish (Bearish) on 10-year yields? Buy (Sell) /S10Y futures. That simplicity enables participants of all types the ability to invest, speculate and hedge one of the most active asset classes.

Studying price history of interest rates in Look to the past, p. 47, generates several ideas for investors, speculators and hedgers.

Investors can view interest rates (across the curve) at or near their all-time lows and may believe they’re staging a massive “return-to-normal” trade.

For a speculator, two-year notes are responding sharply to Fed activity with an average historic daily move of $15 and an initial margin of just $62, making them an indispensable scalping vehicle.

A hedger would note that interest rates are the epitome of a stock portfolio hedge as exemplified by the -0.12 three-month correlation between 30-year rate futures and the S&P 500.

While investors can play interest rates independently, the simplicity of a yield-based quoting convention enables them to make very clean curve trades, such as flatteners and steepeners.

While experienced traders are all too familiar with DV01 conversions when trying to trade TUT (2-years vs. 10-years) and NOB (10-years vs. 30-years) spreads, all small interest rate futures spread trades can be done on a 1 to 1 basis.

Incorporating spread trades into a portfolio can open a whole world of opportunity.

For a brief refresher on how to structure yield curve spread trades, check out How-to sheet, above. Readers should remember that the front leg is always the shorter duration rate product.

Flatteners make money when the yield differential decreases or narrows. Steepeners make money when the yield differential increases or widens.

Michael Gough enjoys retail trading and writing code. He works in business and product development at the Small Exchange, building indexbased futures and professional partnerships.

For a speculator, two-year notes are responding sharply to Fed activity

More Tactics Does the Fed affect rates?

Subscribe at getluckbox.com

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tactics

Cheat Sheet #16

Rem o and ve s this ave page !

The Trading Game Be ready to revise your game plan. By Mike Hart

N

ew products and new types of trades are making investing feel more like a game. But don’t look to reinvent an approach to trading every cycle; instead, stick to a thought-out game plan that allows for adaptation and that can evolve with new information.

That strategy can benefit traders who are looking to create active portfolios. By thinking of trading as a game, they can remove the emotional dimension and instead base decisions on predetermined rules.

To turn trading into a game, establish key components that include mechanical processes and repeatability. Have a playlist of steps and perform them repeatedly.

Mechanics should make 80% of trade decisions. The remaining 20% is the trader’s intuition or “gut feeling.” To maintain that mix, use the rules on the right.

Mike Hart, a former floor trader at the Chicago Stock Exchange and proprietary futures trader, specializes in energy markets and interest rates. He’s a contributing member of the tastytrade research team. @mikehart79

1

2

Entering a trade is a mechanical process.

Be sure to note liquidity, volatility and expiration data.

This study compares managing early at 50% of max profit (at 21 days to expiration) versus holding options to expiration.

Managing the trade was profitable more often, realizing more than twice the return.

High Liquidity Spreads $0.20 or less

Held Options To Expiration

Managed Options Early

Time

SPY – S&P 500, 2000 – 2021, Options sold with 45 days to expiration, Sold 16 Delta Strangles

Options expire between 30 and 60 days

Profitable

84%

91%

Average Daily Profits

$1.40

$3.20

Implied Volatility n High over 20 IVR, Sell options for a credit n Low under 20 IVR, Buy options for a debit

3

4

As a defensive move, increase credits and probabilities by rolling the trade. That means closing out the existing position and coming back in at a more favorable strike.

Initiate the roll when stock price trades past short strike, which is called getting “tested.”

Close out the trade if any one of these criteria is met.

How To Roll Short Strangles Roll Up

Roll the untested side to a higher delta same cycle

Roll Out

Roll position to a new expiration cycle

Go Inverted

Roll non-tested side to a strike past the tested side

Exit Criteria Trade reaches 50% of max potential profit Trade has less than 21 days to expiration Your assumptions changed and you no longer want to be in the trade

Active Investor Alert!

Follow @mikehart79 on Twitter for daily trading ideas and tactics.

August/September 2021 | Luckbox

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tactics

ADVANCED

Three Ways to Play Long Odds Options enable active investors to quantify and manage risk. But sometimes they may want to try for a big score with low-probability, high-return strategies.

By Michael Rechenthin

I

nvestors want to see their portfolios grow in value— it’s why they generally steer a course toward higher-probability trading strategies. But they would do well to think in terms of repeatable “investable strategies” instead of “speculative strategies” over the long term.

Yet, what if someone has a hunch? There’s nothing wrong with placing speculative trades, as long as investors understand they have a low probability of success.

Here are some speculative strategies and the pros and cons of each.

1 The Butterfly Spread In the Advanced Tactics section of the last issue, Luckbox discussed speculation with butterflies. It’s a low-probability trade often accomplished for a small debit (i.e., cost). The cheaper the butterfly, the less capital is required and the more the max loss declines.

The idea is to have the two middle short strikes where the stock is expected to land.

