Odd Lots - How A Former Wall Street Trader Cracked The World Of Betting On Baseball

Episode Date: July 10, 2017

It's no secret that a lot of people in finance like to bet on things. But how many of them take the time to actually beat the house in gambling? On this week's Odd Lots, we talk to Joe Peta, a former Lehman Brothers trader, and the author of "Trading Bases," a book about betting on baseball. Peta started focusing on baseball after a freak accident (getting hit by an ambulance) gave him lots of time to think about applying his trading knowledge to baseball. Eventually he launched a $1 million baseball betting fund that returned 14 percent in a year to his investors. On this episode, Peta talks to us about why baseball is uniquely suited to data analytics, how he was able to exploit market inefficiencies, and what sports betting can teach us about market structure.See omnystudio.com/listener for privacy information.

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slash audio. All investing is subject to risk vanguard marketing corporation distributor. Hello and welcome to another episode of the Oddlots podcast. I'm Joe Wisenthal. And I'm Tracy Allaway. Hey Tracy, remember our episode from a few weeks ago with Phil Helmuth? Yes. Yes, I do. Gosh, it seems like so long ago. Yeah, but I don't think it was. I think it was just like a month ago or something. Anyway, not to pat ourselves on the shoulder, but you know, That was one of the most popular episodes in Bloomberg podcast history. You're definitely patting yourself on the shoulder there, Joe, given that you're interested in poker, right? That's why we had them on.

Yeah, but that's not why I'm not bringing that up to congratulate ourselves or anything like that. There's actually a serious point behind it, behind its popularity, which is that a lot of the finance crowd that we ostensibly target, and which we do target at Bloomberg, is really into stuff about gambling and games and games of chance. Well, that's true. And I mean, there's clearly an overlap there as well, right? Yeah, there's definitely an overlap, definitely lessons that could be applied from finance to gambling, lessons from gambling and betting that could be applied back to finance. And I think from a personality standpoint, you get a lot of people, obviously, in the financial industry who just sort of also are very interested in the gambling side. And of course, the history of finance and gambling are

deeply intertwined. Are you telling me that we're going to talk about poker again? No. Good news. We are not talking about poker on this episode. Although actually, I think maybe our guest likes poker, but I'm not sure. But we are going to be talking about someone who has been active in both sides of the finance and gambling divide. Okay. But, gambling on what exactly? This time gambling not on cards, but on sports. Oh, Joe. Joe, if it's not chess or poker, then it's sports.

Yes, it's sports. So let's jump right into it. The guest on our episode today is Joe Pita. He was a trader at Lehman for many years, were involved in various things including hedge funds there. He's at a hedge fund now, but in between those two things, he was also figured out a way to bet on baseball, and he wrote a book about betting on baseball called Trading Bases. So I think a perfect guest to talk about the two worlds.

I'm going to caveat this with my usual thing, which is I know nothing about baseball or sports betting. So I look forward to learning about it, Joe. You know what, Tracy, it's never, you know, you always say that, but it never proves to be a problem because you always ask fantastic questions. And so I'm confident that this discussion will be no different. Oh, okay. That's very sweet. Let's have them on. Joe Pita, thank you very much for joining us.

Joe and Tracy, it's a pleasure to be on. It's, you know, I'm on a lot of, because of the topic of the book, I end up on a lot of, you know, Vegas-based podcast, etc. and it is a pleasure to be on a podcast that I know has such a high intellectual content. I will try my best to only lower it a little bit. No, no need to flatter us, but we do appreciate. Would you say that the intro was a fair characterization of your background from banking to betting and then now at a hedge fund? Absolutely. The book and the book itself came about literally by accident, I was still working on Wall Street in lower Manhattan when I got run over by an ambulance in New York City. And while I was laid up and in a wheelchair and I couldn't travel

back to my home in San Francisco with my family, while I was laid up, I had this idea to write a book that more or less examined the critical reasoning overlap between asset management, the money ballization of baseball and sports betting. He was clearly a write-what-you-know book for me, but you definitely touched on those in the intro. I can tell you when the book was up for, was being passed around publishers' houses. One of the editors that very much wanted to work on it was Phil Helmue's editor.

