3/27/2013

Since its March Madness, I wanted to share with you a how a hedge fund trader like myself would bet (if it was legal) on a college basketball game. As everyone knows the biggest story of the tournament is the Cinderella story of Florida Gulf Coast University (FGCU) the brand new school and basketball team (they didnt even have a basketball gym till 1997) and their two big upsets of Georgetown (which I predicted here on this blog) and San Diego State.

Now on Friday March 29th FGCU is playing the mighty University of Florida Gators. Now on paper this looks like a blowout, UF is the biggest and best athletic school in Florida, and no one outside of Florida had ever heard of FGCU until last weekend. So it’s not surprising that the oddsmakers in Las Vegas have the UF Gators a 13 point favorite over FGCU. But what a lot of people dont know is that FGCU not only has been hot in the tournament but they also beat the top ranked University of Miami Hurricanes earlier this season. Also in college basketball especially during the NCAA tournament when everything is on the line, (you are one loss away from going home), almost all of the games are pretty close. So That 13 points spread that UF has to cover seems like a very low probability trade.

Also in sports gambling there is something called the moneyline, the moneyline tells you what the odds are for the underdog team to win the game outright without the spread. In Friday night’s game many casinos have FGCU as an 8 to 1 underdog, meaning that if you bet $100 on FGCU to win the game then you would make $800, a great trade right, but somewhat unlikely.

So here is what a smart trader would do, knowing that the odds that a team will cover 13 points in the Sweet 16 of the NCAA is very unlikely they would bet say $100 on FGCU to beat the spread against Florida, meaning that if Florida wins by 12 or less or loses the game you win $100. Its a simple bet and it pays off 1 to 1. Now you also know that there is a small chance that FGCU is the real thing, they are a very athletic well coached team who certainly doesn’t fear a school from there same state. So you would then take another $100 and bet the moneyline, betting that FGCU will upset the Gators and if they do you would get paid out an amazing 8 times your money or $800.

But as we know if the odds are 8 to 1 it means its pretty unlikely, so to hedge your bet and increase your chances of winning, a smart trader would bet $100 on FGCU to beat the Spread, and a $100 on FGCU to win outright. This would cost the bettor $220, (the $20 is the VIG). Now here are the scenarios. The most likely scenario is UF wins the game over FGCU but does not beat them by more than 12, so you would then virtually breakeven on this trade (you lose the $20 betting fee or vig). so your most likely downside zero or breakeven.

Now if FGCU pulls the upset, you then win both bets or $900, on your original $220 bet, which is a 323% return on your money. So that’s how a smart hedge fund trader would bet this game, hedge his downside risk but also have the chance for a big upside win. ( This is just a scenario, and it is not a recommendation to bet.. please remember that)

So getting back to the investing world, I see the same type of zero or low downside/huge upside trade in the $VIX Index or the $VXX ETF ($VXX).
Right now Volatility is low and probably will stay that way because we are entering a holiday period, Easter, Good Friday and Passover, so I would sell April $VIX out of the money call options and buy May VIX index $VXX call options..

Here is why the biggest enemy of options is time expiration, well the April options have a lot going against them they have a holiday on Friday, the market is closed on Friday, and many of the biggest hedge funds and institutions will not be back trading until Tuesday April 2nd, which than leaves only 14 trading days on the April $VXX out of the money calls.. Your May out of the money calls have a much better chance to make money, as they have almost 5 weeks of trading left on them. Also there is a huge contango premium from April to May built into the VXX ETF currently, the contango premium is more than 8%, meaning if you buy the $VXX ETF right now you have to make more than 8% to just break even, a hard obstacle to overcome.

To find out the exact details of this trade or to understand contango premiums in ETFs you can always email me wmeade@purealpharesearch.com

Will Meade
Editor of the Billionaires Portfolio
www.billionairesportfolio.com
wmeade@purealpharesearch.com