Derivatives

Last time we discussed what makes two betting markets related, and we went through an example of how to price one market versus the other.

The same logic from the last section can be used to price any point spread versus any other spread (or a money line, which is the same as a point spread bet with a line of zero). Pricing -1 versus the money line is simple, because you only care about how often the game will tie or land on 1. But you could use the same process to derive the price relationship between the money line and a line of -2.5 or -7.5 or even -28.

If you wanted to do -28, for example, you’d try to estimate five percentages. The chance the dog wins the game, the chance the game ends in a tie, the chance the favorite wins by less than 28, the chance the favorite wins by exactly 28, and the chance the favorite wins by more than 28. If you can come up with good estimates for those five percentage chances, you can estimate how those two bets should be priced relative to one another.

There are three main markets for most events. Two spreads (one being a money line or spread of zero) and one total. A market maker will deal these three markets and move on action. Retail books will follow the market maker’s pricing in each of these markets.

Nowadays, however, books want to offer more than just three markets on each game. They want you to be able to bet on just the first half. Or just the second half. Or just the first quarter. Or just the first inning.

Or they want you to be able to bet on alternative spreads and totals. Say you want to bet a favorite, but you don’t want to lay a big minus on the money line, and you also don’t want to bet -7.5 -110. You want to lay even more points than that—say -13.5—but get a plus money payoff on your bet. That’s an alternative spread.

The same logic applies to totals.

It should be obvious that all of these are related markets. If a team is a favorite for the game, they’ll usually also be a favorite in the first half, first quarter, or the first inning as well. If you wanted to bet which team will score first, the game favorite will be a favorite there as well.

If -7.5 is the current market spread on a game set by a market maker, then the price for -10.5 can reasonably be estimated using the method we described in the last chapter.

And so on. All of these markets that sportsbooks offer these days that are clearly related to the big three markets are called derivatives. The idea being that the pricing for these markets can be derived from the pricing for the main markets.

The key words in that last paragraph are “can be.” How books actually price these derivatives varies, but you can be fairly certain that nobody at your favorite retail sportsbook is making the numbers for every game, every day with a database and a push rate chart.

In fairness, pricing these derivative markets is a very difficult job even for the market maker books. The market makers work by taking bets and moving lines. But what happens if they take a bet on one market, but they don’t take an equivalent bet on a clearly related market?

Say they have an NFL spread at -5.5 and a money line at 68.5% (-217 in American odds). Then they take a few limit bets on the favorite at -5.5, but no bets on the money line. What should they do?

Well, obviously they should move the line on the favorite to make it more expensive, either by increasing the break-even percentage by moving to say -5.5 -120 or by moving the spread to -6. But what about the money line?

Should they leave it where it is because it took no action?

Should they move it an equivalent amount as the spread despite the fact that it took no action?

Should they move it some in-between amount?

It’s a tricky question to answer. On one hand, the relationship between the two markets is obvious. On the other hand, there may be a good reason the sharp bettors took the point spread bets but not the money line bets.

Remember, our method for determining the relationship between these two bets. It was very simple. We just looked at games over the last ten years and figured out how many landed on the key numbers.

But what if that method isn’t good enough? What if there was a recent rule change that made the chance of landing between 0 and 5.5 smaller? Or what if there was some other reason specific to this particular game (as opposed to just looking at an average of all NFL games) for the difference?

There’s no clear correct answer here—and this is one of many, many reasons that it’s actually very hard to be a good bookmaker. Later on, I’ll run down a high-profile example of a bettor who won probably at least eight figures exploiting a situation exactly like this where the relationship between two related markets was different in some games than in other games, and even the market making bookmakers didn’t catch on for over a decade.

There’s a computer security concept called attack surface. More attack surface means more chance that your computer will get hacked.

Let’s say your job is to administer a single server. That server’s job is to relay emails from one network to another network. That’s it. It doesn’t run a website. It doesn’t host Minecraft games. It doesn’t mine cryptocurrency. It relays emails from one network to another.

The security principle states that you should remove as much software (and hardware) functionality from this server that is not absolutely essential for it to perform its task. If the operating system automatically installs a web server, uninstall it. Remove Minecraft. Remove the ASIC Bitcoin mining hardware. Strip the thing down so that it’s running only exactly what it needs to perform its task and nothing more.

Why?

Because if you leave that web server installed but you don’t use it, you will neglect it. And then six months later a bug is discovered in the web server that you aren’t paying attention to, and a hacker exploits that bug to take control of the system. All because something you didn’t use and didn’t need anyway was sitting there neglected.

For a bookmaker, derivative markets are attack surface. Every additional alternative or related market a bookmaker wants to post is a potential vulnerability. Every one of them is sitting there waiting for someone clever to correctly price the relationship between the derivative and main markets and pick off the mispriced markets.

Not only that, but bookmakers are addicted to these derivative markets. They want more, more, more options for their customers. But what they’re really offering is opportunity. ♠

Ed’s newest book, The Course: Serious Hold ‘Em Strategy For Smart Players is available now at his website edmillerpoker.com. You can also find original articles and instructional videos by Ed at the training site redchippoker.com.