The Development of Football Index
I feel as I am going to write a large piece on betting and Football Index you should probably know a bit about me first. I have dabbled with many different forms of gambling and investing over the past 5 years. My successes involve the small property portfolio I have and being early in the cryptocurrency space. My failures involve trading options, horse races pre-off and in play and football matches in play although I continually revisit these activities with the aim of turning them into a success. I was initially a Pharmacist and am currently in London working for a startup company in the finance sector that is doing a seed funding round, although at present I have no formal financial qualifications.
This article contains my observations and opinions on the development of Football Index and the gambling industry. I have tried to form these opinions based on my evaluation of the information I have been able to collect. These opinions and observations could still all be wrong! I welcome anyone who disagrees with the following evaluation to say they do and to correct me where they see fit.
Warning — It is a long article and the first section is on the gambling industry. Its relevant to FI, stick with it!
Terminology
Before we look at Football Index let me go over some terminology that is needed in order to understand this article and give a brief history of the betting industry.
Dumb Money; Dumb money isn’t money owned by someone who is stupid, and the term is not meant as an insult to anyone. It’s very important you bear this in mind when reading the article, I am not trying to offend anyone. Dumb money is money that doesn’t play the market in a way that will allow it to win in the long run. This is what makes it dumb. Dumb money is likely to be dumb because its owner doesn’t understand the rules or the function of the market or perhaps doesn’t care about the rules or the function of the market. It is not an indication that the owner of the money is dumb, they could be highly intelligent. Usually the owner of dumb money isn’t describing the markets processes correctly to themselves and often doesn’t truly understand what they are buying. They take bad bets that will eventually precipitate in a net loss across all their trades.
Sharp money; is the opposite of dumb money -it makes the right decisions because it understands everything about the market. Someone who is sharp will finish up in the long run at the expense of dumb money.
Value; Value is never relative. Value is always intrinsic. Imagine there was a scenario where you could buy an asset that had a negative yield for one pound and sell it to someone for two pounds. Would you honestly say the asset had any value just because you profited from the trade? You knew when you bought it it was a losing bet and whoever bought it off you will only end up losing more. It’s a good trade if its profitable but the asset you traded never had value, it’s just you found dumb money that would take the price. Whether you were dumb money or not in this scenario depends on whether you knew what you sold had a negative intrinsic value. If you didn’t know this then you got lucky and you too are dumb money. If you did but you were certain when you bought it you would find dumb money to offload it too at a higher price then you are sharp money.
Decimal Odds; Decimal odds are the odds format I work with in this document so anyone reading it will need to understand them. Some people use fractional and a few like Vegas odds. For those that haven’t used decimal odds before if you see a football market and Manchester United are priced at odds of 2 to win that means the total return (stake including profits) you will receive is 2 of whatever you bet. So, If I were to bet £1 I would receive £2 if I win the bet. £1 will be my stake and £1 would be profit.
Backing/Laying; To back a bet someone bets on that event occurring. If you see an over or under (O/U) 2.5 goal market where O2.5 is priced at 3 and you back that bet you bet £1 at odds of three. You lose £1 if you are wrong and have a net gain of £2 if you are wright. If you were to lay the same bet you would be betting against it occurring. You would have a net gain of £1 if the game finishes U2.5 but a loss of £2 if it was O2.5.
Fixed Odds betting and how traditional bookies price a market
Bookies use historical data to generate the odds you see when you go to bet on a market. They will figure out the probabilities of an event occurring then price the market in such a fashion that you lose in the long run and they win. This is best demonstrated with an example.
If if you see an over or under (O/U) 2.5 goal market where O2.5 is priced at 2 and U2.5 is also priced at 2 it means the bookies expect there to be a 50% chance of the game being over 2.5 and a 50% chance of the game having under 2.5. To figure out what the probability the bookies have assigned to an event occurring is, divide 1 by the decimal odds they are offering. So 1/2 = 50% hence the bookies think 50% O2.5 and 50% U2.5. In reality if the bookies concluded the odds were 50/50 they would make the odds shorter than this to make money:
On a 50%/50% O/U2.5 market they would offer odds at O2.5 = 1.9 and U2.5=1.9. 1/1.9 = 0.52631579 meaning the bookies have priced the O2.5 and U2.5 as if they each have a 52.631579% chance of occurring. To figure out what the probability of either O2.5 or U2.5 occurring is add the probability of O2.5 to the probability of U2.5; 52.631579% + 52.631579% = 105% (rounded to the nearest whole percent). This market is clearly priced wrong as the combined probabilities of the outcomes is 105%. In reality there is only a 100% chance the game will finish with either under or over 2.5 goals. The 5% is called the over round and it represents the bookies margin on the market they make. To figure out how much money a bookie takes on a market you need to know the volume traded on that market and then multiply it by the over round. So, if £1000 was traded on the market then with a 5% over round the bookies will take £50
A worked example using the above scenario; Paul bets £1 @1.9 that the game will finish O2.5 and James bets £1 @1.9 that the game will finish U2.5. After the bets are placed the bookie is in possession of £2. The game finishes 1–0 and James wins his bet receiving £1.9. Paul loses his bet and receives nothing. The bookies keep 10p which is 5% of the volume traded on the market (£2).