For example, suppose a trader predicts that DraftKings (DKNG), at ~$48, will pinpoint 60 at expiration. (See the table below.)

Buy 1x 55 puts in August Sell 2x 60 puts in August Buy 1x 65 puts in August Traders can accomplish this for a $40 debit.

Objective Target a $60 stock price

Probability Max of Profit Profit

Max Loss

Account Buying Power Required

Very Low

$40

$40

$460 if the stock lands at 60

2 Long an OTM option This is among the least favorite “speculative” trades because the probability of success is low and the costs can be substantial— especially for stocks with the highest volatilities. The higher the volatility, the higher the expected movement and the higher the costs. The higher the costs, generally the lower the probability of making money.

The good news is that it’s easy to determine the breakeven—it’s simply the strike bought with the cost of the option accounted for.

Suppose, for example, a trader predicts that Caesars Entertainment (CZR), at let’s say a price of $90, will increase above $102.50 by expiration (see the table below).

Buy 1x 100 calls in August The trader accomplishes this for a $5 debit.

Objective A price increase above the strike + the debit paid = $102.50

Probability of Profit

Max Profit

Very Low

Unlimited

Max Loss Costs paid of $250

Account Buying Power Required $250

This is generally the least-preferred method of speculation, especially when stocks have higher levels of volatility.

The table below for Activision Blizzard (ATVI) shows an example of the stock with much lower levels of volatility but a similar stock price. Notice that the price of the call is much lower.

Buy 1 x 100 calls in August This is done for a $1 debit.

Objective A price increase above the strike + the debit paid = $101

Probability of Profit

Max Profit

Very Low

Unlimited

Max Loss Costs paid of $100

Account Buying Power Required $100

August/September 2021 | Luckbox

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tactics

There’s nothing wrong with placing speculative trades, as long as investors understand they have a low probability of success.

3 Objective

The OTM vertical spread This strategy isn’t always discussed, but traders can use it to speculate. The costs are low because of the credit received from the short option. It’s still a low-probability event but higher than buying the long option by itself.

Suppose a trader predicts Caesars will increase above $101 by expiration. (See the table, right).

Buy 1 x 100 calls in August Sell 1 x 105 calls in August This is done for a $100 debit.

2108-tactics-adv.indd 50

A price increase above the strike + the debit paid = $101

Probability Max of Profit Profit Low

$400

Max Loss Costs paid of $100

Account Buying Power Required $100

Michael Rechenthin, Ph.D., aka “Dr. Data,” is the head of research and development at tastytrade. @mrechenthin

7/21/21 9:13 AM

trades actionable trading ideas

CHERRY PICKS

R I PE & J U I CY T RADE IDEAS

Naked Puts for the Risk Averse

By Michael Rechenthin n the Tactics section of this issue, an article entitled Three Ways to Play Long Odds (p. 49) offers three strategies for placing speculative trades. Here, readers will find an “anti-speculative” strategy that’s less risky than buying stock.

It’s called the naked put in a liquid exchange-traded fund (ETF) such as SPY, QQQ, IWM, DIA or XLU. This is the equivalent of taking a long position in a stock but with less risk. For an example, take a look at Anti-speculative strategy, right. SPY is the equivalent of buying shares of the S&P 500 three years ago. The naked put (PUT) is the equivalent of selling an at-themoney put in SPY using the option expiring closest to 30-days until expiration. This is held and then repeated.

Notice the simple put underperformed during this period. But it’s OK to underperform the market, even though financial gurus often suggest investors have to outperform a benchmark to be successful.

The advantage of the short put is it tends to make money more consistently and with less volatility on a month-to-month basis. Less volatility simply means the position will have a tendency not to move too much. It will have lower peaks and higher troughs.

I

Sign up for free cherry picks and market insights at info.tastytrade.com/cherry-picks

Anti-speculative strategy The naked put is selling an at-the-money put in SPY using the option expiring closest to 30 days until expiration. Notice the volatility is less than buying SPY itself.

60% SPY PUT 40%

20%

-20% Jan 2018 May 2018 Sep 2018 Jan 2019 May 2019 Sep 2019 Jan 2020 May 2020 Sep 2020 Jan 2021 May 2021 Sep 2021

For a lot of savvy investors, trading isn’t necessarily about making 10%, 20% or 30% returns on a yearly basis because those high returns often come with a higher likelihood of large losses. Instead, many would prefer the consistency that comes with selling a put in an ETF that they wouldn’t mind getting long in.

... the equivalent of taking a long position in a stock but with much less risk.

August/September 2021 | Luckbox

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trades

FOREX

F R E E- F LOAT I N G M AC RO I N S IG HTS FRO M G LO BAL CU R R ENCY T RADERS

Yen Trends as Fed Eyes Rate Hikes

By Ilya Spivak

his writer has argued in the past two issues of Luckbox that structural factors beyond “base effects” of the COVID-19 slump in 2020 were likely to make this year’s inflation pick-up stickier than the “transitory” rise envisioned by the Federal Reserve.

