What is the gambling difference between sports betting and trading stock market derivatives based on indices?

Question

What is the practical difference in terms of gambling between wagering on the future score of a sporting match and wagering on stock market derivatives based on indices, such as the future value of the SPX (by trading call and put options on the SPX) or the future value of the VIX (by trading VIX futures)? The SPX and the VIX are both metrics; there are no underlying assets other than the price of the option or future itself. Like sports gambling, when one trades SPX options and VIX futures there is only an exchange of money on whether the prediction was right or wrong.

If not, what am I misunderstanding?

Answer 1

Day trading derivatives is similar to sports wagering in that the house takes a cut.

Over the long haul (not a short lucky streak), they both require an edge to succeed though I'm not sure that you can find much of an edge with sports betting.

However, derivatives are more complex and they offer you many more ways to hedge as well as offset risk, at the outset and during the bet.

If you extend the time frame from day trading to swing trading (days to weeks or even longer), some uses allow you to mimic longer term investing with less risk but I suspect that's not what you're after.

Answer 2

You are missing that many people or institutions that buy these options don't bet on anything.

Market makers hedge their entire exposure and make money by offering liquidity. That's why option pricing is based on the principle of no arbitrage, risk neutral pricing and replication.

If you are long an index or stocks and worried about short term declines, you can hedge your exposure. The option premium is much like an insurance premium.

You are also missing that an index, even if it doesn't trade on its own, still has underlying securities that can be traded (SPX is actually replicated by numerous ETFs and funds). There is no difference if you cash settle or get the Underlying other than mechanics and that cash settlement doesn't require you to take delivery.

With betting, it's purely about guessing an outcome.

Answer 3

There is a big difference. It all comes down to the fact that for financial derivatives, there's an underlying asset that can be bought and sold, allowing for hedging and arbitrage, which is not possible in gambling or betting.

Let's assume a casino offered a "fantasy SPX option" game. A computer randomly generates a fantasy S&P 500 index that changes by the minute, just like the real S&P 500, a random walk with the same (positive) expected annual return and the same volatility as the real S&P 500. The graphs of the real and the fantasy index would of course diverge but would look roughly similar. Now the casino allows you to buy or sell call options on their fantasy SPX. These are cash-settled options and the market would work just like the one for real SPX options.

You'd see that the prices of real SPX call options and fantasy SPX call options would differ dramatically. The reason is that you cannot buy a bundle of stocks that replicates the fantasy index, but you can do so for the real SPX. This means that you cannot hedge, you cannot arbitrage, and Black-Scholes pricing would not apply to the fantasy market.

If you buy or sell a fantasy call option in the casino, your expected return will be zero (or slightly negative if the casino takes a cut). If it were positive, say, the sellers would raise their price until the expected return becomes zero. Unless they are dumb.

If you buy a real SPX call option, your expected return is positive (assuming that the true expected annual return of the S&P 500 is large enough and the fees don't kill you). The sellers cannot simply raise the price of the option, because then arbitrageurs would show up; by cunningly borrowing the right amount of money and buying the right amount of the S&P500 stock bundle, they could offer to sell a cheaper call option and extract a risk-free profit from the buyers, pushing the other sellers out of the market. Why are the sellers selling options if the expected return of doing so is negative? They are essentially buying insurance. Buying insurance always has a negative expected value.

Answer 4

The differences are purely cultural and arbitrary distinctions. These are necessary in some cultures and belief systems.

Not all cultures or individuals require a distinction between investing or gambling for any reason. Whether that is feelings of personal responsibility, religion, or maintaining respect in their community.

Not all cultures or individuals require a distinction between a negative expected value financial game, and a positive expected value financial game. Gambling is typically considered to be negative expected value financial games, whereas "not-gambling" is typically considered to be positive expected value financial games. Sports betting has been argued to fit somewhere on the positive expected value side, purely for regulatory reasons. Typically these arguments become pedantic and semantical as the root of arguing a distinction is for feelings of personal responsibility, religion, maintaining respect in a community, and for regulatory purposes.

In the United States, uniquely, "gambling" is regulated at the state level and ignored by the Federal government except to restrict banking of gambling services using interstate systems (the internet - as such, online gambling services that are not reliant on licensed banking systems have no prohibitions). While the federal government regulates securities and the derivatives of commodities (but not the trading of spot commodities). This causes the fairly arbitrary cognitive dissonance to be put at the forefront. As any one individual can play any money game at the state level and lose it all, but be presented with a paternal limiting relationship in positive expected value games such as daytrading and investing.

In other countries, these can be the same or different regulatory agencies, at the same level of government. Instead of dual overlapping governments.

But ultimately the venn diagram of financial games significantly overlaps such that it is almost a circle.

Answer 5

Sure, they are logically and mathematically exactly the same.