Sometimes bookies will be on the other side of your bet themselves. But if the event is truly a 50/50 event and they offer you odds indicating it’s got a higher chance of payout and they do this across a series of events you will finish down and they will finish up in the long run. For example, if each time you win you only receive £0.9 profit but when you lose they get to keep your £1 across 100 bets at you would expect to make £0.9 50% of the time and lose £1 50% of the time meaning you’d have a negative expected value of -£5. If you noticed the bookies had left the odds too long on an event and finished up across a series of bets where this occurred then eventually the bookies would simply ban you. They don’t want to pit their wits against yours, they only want dumb money that doesn’t understand their system because dumb money pays them.
Go to any traditional bookmaker and use the maths above on any of their markets to expose their over-round. (Go do it right now!, try it on a market with more than two outcomes too if you like e.g. Win Draw Lose markets. The maths is the same). Don’t do it with a betting exchange, these are covered below.
Betting Exchanges
The first betting exchange was Betfair. It opened in in the late 90’s/early noughties. Its mechanism for pricing a market offers much better value to punters than the traditional bookies method. As such it took margin away from bookies and posed a risk to their model. Before explaining Betfairs mechanism and why it offers better value to punters than the traditional bookies do its worth considering what markets and market places actually are.
Any market consists of buyers/sellers and a market maker who facilitates the transaction and often creates the market. In a frictionless market the buyer could interact with the seller and exchange goods. In reality no market is completely frictionless as the market maker takes fees for either creating or maintaining the market. Taking a bet with a bookie is simply you taking one side of the market; as we saw with the James and Paul O/U2.5 example that was given earlier any money placed by Paul was matched by James on the other side of the market. If Paul was selling James goods over e-bay both would know they were in a market and the fees that E-bay charged (the friction) would be transparent and known about to both participants. If the market participants thought the friction was too high they could move their business to another market with less friction.
It’s my opinion that most punters who bet with bookies don’t realise they are in a market place, don’t know how to calculate the over-round (that’s the friction) and so don’t know how badly the odds usually are relative to exchanges. In short, they are dumb money.
Betting exchanges realised they could simply allow two customers to match on a market place and keep a percentage of the winners bet and that this would offer better value to the participants in the marketplace. In the scenario with James and Paul both the O/U 2.5 market can be priced correctly at O2.5 = 2 and U2.5 = 2. The winner receives £2. £1 of which is profit, Betfair will take 5% of this so 5p. This represent 2.5% of the volume traded on the market. This means the market maker (Betfair exchange) is taking half the fees for maintaining the market that the traditional bookies took. The friction is halved. (For reasons beyond the scope of this article the exchange odds usually have a slight over round but it will be tiny compared to bookies — calculate the over round on a betfair exchange market shortly before the event begins and compare it to the over round at various bookies and you will notice the difference)
There is little justification for the traditional bookie models to exist anymore. They do because there is so much dumb money out there that bets with them. The truth is that traditional bookies have a raft of other tricks they can use to further exploit dumb money and to get it to take bad odds. The exchanges have no financial incentive to get you to take bad odds as they take a fee from the winner no matter what. In one of FIGs podcasts Adam Cole (CEO of FI) suggests Betfair starting out as an exchange but then offering a traditional bookie model alongside the exchange and eventually merging with Paddy Power is evidence that the average punter doesn’t just want exchanges. I would argue this is not the case, the average punter has no idea how the market place functions or that they are even in a market place. In my opinion Betfair used exchanges and the fact that they have better odds to disrupt the industry and scale up but then realised there was so much dumb money on their exchanges that trying to get it to migrate to its traditional more lucrative bookmaking platform would be a good idea. Why charge dumb money 2.5% when you can charge it 5%?
Your Football Index Portfolio
Do the players in your portfolio have value?. That’s what everyone on the index wants to know. Well what did you actually buy? Lets look at what a future actually is. A future is a fixed bet issued by FI that will have a pay out over its lifetime.