He had written Play Poker Like the Pros. So, yeah, there is definitely that overlap between the audiences. So before we get into the book itself, tell us what you were doing on Wall Street before you were hit by an ambulance. And you said, you know, you started focusing on whether some of these critical reasoning and data analytical tools could be applied to sports betting. I take it then even before this endeavor, this had already been an interest of yours. Yeah, I can tell you when it came up. I mean, certainly I'd always been a baseball fan. And the book really is a lot about baseball. It is a memoir, so it does really touch on, you know, sort of the role baseball has played in my family.

My father was an immigrant. And one of the ways he was he wanted to, you know, show his love for America because he was saddled with an Italian name, Hermione, that instantly announced him as, you know, an outsider. One of the ways he wanted to show his love for America was he loved baseball and he was going to become an English professor. That ultimately was sort of his path. So baseball, I was always very interested in baseball. I had been introduced to Bill James and a lot of the Sabermetric theories in the 90s and early 2000s. But it wasn't until I was with Lehman and moved from the sell side to the buy side, which of course your audience understands. I had moved to San Francisco to help launch a Lehman funded hedge fund.

And I was challenged with, as running the trading desk there, what I found was I was working with analysts and portfolio managers who had different skills. And I was really sort of challenged with how do we only have them do what they're good with? And this is one of, I know one of your other guests. I know Michael Mobison, I know you're a fan of his work and you've had him on. And this is something he talks about a lot too. And we've talked since, you know, we've read each other's books. And my goal was, how do I get these guys to only do what they're good at and, you know, not degrade the value that they bring to the table as either analysts or portfolio managers by doing something they're not good at? And I looked to, and I knew to sort of convince them or try to change that behavior, it was going to have to be data driven.

So I looked to the lessons of baseball. I'm like, well, baseball's already solved this. And so I started using that. And so, and they were very crude tools, but it was really trying to identify, you know, not results, but skill sets. And what really struck me, especially then after I got injured when I started thinking about it, is, you know, Moneyball was such a huge hit as a book and as a theme. And it was really, it was embraced by the business world. And I was thinking to myself, like the whole industry of major league baseball is worth, you know, maybe $30 billion. You know, it's probably an average of a billion dollars a team.

There are single financial institutions worth more than that. But why is baseball so much better at using its data to identify skills and not luck, you know, than the financial industry is when there's so much more at stake? So that was sort of an underlying theme of the book. So, Joe, can we back up for a second? Because whenever people talk about sports analytics, they always eventually start talking about baseball and money ball and things like that. What is it about baseball specifically that seems to lend itself to analyzing facts and figures and numbers? Yeah, Tracy, that's a great question. There's really two parts of it. One, it's data rich. The history is data rich. It has been results in baseball beyond just the final score. But results. of each play or really each pitch have been recorded for more than 100 years. So you've got this data-rich environment, but most importantly when you compare baseball to other sports,

is baseball is really a series of one-on-one matchups, 60 or 70 one-on-one matchups, a game disguised as a team sport. So I can with very high confidence say something like, you know, and I use this example in my book, Randy Johnson, who was a prolific strikeout picture, played in both leagues, the American and National League. He played for five or six different teams. He won Sy Young's, I think, for three different teams. And he pitched the different catchers. Despite that all, despite all those other variables, he struck out. roughly one-third of the batters he faced every year. And you could count on that despite all those changing variables. There is no way we could look at Tom Brady and say, so when we evaluate Tom Brady, we have to say things like Tom Brady running a Bill Belichick offense, play action faking to these running backs, throwing to these receivers will complete 60% of his passes. But you could not move him to another team and model his performance exactly the same. same way because it's so much more, there's so much more interdependence. Baseball, and that's why I

found it the best to create models for betting. Baseball is very pure in that it really is one-on-one matchups, like I say, disguised as a team game. That is a great explanation of why sports analytics is so, you know, so much of it comes back to baseball. So I read Moneyball, and, you know, I want to get into where you get your edge, because I read Moneyball, and I, you know, I, you know, you know, the whole idea that I took away, which is that a lot of these scouts of players and general managers had some sort of biases about what made a good player or not, and maybe they just had some rules of thumb and heuristics to look at a player and evaluate them, and they really weren't data-driven, and that when the nerds, so to speak, took over and really

