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# Whose right me or Sheldon Natenberg?

Discussion in 'Trading' started by YoungNAmbitious, Jan 5, 2003.

1. ### YoungNAmbitious

This is not exactly about trading but I encountered this on P. 43-
44 of "Option Volatility and Pricing Strategies" The question
under consideration is simply what is the value of a dollar bet on a roulette wheel that has numbers 1-36 plus zero and double zero and pays off 35-1 if you pick the right number. In other words it pays 35-1 on a 37-1 shot. He concludes that a dollar bet is worth about 92 cents and arrives at this figure by multiplying the 35 dollar return by the chance of winning which is 1/38 thus (35) (1/38)= a little more then .92 So he gets a dollar bet being worth 92 cents or put differently an %8 disadvantage to the player. This number seemed higher then what I had always read so I considered the problem myself. Over 38 trials we win 35 bucks once and loose one dollar 37 times so we are minus 2 dollars after every 38 spins. 2 dollars / 38 = 5.26 cents or so. So I have the player loosing 5.26 cents for every spin or a 5.26 % disadvantage for the player. So he thinks the fare price for the dollar bet is a little more then 92 cents and I think its a little less then 95 cents. who is right? If it turns out that I am retarded I would like to apologize in advance for this. If I am right should I still read the rest of the book?

2. ### Colonel_Blood

The Casinos edge in a double 00 wheel is 5.26%, so your calculations on this front are correct

3. ### patefern

Yes, if you intend to ever trade an option.

4. ### aphexcoil

What makes people play negative expectancy games?

My money's with Natenburg. He's looking at expected value. Natenburg's book is a must read for option traders.

In your example, what happened to the \$1 that you had to put up to earn \$35?

You can look at it 3 ways:

1. Positive Utility: Although the financial expectancy is negative, the utility expectancy is positive. The value of "winning \$35" is more than 38 times the value of "losing a measly \$1." One could look at casinos/lotteries as a dream-selling service -- the player is paying a few cents/\$ to indulge their dreams of winning and living the good life. (These non-financial rewards for participation are another reason why the markets will never be financially efficient)

2. Delusions of Luck: People either don't understand probability or delude themselves about their true chances. The majority of people think they are "above average." Others look at it terms of luck - if they are on a hot streak, then they think that they have a high probability of winning or if they are on a losing streak, then they think they are "due" for a win. (Some traders add the delusion that they are "in control")

3. Loss Aversion: People are evolutionarily programmed to take greater risks if they are in bad situation. As Andrew Lo put it, if you are faced with a Saber Toothed Tiger, you are willing to jump off a cliff to get out of the situation. Likewise, if you are in financial trouble, you might take your last dollar and buy a lottery ticket. (This is especially nasty for traders because it leads to doubling down, overleverage, etc.)

8. ### acrary

It's probably a typo. I have the 1994 revised edition with the roulette example on pp 36-37. The correct house edge of 5.26 cents per spin is listed.

9. ### Lobster

Probably the same part of their brains that makes them pay interest on credit card charges for things they don't even want, but "need and deserve".

10. ### hii a_ooiioo_a

Colonel Blood: "The Casino's edge in a double 00 wheel is 5.26%, so your calculations on this front are correct"

def: "In your example, what happened to the \$1 that you had to put up to earn \$35?"

The problem is Natenberg calculated the payoff as 35-1, when the actual payoff is 36. You get your own dollar back with the other \$35 on your winning spin.

If you don't get your own dollar back on your winning spin, then the loss would be 38 dollars vs. \$35 payoff = -\$3 per 38 tries, and Natenberg's figure would be correct.

#10     Jan 5, 2003
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