The Fed seemed to revise its stance accordingly at June’s momentous Federal Open Market Committee meeting. Officials said they were shifting the timeline for an upcoming interest rate hike because price growth had surpassed expectations.

Having previously anticipated keeping rates flat through 2023, Fed officials now pencil in two rate hikes that year. The priced-in market view implied in Fed Funds futures following the announcement is more aggressive still, envisioning one hike in 2022 and two more in the following year.

It’s not surprising that this pivot drove up near-term borrowing costs and sent the dollar sharply higher against other major currencies.

T

The rising yen A near-parallel rise in the Japanese yen is perhaps a bit more surprising. The Bank of Japan has maintained an ultra-dovish policy stance for the better part of 30 years amid an epic—and mostly fruitless—struggle to bring price growth up to the target of 2%.

A rise in borrowing costs worldwide led by the Federal Reserve, which usually sets the overall trend because of the dollar’s ubiquity as the global medium of exchange, may have been seen as yen-negative.

That’s because the yen serves as investors’ go-to “funding currency” of choice. Because rates in Japan have been so low, traders popularized a “carry trade” strategy of borrowing cheaply in yen to buy higher-yielding assets and thereby extracting the differential as an

52

Dovish Japan?

Because most nominal rates have converged near zero, the size of the inflation haircut has become pivotal.

Five-year Real Yield (%)

Spread vs. Japan (bps)

United Kingdon

-2.938

-260.0

Germany

-1.750

-141.2

United States

-1.593

-125.5

Australia

-0.962

-62.4

Japan

-0.338

0

Five-Year Breakeven Inflation (%) Inflation expectations in Japan are relatively low compared with its global counterparts.

Japan Germany

0.25 1.17

Canada US UK

1.96 2.47 3.28 Source: Bloomberg

income stream.

That approach works best when interest rates are on the rise globally, growing the yield disparities available to exploit. A more hawkish Fed portends just that.

The difference this time seems to be that global policy rates have converged on Japan— moving toward zero and sometimes beyond it into negative territory—collapsing yield spreads.

Recovering from these depths in most places is expected to come together with reflation.

Indeed, as the Fed has made apparent, that’s the driver of the latest outlook change.

However, that does not mean that the structural forces holding down prices in Japan for

decades have evaporated.

So, real interest rates, the nominal yields discounted by the rate of inflation, have turned out to be higher in Japan than most major economies.

Because most nominal rates have converged near zero, the size of the inflation haircut has become pivotal. It’s inherently small in Japan relative to global counterparts, so the inflation-adjusted yield to be had on yen-denominated holdings has emerged as more attractive. It’s the old “carry trade” upside down.

Rising borrowing costs Dovish action from the Bank of Japan (BOJ) is an obvious counter to this narrative. Gover-

Luckbox | August/September 2021

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trades

British pound/yen, weekly A break of seven-month rising trend support bolsters the case for topping in the British pound/yen.

Source: TradingView

nor Haruhiko Kuroda and company already run a yield curve control regime by committing to buy Japanese government bonds in whatever amount is needed to keep the 10-year rate pinned at no more than 0%. If that could continue to work, it might erode the yen’s baseline nominal—and thereby real—yield advantage.

However, that policy seems fragile. The BOJ’s asset purchase effort, one of the pillars of its long-running stimulus program to overcome structural disinflationary barriers, has already gathered nearly half of the country’s bond issuance.

The ability to do more seems limited because critics could accuse the central bank and the government itself of outright debt monetization, an international taboo.

In fact, abandoning this element of the policy mix in the face of mounting external pressure that’s pushing rates higher may become a potent accelerant for any yen gains encouraged against this backdrop.

It brings to mind the Swiss National Bank’s unceremonious abandonment of the 1.20 floor on the euro/Swiss franc exchange rate in 2015 and the utter chaos triggered by the subsequent Swiss franc surge.

Surveying the major currencies, the yen’s most pronounced advantage in this sense seems to be against the British pound. Here, Japan enjoys a real-rate premium of 257 basis points on five-year paper.

While the nominal five-year rate in Japan is -0.102% and the equivalent in the UK is 0.378%, the former country has an expected breakeven inflation rate of just 0.25% at the same tenor (that is, five years). For the latter, this is a whopping 3.3%.

The technical picture appears to support the case for the British pound/Japanese yen currency pair’s downturn. Negative RSI divergence points to ebbing upside momentum as prices test resistance near the January 2018 high.

A break of seven-month rising trend support bolsters the case for topping in the GBP/JPY. Pushing past immediate swing low support at 151.32 may expose a critical juncture in the 148-149 zone. A further breakthrough might also take out the uptrend from March 2020.

The technical picture appears to support the case for the British Pound/ Japanese Yen downturn.

Ilya Spivak is head strategist for Asia-Pacific markets at DailyFX, the research and analysis arm of retail trading platform IG. @ilyaspivak

August/September 2021 | Luckbox

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trades

CRYPTO CURRENTLY

T H E STAT E O F C RYPTO CU R R ENC IES AND DEC ENT RALIZED FINAN CE

Bitcoin Bets & Game Theory

By Mark Helfman

he best investors and gamblers have something in common. They share an emphasis on game theory—a rational way to quantify the expected gains from decisions and probabilities.

