Hedging Investments in Las Vegas

Usually gambling is a risky proposition, but occasionally it can be used to reduce risk.

I heard on the radio today that many months ago a Mattress Entrepreneur in Houston, Texas, said, “If the Astros win the World Series, I’ll refund all purchases over $3,000.” Tonight is a big night for Houston-area mattress buyers; if Justin Verlander pitches well a lot of refunds will be forthcoming, to the tune of $5 million.

Mattress Guy emphasizes that most of that liability is covered by insurance — his business is not at risk — but he finds himself in an interesting situation: if a sporting event comes out a certain way, he loses a lot of money. Tonight it looks like he could use a little more insurance.

Las Vegas to the rescue! By placing a substantial bet on the Astros, he can make back some of the money he loses if they win. If they lose both the next games he loses his bet, but he’s not out the five million. By placing a bet he ensures that either way he loses some money, but he won’t lose as much as he would have, should the Astros win the series.

Meanwhile in Los Angeles, one of the big winners in a World Series game 7 are the ticket brokers, and apparently the Dodgers are particularly broker-friendly, releasing tons of tickets into the market. Should there be a game seven, the brokers will make millions. So what can the brokers do to improve the chances of a payout? Head to Las Vegas! By placing a big bet on there NOT being a game seven, the brokers get a guaranteed payout either way.

What these two things have in common is that wagering on the outcome of the game is the exact opposite of gambling. In one case, it is turning a potential big loss into a guaranteed-but-manageable smaller loss. In the other case it’s turning a potential big gain into a guaranteed-but-smaller gain.

Not long ago some kid became famous because he had bet on Auburn to win the college football championship game. At the time he placed his bet, no one thought Auburn had a chance to even reach the game. But holy shit, after a few amazing upset victories there they were. If they won, the kid stood to make something like $65,000. That’s a lot of clams for anyone, let alone a college kid.

Before the game, some Web site took a less-than-scientific poll asking people: Should the kid place a hedge bet to get a guaranteed $30K (less than half of his big payoff), or should he let it all ride? The results of the survey were presented by state — respondents from every state but one said “Let it ride!”. You want to guess which lonely state had a majority of respondents vote “hedge”?

That state was Nevada, of course, where people who gamble for a living reside. Auburn was winning late in the game, but ultimately lost. The kid got nothing. He failed to accept the gambler’s axiom: If you stand to gain or lose significant money over an event that other people are betting on, use that action to eliminate risk. Gamblers hate uncertainty, and feast on greed.

Unlike hedge funds — mutual funds designed to go up when the market goes down but which actually completely fail at that objective — hedge bets are a pretty cold lock, if only for a very specific circumstance. Here’s hoping that matters to one of us, someday.