started looking at the data that they found that some of this old baseball wisdom wasn't really matched by results. So there was a clear gap between what the data said and what the received wisdom said. Now, taking this over to the world of betting and going to a casino and placing a bet, and obviously the house and the casino is sort of data-driven. Where does the edge come from specifically when you sort of port this over to the world of gambling? It's an evolving edged and it certainly has gotten smaller. it changes. It evolves. Certainly, you know, just using sort of the money ball as an example, back then in the book, on-base percentage was undervalued, right? So there was value to picking up

players that got on base a lot, even if they didn't have the other counting stats like home runs and RBIs that were deemed important back then. And of course, that's shifted. There is no, across Major League Baseball now, there is no, you know, there's, oh, on-base percentage is not undervalued. However, defense may have been undervalued five or six years ago. So there's always a pendulum, and any time in a course sports betting or there's a price for each team every night, you know, and as you know from financial markets, while prices do incorporate a lot of known information, they also incorporate emotion. And you can see that there is always when it comes to, say post-season betting or futures betting, there is always a, I almost call it a, an ermaze-type

premium on the Yankees or the Cups. You know, there's a retail markup. So you can find small edges there, but specifically when you are looking at single games, as I talked about in the book five years ago there, and this really goes back to sort of what Mobison says, there is still an element of looking at past results when pricing the current market. And pictures, especially five years ago, were subject to, you'd look at a picture's ERA, which is how many runs he gives up over a game. And that, you know, his past ERA or his current ERA for the season had a lot to do with how he might be priced in July. But if you dig deeper, there were better ways to look at what his future ERA should be. And you do that by looking at his skill sets, not his results, because ERA is

dependent on the defense behind him. It's dependent on the luck of sequencing, which I call cluster luck, in terms of what tends to be much more sticky is the skill set of what percentage of batters does he strike out. What percentage of batters does he walk? What percentage of hit balls are ground balls. And that can, and you will find some pictures that you will look at those inputs and you'll say, oh, you know, a regression analysis tells me he should have an ERA of upper threes instead of upper twos. So, you know, he might be overvalued on a single game. And the important thing with any, with any endeavor of capital, of course, is you want to find a small edge and then you want to put a small amount of money on it. You know, it's that old idea that you never want to risk tomorrow's

edge by over-allocating today. And that's, you know, that's just, and that's, again, a lot of the overlap, I find that the world of gamblers and even poker players, they tend to overestimate their edge. And I tried to talk about that in the book, too, that, hey, one thing the financial industry is really good at. One thing hedge fund pros are really good at is understanding survival. And then, of course, I drew the comparison to Dick Fold, who did not understand that, who had a wonderful franchise and risked it all, you know, by overbeating on real estate. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive,

murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard. At Vanguard, institutional quality isn't a tagline. It's a commitment to your clients. We're talking top-grade products across the board of over 80 bond funds, actively managed by a 200-person global squad of sector specialists, analysts, and traders. These folks live and breathe fixed income. So if you're looking to give your clients consistent results year in and year out, go see the record for yourself at vanguard.com slash audio. That's vanguard.com slash audio. All investing in subject to risk,

Vanguard Marketing Corporation distributor. So, Joe, the subtitle of your book is how a Wall Street trader made a fortune betting on baseball. Walk us through exactly how you made your bets and how much you actually made. I will address that, but I will tell you we can get a little inside sort of publishing here. And you may know this. Wait, don't tell me the exaggerated the title. I refuse to believe the publisher would ever do that. Yeah, right, exactly.