While generally applied to economic decisions, game theory can also help gamblers identify optimal moves in games like poker that involve a series of decisions.

But most investment analysis relates to intrinsic value, macroeconomic trends, and trading and hedging strategies. Billionaire investor Paul Tudor Jones, for example, wants to allocate 5% of his portfolio to bitcoin to protect against inflation while he’s strategizing to take advantage of the occasional booms.

Many mainstream investors choose exchange-traded funds, or ETFs, to provide access to new financial technology. Active

T

traders, on the other hand, may want to play in a volatile asset class.

So, what happens when they set aside those considerations in favor of game theory?

Instead of looking at the merits of bitcoin as an asset, they would consider the potential outcomes of a decision to buy it or not.

Past as prologue?

Investors need only to glance at the chart entitled Ever upward, pg. 55, to spot an obvious trend: Bitcoin goes up in value.

Not just up, but way up—from $0.003 to $30,000 over 12 and a half years, and $400 to $30,000 over the last five years.

The Ever upward chart also indicates bitcoin’s upswings of more than 1,000% and crashes of greater than 80%. (The chart doesn’t show the fake trading, criminal activ-

ity, bans, scams, manipulation, speculation and all sorts of other shenanigans that have marred bitcoin’s history. But we’re not looking at that. We’re considering only the investment case.)

Bottoms go up, too It’s also worth noting that during bitcoin’s boom-and-bust cycles, its price never dips below the 200-week moving average, a measure of price over time. That line always goes up, as shown in Ever upward.

Coincidentally, that moving average correlates with on-chain data and trading patterns that mark every major market bottom.

As long as those patterns continue, the 200-week moving average should serve as the floor for bitcoin’s price. At the same time, savvy players can use that line as a stop-loss.

Once the price goes below, the trend breaks and signals an opportunity to get out before the inevitable fall to zero.

Choices and consequences Bitcoin is a speculative investment that has averaged 200% returns year-overyear. So far, its price never stays below its 200-week moving average and always goes higher over time.

For investors considering whether to put, say, $300 into bitcoin as a long-term portfolio asset, here are the most likely outcomes:

Outcome 1: Bitcoin’s price drops below the 200-week moving average ($13,000 today).

Result: lose $170.

Outcome 2: Bitcoin behaves like other commodities—sometimes up, sometimes down. Result: break even with opportunities to take profits once in a while.

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Outcome 3: Bitcoin’s price continues to go up 200% each year, on average, and sometimes up 1,000% or more. Result: $600 on average each year, with an occasional massive windfall.

Outcomes 1 and 2 have never happened.

Outcome 3 has always happened. So which appears most likely?

It’s impossible to say. Nobody can predict the future. Sometimes patterns stop. But from a gambler’s perspective, it’s not the worst bet.

Far from it.

Does that mean bitcoin will continue to grow? For those who believe it will, buying is mandatory.

For those who don’t believe it will, what other long-term passive investment offers better risk-adjusted outcomes?

Mark Helfman, crypto analyst at Hacker Noon, edits and publishes the Crypto Is Easy newsletter at cryptoiseasy.substack.com. His second book, Bitcoin or Bust: Wall Street’s Entry Into Cryptocurrency, reached No. 2 on Amazon. @mkhelfman

2108-trades-crypto.indd 55

Ever upward Despite bitcoin’s boom-and-bust cycles, its price never dips below the 200-week moving average, a measure of price over time.

BTC Price 200 Week Moving Average

Source: LookIntoBitcoin

7/21/21 9:05 AM

trades

DO DILIGENCE

QU I E T FOU N DAT I O N HELPS P ROACT IV E INV ESTO RS U NDERSTAND T HEI R PORTFOLI OS

Lucky Gambling Stocks

By James Blakeway

here was a time when Americans who felt the itch to gamble packed a bag and flew to Las Vegas to revel in one of the few meccas of legal gambling on the continent. Failing that, they could make a cash bet with a buddy that Michael Jordan would score more than 30 points that night.

But times have changed. More states have legalized gambling and online sports betting, paving the way for companies to cash in on Americans’ love of wagering.

That brings opportunities for investors because some of the nation’s top gambling firms are publicly traded. It provides a sub-sector for diversification, but keep in mind that investing in gambling firms represents another bet on discretionary consumption.

For investors looking to stick with the traditional Las Vegas companies, stocks offer access not just to casino profits but also to a post-COVID resurgence in tourism.

Publicly traded firms own the largest brands on the Las Vegas Strip. In the traditional hotel and casino market, investors can choose among shares in Caesars Entertainment (CZR), Wynn Resorts (WYNN), MGM Resorts (MGM) and Las Vegas Sands (LVS).