To start with let’s pretend that you can’t trade the future. If you can’t trade the future, then FI can’t derive fees from your trading activity and there can be no price speculation. This would mean for FI to be profitable they must pay-out less on that future than what they sold it for e.g. If they IPO it at £2 the dividend pay-out over the lifetime of the future must be less than £2. For you to be profitable it must pay out more than £2. Remember when the player retires the future is worthless -you do not get your money back so the actual dividend payout must exceed £2. This means over the lifetime of the future you must receive a yield of greater than 100%.
Look at that in a football context — how long is a players career? Lets say it’s from 19 through to 34 and lets say that the player is in a PB paying league for his entire career and is eligible for MB for the entire time (very generous parameters for our test). What’s a reasonable return each year? Let’s say 6%. That means the player has 15 years to earn me my initial stake (100%) and my annual yield (6%) 15 times. That’s 6% x 15 = 90%. So over 15 years the player needs to get me 190%. 190%/15 = 12.7% meaning I need to get 12.7% a year on my player just to get 6% average by the time he retires.
This scenario was run under incredibly favourable conditions. I gave the player a full 15 years of PB pay-out eligibility, in truth the beginning and end of a player’s career is much less likely to give PB and so they will have to make much more of the 190% return during the prime of their career. I gave them a full 15 years as a professional. This isn’t likely either and they certainly won’t be at peak for a lot of it. I only demanded a 6% yield. The yield you demand is subjective, but I would argue that it needs to be a lot higher than 6% in order to justify the risks associated with what I am buying. Also I haven’t discounted future cash flows for the effect of inflation either; the value of money decreases over time so to achieve an annual 6% in today’s terms you need pay-outs in the future to be more than 6%. I have also not included trading fees you will have to pay every three years to keep the bet alive (these are very important and covered later in this article).
I heard Adam Cole state on one of the podcasts with FIG that they keep an eye on the dividend yield of the top players and they thought they were pretty generous relative to groups like the Halifax. Well they have to be, when my bank manager at the Halifax retires he doesn’t take my deposits with him! When a player on FI retires the owner of the future does not get the price of they paid for that future paid out to them! The price of the future upon retirement is zero.
In truth a lot of the players on the index don’t have anywhere near 15 years left to pay out the purchase price + yield to the buyer. Figure 1 looks at the current players price and assumes they will have to retire at 34. It then asks how much each player will have to earn on a yearly basis to cover their price before they retire (Divs/Year). This basically means how much will they have to receive on a yearly basis for anyone buying them today to break even (not even make a return!). I have used 34 as the cut off because relatively very little dividends go to players over this age so statistically they are as good as retired. The Total Divs column shows how much they have received this season so far in PB & MB (G&A is not included). I have used 34-X (where x is the players listed age) to calculate the years remaining. This is generous and essentially assumes all players have had their birthday on the day this data was captured.
Note; this data set is a capture from shortly after the conclusion of Game week 21 — It’s taken from NoirXs data set. NoirX is the best data provider in the FI community at present in my opinion as the excel format allows for greater manipulation of the data than any of the other provider (Although I also use IndexGain).
So Ronaldo would need to return £10.23, assuming he retires at 34, for anyone buying him at £10.23 to break even on him. If you think he will retire at 36 then he would need to return £5.12 a year for two years. Pogba has returned £3.47 this year to date and he is the highest returner in real terms. He has to return £1.87 a year between now and his 34th birthday.
So who is valuable ? -Well who can return more than the price you pay for them between now and the players 34th when they retire?
How valuable are they? — Well how much can they return above the price you pay for them between now and their 34th birthday.
You pay £6.11 for Bale — he needs to return £1.22 for 5 years to break even. Let’s imagine he returns £1.40 a year for 5 years so he will return £7.7 in total. So £7. 7/£6.11 = 1.15 meaning you are receiving 115% percent of your capital back. Let’s assume I don’t have to pay any fees then 15% / 5 years = 3% a year. Its definitely value, but you would have to decide if its good value or not given the asset class and its risks.
Trading and Fees
I hope that no one who has read this far is thinking “He hasn’t taken account of the fact I can trade my future to someone else and achieve capital growth!”. If you are then you have missed the point in the last section; If you buy player X today and you know player X will not pay out enough to cover his price before the futures reach zero value upon retirement, then why on earth would anyone want to buy him off of you at a higher price? The only answer would be “because they are dumb money”.
There is no such thing as relative value, when many assets that have a negative intrinsic value start trading for even higher prices meaning each new owner is receiving an even more negative return from the asset then the assets are in bubble territory. All the assets have negative value and the bubble is being propped up by dumb money, trade it at your peril. If the money gets sharp and you get left holding the asset you will be the dumbest money on the market.