And you know this even from publication that, you know, bylines, the person who writes an article doesn't write the headline, right? And they get trapped by the headlines sometimes. Well, I certainly learned from the publishing industry that the author owns everything between the covers, but the cover itself, including the title, belongs to the publisher. Now, fortunately, the hardback cover, that was my title. The title of the book was, was Trading Basis, a story about Wall Street gambling and baseball, not necessarily in that order. when the paperback rights were sold, I think, to Random House, they renamed it or they put the subtitle there. I never wanted the focus to be on, you know, that sort of thing like how somebody made a fortune. Because for one thing, a fortune is relative, right? And for another, one of the things I kind of talk about in the book is that professional investors, they never talk about, you will never hear a hedge fund. say, hey, we were up $2 million yesterday. You will hear them say we were at 40 basis points, right? And that is really what I tried to get across in the book is it doesn't matter how little or how much money you have. The idea of capital allocation is the same for everyone. Well, Joe, let me rephrase my question then,

because this is actually what I wanted to get into. So you're betting on a sport. You're betting on a particular outcome. It seems to me like that outcome is probably going to be either win or lose. So how do you risk adjust whatever return that you're actually making from sports betting? Fantastic question, because I really did dive into this. And to the story about, you know, a fortune, I did for the epilogue of the book, I did raise a fund. It was a million dollar fund. And I went to Vegas for the summer of 2012 and actually ran a baseball betting fund, you know, legally in Vegas.

and that you're the idea of how much to bet on each game is very important because each game's a binary event. It's, you're either going to, you know, it's not double because the odds of the game might be say two to one. But you're either going to lose everything you bet or you're going to, you know, win, you know, essentially what you bet or a little more, maybe a little less depending on the odds. So the idea was, what I had the idea was, okay, let's look back to the financial industry. We know baseball has this great, this idea of the replacement player. And it's kind of an amorphous concept. And you hear that every player is essentially judged in the money ball world by how many wins they create over the replacement player. Tracy, wait, remember Tracy when we were chatting?

And Tracy was like, what's one thing I should know about baseball? and our colleague said, the one thing you should know is war. And here you go, wins above replacement. All right. So go on. I just wanted to, sorry, I wanted to jump in there and point out that this was something that came up in Tracy's prep for the episode. Well, if you think about the, and the idea is the replacement player is readily available to anyone. You could pick up this player from either the minor leagues or on waivers and any team has access to them for essentially a minimal contract. that concept actually applies perfectly in the financial world and that is, you know, the S&P 500. That's the replacement player for every investor. That's the passive alternative that is readily available for any investor. So if you're going to pay up the, you know, that's, if you're going to pay up for active management, right, they have to beat this passive benchmark. Well, the nice thing about the passive benchmark as well is it works as a investment tool in the sense that, I know the standard deviation of returns of the S&P 500, and I know the expected return,

so that if I'm really running a baseball fund that is truly an alternative asset, well, I should have daily returns that either have, you know, hopefully have a higher return than the S&P 500, but the same amount of volatility. So to get back to your question, Tracy, that was really how I played with. How much should I be betting on single games was to really find that, um, amount that gave me returns without giving me excess volatility. And what it did turn out was specifically if you looked at a slate of games in a day, there's about 15 games every day in Major League Baseball. If I identified five or six to bet on, it was rare that what I would even

put 1% of the capital on one game. Usually the bets were somewhere between a third of a percent to maybe three quarters of a percent based on how much I thought there was a perceived edge. So really, it was almost like I always kind of of likened it to owning a roulette wheel, right? If you own the roulette wheel, if you're the house, you have a small egg and you just want to spin that wheel as many times as possible in a day. And you don't want people place a million dollar bets, right? You want them placing a whole bunch of smaller bets because that's how, you know, that's where you have your edge and that's where you extract your gains in the end. And that was the, I applied that same, you know,

capital allocation theory to a slate of baseball games each day. All right. Well, let's just talk results for a second, though. You raised a million dollars for your fund. First of all, A, how'd you raise the million dollars, and B, how'd you do? Well, the A is fascinating. So I handed in my book, I handed in the manuscript for the book after the 2011 season, which is what the bulk of the book is really about. It's sort of my, like I say, my memoir of being injured during 2011. And I handed it in, and the publisher, Penguin, came back to me once I handed in the manuscript in March, and they said, we love it, which was certainly satisfying to me because I was, you know, an unknown author with no works behind me.

And they said, we're going to publish it in March of 2013, but we're going to need something for 2012 in there. And they said, if we gave you the marketing budget for the book, would you go to Vegas and bet on baseball games for us? We kind of think that would be a cool pitch. and I, of course, I of course said, absolutely. That really does sound like fun. And I knew if I did that, that I'd better talk to some of my degenerate family and friends, too, and see if they wanted to be involved as well. And that's how I raised a million dollars. It was essentially family and friends and the publisher. And that was the epilogue of the book. In that year, I was up 14% for the year in terms of the fund. Which is about what I think my eggs would be. The 2011 season, which was just me, and I was up 40%.