Both Caesars and MGM have more than recovered from the

T

slump of early 2020, while Wynn and Las Vegas Sands both saw their peak prices in 2018 and have not touched them since.

Macau and beyond

Of the four companies, Las Vegas Sands is betting the most on international markets. Despite still trading on the New York Stock Exchange, many of Las Vegas Sands’ properties are now located in Asia, with five in Macau and the iconic Marina Bay Sands in Singapore.

Keep that international concentration in mind. With the company’s stock well below its 2018 high of $81.45, investors may find upside opportunities as the tourism industry continues to recover around the world.

For other exposure to the Macau gambling market, investors can analyze Melco Resorts (MLCO), which trades on the NASDAQ. Much like Las Vegas Sands, Melco is above the 2020 lows but still far from its 2018 peak of $32.95.

While many still consider Las Vegas the gambling hub of the country, wagering-oriented firms continue to expand across the nation. States continue to relax gambling bans and restrictions, happy to accept the tax revenue and economic opportunities that gambling affords.

Two companies that stand out are Boyd Gaming Corp. (BYD)

While many still consider Las Vegas the gambling hub of the country, wageringoriented firms continue to expand across the nation.

and Penn National Gaming Inc. (PENN). Both operate portfolios of casinos across the country. In January 2020, Penn acquired a 36% stake in Barstool Sports, and the companies launched Barstool Sportsbook in September. They plan to continue expansion of their online sports-betting business. Both Boyd and Penn saw massive rallies in their stock price from the middle of 2020 to early this year before recent pullbacks.

Investors looking for a more direct sports-betting investment can look to DraftKings Inc. (DKNG), which IPO’d via a SPAC (special-purpose acquisition company) merger in late 2019.

Since then, DraftKings’ shares experienced a volatile rise to a high of $74.38 in March. Investors feeling bullish on the company’s continued expansion into new markets and product offerings may wish to take advantage of any steep slumps in the stock price.

Longer-term, investors should keep their eyes on California in 2022, when sports gambling will be up for legalization via ballot initiative. Legalized sports gambling in the country’s most populous state would be a game-changer for companies.

Exchange-traded funds

In many industries and subindustries, exchange-traded fund provid-

Past performance is no guarantee of future results. Information provided in an EPI Report does not consider the specific profile, objectives or circumstances of any particular investor or suggest any specific course of action.

Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her investment professional. Investment suitability must be independently determined for each individual investor. QF does not make suitability determinations or investment recommendations for investors. EPI utilizes the S&P 500 as its benchmark given that the S&P 500 is considered a barometer of stock performance in the United States. Aspects of the analysis and information found in an EPI Report are based upon simulated and/or hypothetical performance. Simulated and hypothetical performance have inherent limitations and do not represent the actual performance results of any particular investment products. The EPI Report does not guarantee any results or outcomes in the financial markets. Investors should be aware of the methodology used to produce an EPI Report and the inherent limitations when placing reliance on the results. For additional information about EPI Reports, visit the QF website: quietfoundation.com.

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DraftKings as royalty Stock prices for DraftKings Inc. far outpaced other gambling industry stocks.

DKNG 500%

PENN BYD

400%

CZR MGM

300%

WYNN LVS

200%

MLCO 100% 0%

Jan 2020

Mar 2020

May2020

Jul 2020

Sep 2020

Nov 2020

Jan 2021

Mar 2021

May 2021

Jul 2021

-100%

Data as of June 23

ers capitalize on the chance to offer a bundled investment option. That holds true for the gambling industry with VanEck offering the VanEck Vectors Gaming ETF (BJK).

The fund holds 40 national and international gambling firms, including all of the stocks mentioned above. The ETF seeks to track the MVIS Global Gaming Index but does so with a higher expense ratio (0.65%) than a typical index ETF. Additionally, the VanEck ETF saw an average of only 49,000

More Alpha Boost your portfolio’s return

shares traded per day in 2021, often trading with a $0.20 bid-ask spread.

That combination of a higher expense ratio and lower liquidity could make investors wary.

Instead, investors may choose to allocate capital across a variety of gambling-focused firms.

Most of the stocks listed here cost $100 per share or less, making diversification an easier endeavor for small accounts in the new age of zero stock commissions.

Larger bullish traders, comfort-

able with the risks of short put options, may look to sell puts in Las Vegas Sands and Melco Resorts, both of which show negative returns for 2020 and 2021. As indicated, this is a bet that tourism and gambling will bounce back in Asia, especially in Macau.

Despite the recent pullbacks in DraftKings and Penn National, some traders may still believe the stocks are overvalued. Those with bearish outlooks may consider long put spreads or long put calendars as a strategy, given the current low implied volatility.

Options traders looking for ideas to enhance their positions and add new diversified trades may be interested in Alpha Boost. This upcoming service from Quiet Foundation will analyze a portfolio and present options trade ideas in names like Las Vegas Sands and DraftKings, as well as other liquid stocks and ETFs. While it can be tempting to go all-in, remember to stay diversified, never bet it all on black and always do your due diligence.