A good price of a future from the buyers perspective is any future that has a positive expected value over the life time of that future. One that returns greater than the capital paid for it. If you buy these futures, you will either A) receive more in dividends than you purchased them for over the lifetime of the future or B) hold the future long enough to see dumb money buy it off you for more than it can return over its remaining existence.
The trading dynamic on football index is simply the ability to cash your bet out early. Note that your bet is not really 3 years long. It’s actually the lifetime of the player but every 3 years you will pay a 2% roll over fee plus market spread to keep the bet going unless you sold already. From FIs perspective they don’t care who owns the bet, they only care how often the bet is turned over and by saying you can only hold a bet for three years they ensure that a share is turned over at least once every three years. If a player had a 15 year career, you bought on IPO day and it didn’t go up in price and you were able to keep rebuying in at the price you sold for you would incur 5 x 2% (over the 15 years) of your initial purchase price so 10% in total. What this effectively means is the future has to return 110% over its lifetime for you to break even. If you couldn’t buy at the price you sold for and the spread was also 2% you’d need to achieve 120% to break even. Under these conditions each future has to pay-out more than 120% of the price you pay for it if you want to make a gain by the time the 15 years is up.
If you cash out with a traditional bookmaker they will often offer you poor odds when you cash out. You will be happy that you got money but in truth if you were to be offered that exact same cashout over and over you would be financially better off not taking it. With FI the ultimate aim is for you to be able to cashout your bet with someone else on the market. FI don’t have to worry about whether person A offers person B good odds or not as they make 2% either way and currently make a spread to (although this might change when liquidity providers step in).
However, it will always benefit FI to either issue more futures or buyback futures depending on the price of them relative to the pay-out over the players career. If the pay-out over the futures lifetime is less than what the future is currently trading for then FI would do well to issue as many futures at that price as they can. So, if player X rose to be top of the index even if he was paying out £4 a year in divs he may well never recoup his current giddy price and as such FI would do well to issue more futures in that player at the current price as they know they will never have to pay back the full amount. Alternatively, if a future falls so low that it’s trading at a price below what it will pay-out, thus giving it a positive expected value, FI would do well to buy the future from the dumb money that hasn’t realised they are selling too cheaply. There are some caveats to these two scenarios where FI could lose money by issuing more shares at higher prices, but these scenarios can be avoided by widening the spreads.
The Spreads
People often query why the spreads are wide on certain players. I would suggest it’s because FI don’t want a player on their books who will lose them money. The instant sell function FI have means they could possibly IPO a player with a negative intrinsic value but be forced to buy it back at an even higher price after the dumb money in the market has pumped it. On the face of it this would seem like a losing bet to FI. The way I would control this if I were FI is to widen the spread on the player, this disincentives the market from selling FI the player as the market won’t have made as much of a profit (if any) from the trade. If someone still sells even after FI have widened the spread then FI have less risk as they bought the player back off of the market for a lower price, thus reducing the difference between the IPO price and the price they were forced to buy it back at. In truth I doubt FI mind much if they buy back the player at a higher price if he is young as speculation on the players future means he will likely be off their books again before too long. Where it could possibly cause a loss for them is when the market sells them an overvalued player towards the end of their career. I would be very careful in these situations if I were FI as its less likely the market will come back for that player in the future and FI may be left with a losing position. I would make the spread very large indeed in order to convince market participants to keep that losing position on their books.
The IPO Hike
When you see FI drastically increasing the IPO prices but not increasing the dividend yield this is the mathematical equivalent of the bookies decreasing the odds on the O/U 2.5 market in the example we discussed earlier. The chances of that player paying over 100% before their career ends decrease drastically. No one expects FI to lose money but at the same time I think it’s reasonable for us to expect a lot of players to have a positive expected value, so the market has something real to chase and we aren’t just shovelling assets that aren’t worth their IPO value to the dumb money that doesn’t get what’s going on. FI should seek to function like an exchange and make its money from the fees derived from market participants trading and not by actively opposing those participants and selling them overvalued bets as a traditional bookie would.
Its unclear how many of the new IPOs have a positive intrinsic value or how accurately FI model the expected value on any of their positions.The dividend hikes announced alongside the share split due to occur on March 26th 2019 increase the intrinsic value of the futures but not to the extent that they mitigate the near four fold increase on the IPOs that has occurred since November.
In the next article I intend to examine the IPO hike further and the development of in play dividends (which I have largely sidestepped in this article). Until then, happy trading!