And that's not, it was not repeatable. Just a lot went right. You know, that's the old skill versus luck. The actual edge was much, much slower, and I knew that. But it was a fun ride. And I view 2012 as being much more indicative of what you could expect from a data-driven model, you know, that really tries to conquer baseball. betting. So is sports betting, is that a legitimate replacement for investing or trading more traditional financial assets? And if it is, then what is actually the difference between trading and

betting? To quote George Washington and Hamilton the musical, not yet. Because it's the epilogue of the book I really tried to write almost as a business school case study in this in sort of looking at it is is there actually a market as an alternative asset? Because one thing we do know is if you're betting on sports or if you're investing with someone who's running a fund, we do know that it's not correlated to, you know, stocks and bonds. It is truly an uncorrelated asset. So it meets that requirement. What it doesn't meet, however, is there's not enough liquidity. I estimated that I could have run a two, maybe three million dollar fund, and that was it. Because past that, I couldn't have scaled up the bets. There just wasn't enough liquidity in the market to be making bets.

But most importantly, and while I tried to give, while I tried to point out the ways that the financial industry can learn from baseball in the book, I also tried to point to point out, out that Vegas and specifically the industry of running sports markets could really learn a lot from Wall Street. And unfortunately, they're not there yet. It is still an antagonistic relationship between the sports book and the better, which is the way when I entered the NASDAQ market in 1995, that's the way NASDAQ trading was. It was fragmented. We were suspicious of every customer who walked through the door and every trade was us first them. Once NASDAQ evolved into more an agency market, it became the business of asset collection and bringing together buyers and sellers.

And it's what poker does. Poker, you know, as you may know, in poker, the house doesn't bet against the players. The house simply collects rents by getting the players into the same room. And if sports betting ever evolved into that, it could be a huge market and it would turn into an asset gathering market as opposed to, you know, sort of what it is now, which is us first them. I see that. I cannot get some of the people in the industry to see that, and I have tried. Joe Pita, he's the author of Trading Bases, and he's currently at Kingsford Capital. That was a great discussion. I loved that last bit about market structure, that lesson there. Really appreciate

you coming on odd lots. Joe and Tracy, thank you so much for having me. So Tracy, another episode about gambling and sports, which you claim to not know anything about, but you did know stuff. You asked great questions. Well, I don't know that much about it. But what fascinates me is it's really that question of, you know, like what makes a market and what's the difference between betting and trading and investing and where's the overlap?

And I thought Joe did a really, really good job of identifying that. Yeah, I did too. I mean, I really liked his answer about sort of how to, A, where he found the statistical edge from sports betting and, you know, basically there's still a lot of emotion, home team biases, streak biases, things like that that you can spot in the odds of a game. And then that last answer sort of about the difference between the sports book at a casino, which he described as antagonistic versus a poker room where they just want to, you know, sort of get liquidity and bring people together sort of very. interesting lesson back to think about how sort of more traditional financial markets are structured. Yeah, for sure. So, Joe, when are we going to go on our crayfish eating, poker playing, baseball watching tour of the U.S.? We got to do that very soon. But until then, this has been another episode of the Odd Lots podcast. I'm Joe Wisenthal. You can follow me on Twitter at the

stalwart. And I'm Tracy Alloway. I'm on Twitter at Tracy Alloway. And you can find Joe on Twitter at at Magic Rat SF and our producer Sarah Patterson on Twitter at Sarah Pat with two teas. Thanks for listening. The news doesn't stop on the weekends. Context changes constantly. And now Bloomberg is the place to stay on top of it all. Hi, I'm David Gurra. Join us every Saturday and Sunday for the new Bloomberg this weekend. I'm Christina Ruffini. We'll bring you the latest headlines, in-depth analysis, and big interviews. All the stories that hit home on your day. days off. And I'm Lisa Mateo. Watch and listen to Bloomberg this weekend for thoughtful, enlightening

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