James Blakeway serves as CEO of Quiet Foundation, a data science-driven subsidiary of tastytrade that provides fee-free investment analysis services for self-directed investors. @jamesblakeway

What happens in Vegas...

Publicly traded firms own the largest brands on the Las Vegas Strip.

Data as of June 23, 2021.

Company

Caesars Wynn Resorts Entertainment

MGM Resorts

Las Vegas Sands

Melco Resorts

Boyd Gaming

Penn National Gaming

DraftKings

Symbol

CZR

WYNN

MGM

LVS

MLCO

BYD

PENN

DKNG

Notable Properties / Businesses

Caesars Palace Paris Hotel Harrahs Flamingo Planet Hollywood

Wynn Las Vegas Wynn Macao Encore Boston

Belagio Mandalay Bay MGM Grand Mirage

The Venetian (Las Vegas & Macao) Marina Bay Sands (Singapore) The Plaza & Four Seasons (Macao)

City of Dreams Macao Studio City Macao

Fremont Ameristar Gold Coast B-Connected Sports

Barstool SportsBook Hollywood Casino Group Boomtown Casino Group

DraftKings Sportsbook Draftkings Casino

2020 Return

24.5%

-18.1%

-4.6%

-12.0%

-22.5%

43.4%

237.9%

335.1%

YTD Return

39%

11.6%

36.9%

-10.5%

-7.9%

42.1%

-11.1%

8.5%

August/September 2021 | Luckbox

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THE TECHNICIAN

A V E T E RA N T RA DER TAC K LES T EC HNICALS

Cryptocurrencies: Gambling or Investing?

By Tim Knight

ost people can’t help wanting to parlay a small investment into a windfall. So they buy real estate, procure precious metals, execute options trades or bet on horse races.

At one extreme, they make reasoned, logical, fact-based investments. At the other extreme, they risk their bankrolls on reckless wagers with a good chance of failure and a small chance of an outsized return.

What distinguishes an “investment” from a “gamble” comes down to a personal judgment based on experience, values and even religious upbringing.

Most visitors to Las Vegas are clearly gambling and, on the whole, losing money. That’s because multi-billion-dollar corporations haven’t set up shop in the desert out

M

of the goodness of their collective hearts. They’re there to make money.

Yet with sufficient knowledge of games of chance and enough experience, some players could be considered investment professionals.

At the same time, straitlaced puritanical critics view the simple act of purchasing common stock with the intent of holding it for years as “gambling.” They even utter the word with contempt.

Gambling or investment?

In the world of investment, observers don’t think of a decision as “gambling” if it’s backed with knowledge, has an appropriate risk/reward ratio and there’s a commitment to longevity.

“Gambling” can even have a positive connotation if it means the execution of a relatively short-term,

well-reasoned decision based on probabilistic outcomes.

And one of the most appealing new vehicles to do just that is cryptocurrencies. Investors don’t need to understand the technical details of how crypto works to succeed, but it helps to have a basic grasp of these financial instruments.

Good as gold? Better!

When crypto burst upon the scene a few years ago, some viewed it as a digital form of precious metals.

They lauded it as a hedge against inflation, a refuge from the frailties of fiat and a seething rebuke to the authority of central bankers.

But crypto’s even better than that. As an investment, it has some tremendous advantages over the physical world of precious metals.

Specifically: n Extremely tight bid/ask spreads.

For crypto, these are virtually non-existent, whereas the bid/ask with physical gold feels as though it’s a mile wide. Traders who stroll into a precious metals shop or execute an order with a large retailer instantly lose between 5% and 15%.

That’s the difference between what a buyer pays a shop and what a shop pays a seller—in other words, retail versus wholesale. n Around-the-clock access. What if it’s Saturday morning and someone suddenly feels a desperate need to sell a stockpile of gold bullion? Well, tough. They’ll have to sweat it out for 48 hours until a dealer opens on Monday and then sell it for whatever

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the price happens to be by the time opening rolls around. They could sell crypto anytime the mood strikes, day or night, 365 days a year. n Size of movement. Crypto has moved hundreds, thousands or even tens of thousands of percentage points over the years, whereas precious metals have, relatively speaking, hardly budged. That’s exciting when it goes up, but it can fall much more swiftly than more standard investments, as multiple instances of 50% plunges have illustrated. However, crypto has proven vastly superior to most investment vehicles in its capacity for larger returns, even without leverage.

An insular world So what does crypto have to do with a large alkaline body of water in the West? Well, airline passengers flying above the state of Utah often glance out the window to see the Great Salt Lake.

It’s huge and impressive, but it’s a mere remnant of Lake Bonneville, which once covered what is now the massive Bonneville Salt Flats.

This Utah “sea-change” can serve as a metaphor for crypto. The money flowing into crypto pretty much goes in one direction. The reason is simple: It’s an enormous task to make it flow in the other direction.

