May

2

Einstein purportedly said that compound interest was the most powerful force in the universe. I challenge his statement and offer the hypothesis that the vig is the most powerful force in the universe, exceeding that of even free market forces because it's always there. Exerting a constant force on every trade, transaction, purchase, sale, or any human activity of any kind, the vig is always first in line to get paid.

The vig is a powerful enough force that both winners and losers pay, without even realizing it in many cases. The vig has clever ways of hiding and disguising itself but is always there. From the widening and narrowing bid/ask spreads in the market, to the 35 to 1 (or even more insidious 35 for 1) payout on a single number on the roulette wheel, the vig constantly grinds out and extracts it's percentage on every trade or activity. Like the steady beat of a metronome, the vig is just extracted, extracted, and extracted some more.

The general public has little awareness of the vig, but the vig takes a huge toll from the unsuspecting public. All of the great deals offered the public generally have a higher vig, although even the professionals must pay it. Games with longer odds such as trifecta pools, keno, and lotteries charge high vig, while short games and trades usually have much lower vig. Games that advertise that they're commission free usually charge the highest vig of all, such as those bucket shop Forex places that are sprouting up like mushrooms all over the place. The vig allows the beautiful Vegas casinos to exist, Churchill Downs to run it's card, and allows the temple at Wall and Broad to continue it's operation day and night.

I contend that although the electronic trading is supposed to increase liquidity and eliminate the vig charged by the locals, thus benefiting the public, the opposite occurs. The apparent percentage takeout of the vig might be reduced, but the increase in the velocity of trading, with a smaller vig collected each round trip, more than makes up the difference, sort of a Laffer Curve applied to the vig.

One can easily see this by looking at the volume and revenues at places like the CME where volume has exploded and the market cap of those high temples of finance has gone into the stratosphere. Those beautiful buildings have been built by the pennies per transaction takeout from everyone, every trade, and it all adds up. The apparent reduction of vig has allowed the online poker sites to flourish with advertised low rakes versus the brick and mortar clubs. People think they're getting a great deal with such a low rake but don't realize that they're playing at a rate six times faster than in real life and probably paying out more vig than they would in Vegas, Atlantic City, or the numerous underground clubs I used to frequent in my misspent youth.

Although the vig is a constant fixed percentage in sports betting, in the markets it is ever changing. With the advent of the electronic markets, I have a certain difficulty these days in calculating the amount of vig I pay every trade, although I have a general idea. I have some pretty sophisticated math that's supposed to help me figure out the vig I pay, but even that's just an approximation When I was a local, I knew how much vig I collected down to the quarter cent depending on what type of trade I was accepting. I collected a certain amount of vig buying a spread, selling a spread, trading with little locals, and fading paper from the public. I offered discounts in vig for size, and would give up a quarter cent if I knew I could bag a big order. I also knew how much vig I would have to pay and the percentage that might change if I were desperate enough. Even though I collected vig every day, I also knew how precisely much vig I would have to fork over at the end of the day to play in the pit, because everybody has to pay tribute to someone. Since every player pays vig in trading, the money has a way of working it's way up, to some unknown repository somewhere. All of this paid tribute and upward movement of money feels like it has a part in a certain Francis Ford Coppola movie that was so popular in the 1970's.

Free market forces do affect vig, widening and narrowing the percentage, but while free market forces might disappear for awhile due to governmental regulations and laws, the vig will always be around. Vig shows up in many other clever disguises such as lower yields on fixed investments, taxes, assessments, points, fees, payoffs, and graft. Vig has to be calculated into every transaction, and must be figured into every apparent overlay one might spot.

My late, great, grandfather used to cite the old axiom that "There's two kinds of people in this world, those who pay interest and those who collect interest." While he was spot on with reciting that observation, he sadly neglected to tell me that everyone has to pay vig, a hard lesson that I had to learn for myself.

Steve Ellison writes:

A traditional recipe for business success: reduce the price of a product and thereby generate much greater demand and higher profits.


Comments

Name

Email

Website

Speak your mind

13 Comments so far

  1. Penn State Clips on April 29, 2009 12:06 pm

    Great post, Jeff, thanks, though I take exception to “Although the vig is a constant fixed percentage in sports betting, in the markets it is ever changing.”

    The vig is constantly changing in sports betting as well. Books will often adjust their vig (to the point that some bets become +102 or even +105) before adjusting their point spread. This is especially true if they are on a key number, like 3 or 7 in the NFL.

  2. steve on April 29, 2009 2:10 pm

    The chair writes on the spread, the vig , slippage and more in his book Ed Spec. that in and of it self is worth y of the purchase price.

    sit at a poker table and study the math. in a low stakes game the rake is $4 per hand. Each hand the dealer gets toked $1 or $2 dollars. the dealer can easily deal 25 hands an hour. So conservatively, $125 disappears from the table every hour. In Florida the poker rooms can be open for 12 hours a day. $1375 is taken off the table in a day. The real estate is a 32 square feet approximately for the table and chairs. not a bad return. Therefore in order for the game to survive, there must be a constant influx of capital. And in order to be a net winner, this is a very difficult slippery slope to climb. My advice, play a home game, hire a dealer to keep the game flowing and the betting right and let the chips fall where they may. If you want to be serious about poker, keep meticulous records record every session and at the end of the month evaluate your return. You will be startled as to the results. Or better yet go to Bobby’s room at the Bellagio and take your chances there. Just bring enough for the buy in $20,000 will get you started. You will probably last a few hours if you play tight because the blinds are typically $300-$600http://www.bellagio.com/casino/bobbys-poker-room.aspx

    There is an old poker saying “you can shear a sheep many times but you can skin him but once. Casinos and poker rooms prefer to shear the sheep rather than skin them. They do this by taking a little bit every time and in return providing rfb and sometimes transportation.

