Prop Bets, Hedging, Skin in the Game, and Remote Work
A multi-topic newsletter focusing on improvement via downside
I’ve kicked off this newsletter with a bunch of longform content. I initially planned to experiment with various styles and formats, but the truth is that I’m suited to write longer articles. I believe in the power of focusing on fat tails. From Taylor Pearson, who I recommend checking out:
In his essay Do Things That Don’t Scale, Y Combinator’s Paul Graham notes that “[he] ha[s] never once seen a startup lured down a blind alley by trying too hard to make their initial users happy.”
This is 80/20 thinking. Because everyone is operating with a bell curve model in their heads, they are spending the same amount of time and energy taking care of each one of their users. But because not all users are created equal, if they were optimizing properly, they would spend 50% of their time on the 1% of users who are most excited about the product — and being an early adopter is a strong sign of being excited.
Even outside of strategic reasons for writing longform content, I simply enjoy it. You’ll always find me on the side of being too niche over too general.
There are some topics I’ve wanted to touch on that don’t really lend themselves to a 3,000-word article, though, and so I’ll occasionally publish some quick-hitter posts that bounce around a few different subjects or thoughts I’ve had.
Prop Bets for Motivation
I once bet a poker player he couldn’t learn Mandarin in one year. And guess what? With enough money on the line, he shocked everyone and became fluent in less than 12 months, parlaying the bet into a high-paying job in Shanghai.
Just kidding. He failed miserably. Becoming fluent in Mandarin is a bit ambitious, although he did learn to say “They are eating peaches,” which I think has some value. If he’s ever taking a stroll through Beijing and sees a group of locals eating fruit, he’s gonna really impress.
That bet aside, I’ve found the most effective way to trigger internal motivation is through betting. Money is a useful tool—or the threat of losing it, anyway—but your bets don’t need to be financial ones. I’m a big believer in the power of downside; humans are inherently more motivated by what they can lose than what they stand to gain. Making a goal public and having real consequences for not achieving it—or, better yet, competing against someone else trying to beat your ass—is a really useful means of self-improvement; with the right bet, even if you lose, you win.
If you want to get in better shape, book a fitness-oriented bet with a friend. I’ve done a bunch of these bets that have really improved my motivation to work out. You can bet on improvement in a specific exercise, a change in your body-fat percentage, or a penalty bet in which you lose $X for a specific action (say, drinking alcohol or eating certain types of foods). I booked a no-alcohol/no-sugar bet that would have cost me $1,000 for each infraction. Pretty easy to not drink at that price. If you don’t like paying $12 for a beer at a ballgame, you’ll really hate $1,012.
Hedging
Working in the gambling industry, I hear non-stop chatter about “hedging,” usually out of a big bet. Hedging is a tool used in basically all forms of investment, but I think there’s a lot of confusion and/or incorrect logic around the pros/cons of hedging.
First of all, buying out of a bet because it’s too big isn’t hedging; that’s just you being a pussy. If you make a bet—whether it’s in sports or with a stock or in crypto—and it gets to a point that it’s “too big” for you to stomach such that you want to buy out at a reduced -EV price, then you made too big of a bet to start. You’re guaranteed to lose money like this. If you can’t let it ride, don’t make the bet, because you’re losing all your EV by getting out.
There are a couple situations in which hedging makes sense, one of which is when you have an unexpected change in finances. When I first started working in DFS, I partnered with DraftKings on my books in exchange for equity. I probably could have gotten way more stock than I did—I’ve messed up like every deal I’ve ever done, although I’ve slowly improved from worst-negotiator-in-the-history-of-the-universe to just-regular-shitty level—but either way, it has ended up being a nice deal.
When DraftKings recently went public and the stock price soared, it turned into a terrific (potential) payday. For a long period of time, I couldn’t sell the stock, and even now I’m still just holding for capital gains reasons. The total value isn’t enough to really make me do much besides just sit on this stock for 12+ months, but what if it represented, say, 75% of my entire net worth? Then the math changes.
Let’s say given my shares and the current price that my stock was worth $150,000 with my net worth otherwise being just $50,000. Then, it would be smart to make some moves to hedge, even if I thought it offered a slightly negative expected value, just because my future net worth would be so volatile, almost completely dependent on the stock price. If I shorted DraftKings in such a way that I basically locked in $140,000 of the $150,000 value, that’d be a trade I’d be willing to make in this hypothetical.
You should buy insurance when your life would be materially altered by a specific downside scenario. In this example, hedging is simply buying insurance on your future net worth.
So one reason it’s smart to hedge: when a specific investment unexpectedly becomes too great a percentage of your net worth or the downside is too much for you to stomach. Slightly -EV decisions in the short-term to “buy insurance” on your future can be super +EV long-term. But you shouldn’t willingly be getting into situations in which you know you’d hedge out later (read: big sports parlays).
The second reason to hedge is the same reason you make any bet: it’s +EV. When a specific action is +EV and runs counter to something you’ve done in the past, I’d argue the threshold you have for action can be reduced to a point of basically neutral expected value.
Even neutral-EV bets that minimize your volatility can be +EV for your overall portfolio long-term. Situations change, you gain more information, and what you did in the past is irrelevant to the current EV of a decision. If you bet on a sports team at +110, for example, and then injury news comes out or the weather changes or whatever and the line moves and you think the other side is now neutral or very slightly positive expected value at even money, that’s a smart bet to make; you’re freerolling, betting X money on each side and either losing X and winning back X (breakeven) or losing X and winning back 1.1X (5% ROI).