Yes, some services permit relatively easy conversion of crypto into fiat. But most fiat that’s been turned into crypto simply remains in crypto-land, either locked away in digital wallets or being converted from coin to coin. It constitutes a veritable financial sea unto itself.

Changing crypto into green cash to spend at Whole Foods requires a whole series of steps. It takes effort, it takes time and, generally speaking, it’s a hassle that most people would prefer not to endure.

So, not many people make deposits into crypto accounts with the idea of hopping between spendable fiat and crypto. The money goes in and does the only thing it’s capable of doing easily, which is being

Cryptocurrencies have some tremendous advantages over the physical world of precious metals.

converted from one coin to another.

Thus, the gigantic Lake Bonneville represents the $6 trillion that the Federal Reserve Bank created and has found its way into all manner of assets.

The fraction that remains— symbolized by the much smaller Great Salt Lake—is the $2 trillion of various cryptocurrencies out there.

The rest of the “water” has retreated elsewhere for other more traditional purposes, such as buying houses, cars, groceries, gasoline, vacations and equities.

But the isolated body of water surrounded by hostile desert isn’t going anywhere. Think of it as an island made of water, so to speak, conjured from the largesse of the Fed. Because otherwise, it simply would not exist.

Another crypto metaphor Here’s a way of thinking about crypto as a tool for successful gambling. Imagine a hodgepodge of lakes—hundreds of them. Let’s call a huge one Lake Bitcoin. Some are smaller but still substantial, including Lake Ethereum, Lake Cardano and Lake Litecoin. Some seem like tiny puddles at risk of evaporating in the midday sun.

Meanwhile, people scurry around on dry land, pitchers in hand, ready to scoop water out of one lake and into another. Some don’t bother and simply leave the water where it is.

Others move water actively.

But the size of each lake changes constantly, growing larger or becoming smaller. Sometimes the entire region benefits from a huge rainstorm of fresh fiat. Other times, a scorchingly hot day diminishes the bodies of water, much the way the entire crypto market shrinks when China threatens to ban crypto for the umpteenth time.

Those who choose to “gamble” in this metaphorical universe most likely will prosper if they figure out which lakes will become larger and which will grow smaller. It’s all because Fed Chair Jerome Powell

opened the heavens and dumped a diluvial cataclysm.

Chart-friendly crypto One vitally important characteristic of crypto trading that aids good judgment and discourages of wild guesses is this: It’s chart friendly.

What that means in this context is that, simply stated, cryptocurrencies appear to “obey” classic lessons and methods of technical analysis far better than any other markets.

The reason, almost undoubtedly, is that cryptocurrencies operate in a classic, organic market. Indeed, there is probably no market more purely classical than crypto.

Think of the stock market since the year 1987. Only a fool would believe that the federal government hasn’t had a tremendous influence over equities during the past third of a century.

Between the trillions of dollars the government has spent on quantitative easing, the “Plunge Protection Team” created following the 1987 crash, the endless speeches, programs and tax regulations directly in support of creating a “wealth effect,” it has reached the point—as it did years ago in Japan— that the government has vastly more influence over the ups and downs (but mostly ups) of the market than the general public does.

Crypto, on the other hand, is a classic market of buyers and sellers, supply and demand, booms and busts—all without the meddling of an exogenous governing force which is “just trying to help.” Take note of the two crystal clear examples in Spring into bitcoin, on p. 60.

First, the red circle shows a trendline break, which warned of an immediate drop in price of literally 50% in a matter of weeks. The second, marked with the green arrow, shows how important support was provided by a trendline spanning several years. Simply stated, when it comes to crypto, technical analysis works.

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Post-diluvian attitude Set aside the futurists who point to crypto as the basis for a new economy. Eschew the political missives that declare crypto a libertarian dreamscape made possible by blockchain ledgers. What matters to a profit-seeking decision-maker is interpreting the possibilities of crypto as something similar to the more familiar turf of equities and options.

With that viewpoint, seize the opportunity to focus on which metaphorical lakes provide the best chance of a successful gamble. The next issue of Luckbox will provide methods for that analysis.

Tim Knight has been using technical analysis to trade the markets for 30 years.

He’s the host of Trading the Close on the tastytrade network and offers free access to his charting platform at slopecharts.com. @slopeofhope

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Spring into bitcoin This bitcoin chart shows a trendline break (red circle), and the green arrow shows how important support was provided by a trendline spanning literally years.

60000 55000 50000 45000 40000 35000 30000

25000

20000

0.0%

Source: slopecharts.com

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FUTURES

A SAV V Y F U T U R ES T RA D ER’S TAK E O N T HE M AR K ETS

Lighting up Cannabis Futures

By Michael Gough

ullish or bearish, most traders have an opinion on pot stocks, and those opinions have manifested themselves in the volatility of the prices. Tilray Inc. (TLRY), for example, has seen prices as low as $2.50 and as high as $215 in its short threeyear lifetime on public markets. It’s currently trading for roughly $15.

While it’s anybody’s guess where the stock prices go from here, day traders, investors and short-sellers alike can agree this sector is bursting with opportunity.

