The Anatomy of a Good Bet

Turning $65 into $12,000: Positive EV Asymmetric Payoff

You might have heard that purchasing lottery tickets is a bad idea, and that you are almost certainly going to lose money on it. However just because it gives you an improbable chance of hitting the jackpot, doesn’t mean it is a mistake.

If it was, then purchasing insurance would be a bad decision given how infrequent claim events occur. Purchasing home insurance is quite literally the definition of betting for your house to burn down, so that you win a large payout. [1]

Positive Expected Value Bets

In the previous post regarding trading vs gambling, we brushed upon the notion of making positive expected value (EV) bets. To reiterate, these are bets made such that you will make money in the long run.

This is important.

What makes lottery tickets bad, is the fact that it is a negative EV bet. This means that you are effectively throwing away money with every ticket you purchase — this is no different than testing your luck at a slot machine (or pokies). Sure, you might get lucky in the short term — but the odds of you being struck by lightning are higher than you winning.

Asymmetric Payoff Bets

You might be thinking now if there exists such a bet where you could potentially win big time, and yet is a positive EV bet. And the answer to this, is that it certainly exists — but it is rare. Most Wall Street trading firms purchase volatility cheaply and in the event of a market crash, these payout hundred-fold. Jane Street made $8 Trillion in the 2020 crash essentially from this.

However before you go and hastily punt on volatility, such strategies are generally reserved for large institutions. These are often treated as a cost of doing business, and typically result in worthless payouts. More on volatility in future newsletters, but a good proxy of thinking about it is how much someone would pay for insurance (obviously more if they are scared).

Case Study

So where else might you find such opportunities? While I generally do not condone blindly trading options, it does give us a great case study to a great trade (in my opinion).

Unless you have been living under a rock for the last few weeks, you would have heard about the Gamestop (GME)…