As a real-world example, this spring I considered investing in a small company buying N-95 masks. I ended up not doing it, but the reasoning was basically this: I have a ton of exposure to the sports industry, which is very much tied to the future of COVID. In scenarios in which sports (and my future net worth) are negatively impacted by the virus, it’s likely that masks would be in high demand, in which case even an expected value of $0 for that investment would be +EV long-term because it would limit volatility at no cost. You could argue even a “bad” investment of this type could be beneficial, although part of that calculation is simply your appetite for risk.
In any event, the more correlated your investments, the more EV you need to justify taking on additional risk. When they aren’t correlated at all, you don’t need quite as much EV, and when they become inversely correlated, you can “hedge” by moving down to neutral-EV to even slight -EV in certain situations in which you possess a lot of downside.
To sum up my thoughts on hedging:
It’s smart if it’s used as true insurance. It’s smart if it’s neutral-to-plus EV when inversely correlated to other investments/bets you have. But most times, you’re just being a pussy and should let it ride.
Why Skin in the Game Matters
One of my favorite excerpts from Skin in the Game:
I went on television once to announce a newly published book and got stuck in the studio, drafted to become part of a roundtable with two journalists plus the anchor. The topic of the day was Microsoft, a company that was in existence at the time. Everyone, including the anchor, chipped in.
My turn came: ‘I own no Microsoft stock, I am short no Microsoft stock, hence I can’t talk about it.’ I repeated my dictum of Prologue 1: Don’t tell me what you think, tell me what you have in your portfolio.
Talk is cheap, as they say. If you want to know about stocks, you watch what a successful trader does rather than listen to what television analysts say. If you want to learn sports, you watch what a successful sports bettor does rather than, again, listen to what television analysts say. The only time to prioritize what someone on TV says is when the only alternative is a radio host.
The primary reason I think it’s important to learn from those with skin in the game isn’t because it’s honorable to take on risk (although it is) or because doing > saying (although it is) or because I’m biased toward placing downside on beliefs (although I am). The main reason is simply because looking to those with skin in the game is a useful heuristic to finding what works—a quick way to get closer toward the “truth”—as there’s a selection bias in terms of who you’re analyzing.
In real markets where people have skin in the game—and actual downside when they’re wrong—it’s not just the people operating that are meaningful. It’s all of the people no longer there—the ones who lost their money or were otherwise forced out—who truly matter. Whenever there’s a mechanism for poor ideas or -EV actions to die off—whenever an industry or field mimics natural selection—it means what’s left (say, elite pro poker players) is statistically more likely to be in line with reality than in areas in which there’s no such “survival of the fittest” trait (say, writing about poker strategy).
That’s not to say those who talk can offer nothing of value. Specifically, you can trust those with success who have skin in the game, or you can trust those appropriately using math/logic. Preferably both. Here’s how to find who you can trust.
You shouldn’t really trust what I say; hopefully you question everything and just use these posts as a springboard for thought. But if you do place emphasis in what I say, it should be because I can clearly articulate the logic behind what I’ve accomplished thus far—the areas I’ve found success when taking on risk. And more astutely, I hope you can learn from my many mistakes.
Question everything and everyone. But when it comes to looking for truth, a good starting point is the most successful people with downside because there’s a selection bias that increases the likelihood of them being correct for the same reason the odds of blindly choosing a delicious restaurant in New York City are higher than in Des Moines: the competition in NYC has forced out a higher percentage of the poor restaurants.
On Remote Work
COVID seems to have at least one beneficial impact to the economy over the long run, which is to speed up the timeline on certain aspects of our lives that were an inevitability.
One of them I’m not happy about is the surge in remote work, which I thought was one of the biggest possible edges available in business. My company FantasyLabs was completely remote and any company I ever create would be that way.
The primary benefits of remote business are:
Lower costs (no office)
Fewer meetings (less temptation to be busy over productive)
Unrestricted hiring (hire the best, regardless of location)
These are all important, but the last one is the most impactful. The internet has opened the ways in which you can make money by many orders of magnitude—to a degree most people don’t yet grasp. Yes, it might be more difficult to monitor employees when they’re working remotely, but who cares? When someone is doing work they’re meant to be doing—when you find an A+ hire, which is probably hundreds of times easier when they don’t need to live in a specific location—you don’t need to worry about monitoring them and their output will naturally be so much greater because they’re doing what they should be doing.
It also should reinforce a concept I believe is incredibly important and fundamentally misunderstood; in the internet-age, people create value with their unique, irreplaceable knowledge, not with their time. You’ll never become wealthy or hire the right people if you think about output in relation to hours spent working. An amazing engineer can make a company millions of dollars with one beautiful, logical line of code. Remote work should help employers naturally focus more on output than time spent working—which is what they should have been doing anyway.
In this way, it kind of sucks (for those already operating remotely) that other businesses have removed to remote work simply out of necessity, stumbling upon the most efficient solution by accident. Not every business can function remotely, of course, but the ones that can and weren’t—a huge percentage of companies—just got extremely lucky. No need to worry, though; making money in business is still the easiest game in town, and there are so many incredible edges remaining.
Many of them are versions of my principles for Lucky Maverick.
Totally agree with Josh....this is by far my favorite read each and every week!
Another great article! Touched on some different topics and provided useful insight for each