But with so many cannabis stocks to choose from, how might one decide which is the right product? Look at the wide range of performances of some of the most popular names in “Pot proliferates,” below.

For more holistic exposure, consider the new Small Cannabis Equity Index (S420),

B

Pound for pound, cannabis futures are immensely more capitalefficient than single pot stocks or exchange-traded funds. which tracks the performance of 21 liquid, large-cap cannabis industry companies listed on the New York Stock Exchange and Nasdaq.

Besides Tilray, stocks comprising the underlying index include Aurora Cannabis Inc. (ACB), Canopy Growth Corp. (CGC) and Cronos Group Inc. (CRON), to name a few.

There’s also exposure to blue-chip tobacco companies, such as Altria Group Inc. (MO) and Philip Morris International Inc. (PM), that are attempting to break into the canna-

Pot proliferates With so many cannabis stocks to choose from, traders might consider the broad exposure of the new Small Cannabis futures.

TLRY OGI

300%

HEXO 250%

S420 CHRON

200%

ACB 150% 100% 50% 0%

Jan 2021

Feb 2021

Mar 2021

Apr 2021

May 2021

Jun 2021

Jul 2021

Source: dxFeed Index Services

62

bis sector. For a full list of the components of the Small Cannabis Equity Index, check out indexit.dxfeed.com.

While exchange-traded funds (ETFs), like the Alternative Harvest MJ, track a similar basket, Small Cannabis futures offer several benefits that ETFs don’t have, including efficient margining, less stringent day-trading requirements and more favorable tax treatment.

Pound for pound, futures are immensely more capital-efficient than single pot stocks or ETFs. While stocks and ETFs are margined at 50% to 100% of their notional exposure, Small Cannabis futures exposure can be achieved for roughly 15% their notional size.

That means investors need roughly $200 in margin to buy or sell one contract of Small Cannabis, which provides nearly $1,200 worth of cannabis stock exposure. Whether investing or trading, they can use those savings to increase exposure, diversify a portfolio or hedge.

Besides being capital-efficient, futures are flexible for day trading. Investors can sell futures contracts just as easily as they bought them and with the same margin requirement.

Short-sale restrictions or unduly, hard-toborrow costs never prevent capitalizing on market activity.

Plus, for small-account traders, futures contracts are not subject to the FINRA (Financial Industry Regulatory Authority) Pattern Day Trading Rule. So, with a roughly $200 margin and an average historic daily move of just $35, Small Cannabis futures were neatly designed for accounts of all sizes.

As a bonus, the IRS views futures as 1256 investment products and taxes them differently from stock, options and ETF trades.

Unlike stocks and ETFs, which are taxed at either a short- or long-term rate, depending upon the duration of the holding period, futures gains are taxed at a blended 60% long-term rate and a 40% short-term rate, regardless of the holding period. That can potentially net a profitable trader thousands of dollars in savings over time.

Regardless of one’s opinion of cannabis, investors would do well to take a look at Small Cannabis futures for a novel way to invest or day-trade 21 of the most actively traded and liquid pot stocks with more efficient margining, flexible day-trading capabilities and more-effective tax rates.

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Billy GOAT: Big Bets and Bad Beats Billy Walters, one of the most successful sports bettors in history, revolutionized sports wagering by using algorithms and computers to analyze team and player statistics, and mispriced betting lines as part of a band of bettors called “The Computer Group.”

In 2011, after winning a well-publicized $3.5 million wager on the Mickelson Trump underdog New Orleans Saints in Super Bowl XLI, Walters told 60 Minutes he had never had a losing year as a gambler and had won as much as $50 million in some years.

But his lucky streak hit a snag in 2017 when he was indicted for insider trading in Dean Foods to pocket more than $40 million. Enter a new luckbox—golfer Phil Mickelson, who was betting frequently on Walters intel.

As reported in a 2017 Golf Digest story, “most insider-trading prosecutions begin with two people—known as a tipper and a tippee.” The first is an insider with a duty to keep corporate information secret, and the second sells stock based on the tip from the insider. Billy Walters was a prototypical tippee. The complexity arises when the tippee passes inside information to a third party—in this case, from Walters to Phil Mickelson, according to the article.

“If Mickelson traded on this information (as he apparently did) but had no contact with the original insider (as he apparently did not), was Mickelson guilty of a crime?” Mickelson was never indicted. Despite a vigorous defense, Walters was found guilty of fraud and conspiracy. The court handed down a five-year prison sentence and fined Walters $10 million. But after four years of incarceration, Walters’ luck resumed when the pandemic prompted his release to home confinement. This past January, Donald Trump commuted his sentence with the support of Mickelson and former Senate Majority Leader Harry Reid.

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More Walters & Mickelson (Golf Digest)

PHOTOGRAPHY: (WALTER) BRENDAN MCDERMID/REUTERS; (MICKELSON) KYODO/REUTERS; (TRUMP) EDUARDO MUNOZ/REUTERS

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