Hedging releases capital
King Yao is the author of Weighing the Odds in Hold‘em Poker, and Weighing the Odds in Sports Betting. He uses his experience in financial derivative markets and translates it into casino play. Since he left his trading position in 2000, he has been playing poker and betting on sports. He travels to Las Vegas frequently, especially during football season.
The hedge releases capital
When you own shares of stock, you do not need to put up additional capital to sell those shares. On the other hand, if you bet on one team and then decide to “sell” by betting on the other team, you usually have to come up with funds for the second bet just as you did for the first one, and you have to wait until the event is over before you can collect, even if it is a perfect scalp.
There are some betting exchanges in Europe and elsewhere where people can trade sports bets the way they trade stocks. Hedging with a slight negative EV by closing positions at these betting exchanges may be a valid reason to hedge if there is another opportunity available with greater positive EV.
Another way you could hedge and release capital is by selling your futures ticket to another bettor. Maybe you and the other bettor have a difference of opinion in the value of the futures ticket and you both think you are making a good trade.
Thoughts While Hedging
The two crucial elements in evaluating whether a hedge is worthwhile are the EV of the hedge and the risk it reduces in an initial bet that is still active. You need to balance the EV versus the change in the risk profile. Reducing risk is good, but not if the cost is too high. The right balance is based on your personal risk preferences.
Here is a 4-step thought process to evaluate the EV of the hedge and the change in the risk profile.
- Estimate the EV of the hedge
- Understand the risk of both the initial bet and the hedge bet
- Evaluate the remaining risk after the hedge
- Compare the EV to the remaining risk profile
Estimate the EV of the hedge
Estimating the EV of the hedge is crucial because it tells you how aggressive to be when hedging. You should act differently depending on whether the hedge is a positive-EV bet, a zero EV bet or a negative-EV bet. Estimating the EV of a wager may be the most difficult part of the process.
Understand the risk of the bets
Understanding the risk of any bet that you hold is always useful.
Here are three issues you should figure out to assess the risk in any bet.
- Estimate the probability of winning.
- Calculate the current EV of the wager.
- Determine the maximum win and maximum loss using the current EV of the wager
An understanding of these three issues for the initial wager gives you a good idea of your risk.
Here is an example. It is late in the season, and USC is in a good position to win the BCS Championship. You make that bet at 5-1 for $100. In order to win the BCS Championship, USC needs to beat UCLA in a regular season game, and then beat Ohio State in the BCS Championship game.
Estimate the probability of winning
The fair money line on USC against UCLA is USC -450 or 81.8%. You estimate that if USC meets Ohio State, USC will be an underdog and have about a 34% chance of winning the game. Thus you expect USC has a 27.8% chance of winning the BCS Championship (81.8% x 34% = 27.8%). You have just estimated the probability of winning the initial bet.
Calculate the current EV of the wager
You risked $100 to win $500 on the initial bet. With a current probability of 27.8% to win the bet, the current EV of the bet is:
= (win amount x prob. of winning)
- (lose amount x prob. of losing)
= ($500 x 27.8%) - ($100 x 72.2%)
You have just calculated the current market value of the wager. You have theoretically won $66.80 on the wager.
This is part of an occasional series of articles.