Merry Superbowl Sunday, and a happy offseason.
Like most finance types, I have a life-long fascination with risk and uncertainty. If I had my druthers, I’d move to Vegas and start a sports gambling show co-hosted with Jennifer Lawrence. It’d be called “Jenny and the Bets.” If that’s not possible, I’d get Kelly Clarkson to join me in the “Kelly Clarkson Criterion.”
Suppose you woke up in Vegas today and wanted to bet the Broncos would cover the 2 point spread. Assume you estimate a 55% chance of this happening. How much of your bankroll (or, analogously, your portfolio) should you wager on the bet? The kelly criterion answers questions like these. To help you celebrate this American holiday, I’ve created an excel workbook for this calculation.
The Kelly Rule has three inputs: your bankroll, the payoff odds and your estimated probability of winning. In this case, I’ve assumed a bankroll of $5,000 and that the bet odds are -110. In the gambling world, odds of -110 means that you have to risk $110 for the chance to win $100.
In this example, the Kelly Rule states that you should risk 5.50% ($275) of your portfolio on this one bet.
Personally, I’m often surprised by the aggressiveness of the Kelly Criterion. If your probability of winning is actually 55%, then you should optimally wager $275. Any less and you leave winnings on the table. Any more and you will be too decimated by the losses.
Here’s another “plus money” example.
One of the prop bets today is picking the Superbowl MVP. If Seahawks Quarterback Russel Wilson is selected, sportsbooks will pay bettors at +300. This means that they will win $300 for every $100 they risked. If you think there’s a 35% chance of Wilson winning the trophy, you should actually bet 13.33% of your portfolio on that outcome.
A bet of $666 on a Seahawk. As a Niner, that feels appropriate.