  3. New Article « Masteroftheuniverse’s Weblog on April 29, 2009 3:26 pm

    […] leave a comment » I was up for most of last night and wrote a little article over at Daily Speculations. […]

  4. vniederhoffer on April 29, 2009 3:49 pm

    It is because of Nock and Bacon and vig that we are graced with this post of Mr. Watson's which ennobles this site. The chapter on vig in EdSpec might have subconsciously inspired Mr. Watson, and it is likely that we both were inspired to reach for such subjects by a muse of the market. vic

  5. Russell Sears on April 29, 2009 4:35 pm

    The Feds job seems to be adjusting the “vig” for banks. When they get to the maximum spread by lowering the rate to zero, they give them capital (or time), so the vig can work its magic.

    They have learned from the savings and loan crisis. Afterwards there will be no easy way to count the vig to the public. It will be presented as a “gain” to the taxpayers, because the interest was paid.

    As Jeff says, “The general public has little awareness of the vig”

  6. david higgs on April 29, 2009 5:22 pm

    Be thankful you haven't been vigged by the biggest vigger of all, the Madoff vig…

  7. George Parkanyi on April 30, 2009 11:39 pm

    Well, if the vig is such a force and so inevitable, is there a way to turn the tables and emulate it using market instruments?

  8. Gangineni Dhananjhay on May 1, 2009 7:43 am

    As a day trader and high frequency trader I am constantly against the three forces of vig, spread and slippage. In the market ecosystem ultimate survivors appears to be Brokers, Exchanges, Regulators and Governments in the form of taxes and duties.

    How to determine the optimal relationship between vig and capital so as not to be devoured by big speculators ?

  9. Steve Leslie on May 1, 2009 11:42 am

    To George's question, if you are looking for a vehicle that prospers due to the vig here are some suggestions.

    Paychex
    Paypal
    Visa
    Mastercard
    CME
    any exchange stock such as New York Stock exchange
    NASDAQ
    The Options exchanges eBay
    Auction companies
    Banks
    Online Brokers
    Health Care information processing stocks
    ETF that invest in banks and above mentioned stocks
    Off track betting companies
    Lottery companies

    When you come to think of it after a while the list becomes enormous. Disclosure I am not recommending these nor do I necessarily own them.

    Good luck with your research!

  10. manuel bravochico on May 1, 2009 10:41 pm

    Good points. One does have to monitor vig.

    However, let's not get carried away with this Vig stuff. If you trading right, Vig is a hurdle not a wall. If Vig is moving the overall needle on your pnl between profitability and loss, there something wrong.

  11. Portfolio Results for April 2009; down 3.7% « 0 to IPO in 7 Years on May 1, 2009 10:44 pm

    […] Tonight before setting up for this post, I carefully walked through the trade settlements in the Questrade account that hold REAP groups 1 and 2.  They do some funky adjustment transactions to make the dual-currency functionality work, but the commissions and both currency-type transactions worked correctly.  What these accounts let you do is to hold both CAD and USD in the same account, and to settle in the currency of the trade.  There are no currency conversion costs as long as the same-currency trades either offset in value and/or or there is enough of the currency in cash to cover any purchases.  Transaction costs (vigorish, or “vig”, in trader parlance) were huge for me last year, since I had to settle all trades in Canadian dollars, and all my US trades required currency conversion.  Also now, commission charges at Questrade are going to be about 1/6 of what they were at Scotia - together a huge cost reduction.  For an excellent post on the vig and its implications, check out Jeff Watson’s contribution on the topic over at Daily Speculations. […]

  12. douglas roberts dimick on May 3, 2009 4:08 am

    A Response to Buffet et al… Complex Math: The Vig is Why

    Buffet may prove to be right about modern portfolio theory…

    Buffett and Munger: Stay Away From Complex Math, Theories
    By Scott Patterson, OMAHA, Neb. — A theme that keeps cropping up from Warren Buffett and Charlie Munger at the Berskire Hathaway meeting is their complete disdain for modern portfolio theory and the use of higher-order mathematics in finance.

    Mr. Buffett: “There is so much that’s false and nutty in modern investing practice and modern investment banking…

    There’s this holy writ, the efficient market theory… How do you teach your students everything is priced properly?… What do you do for the rest of the hour?…

    If you need to use a computer or a calculator to make the calculation, you shouldn’t buy it…

    The famous physicist Max Planck was talking about the resistance of the human mind, even the bright human mind, to new ideas…. And he said science advances one funeral at a time, and I think there’s a lot of truth to that and it’s certainly been true in finance.”

    See http://blogs.wsj.com/marketbeat/2009/05/02/buffett-and-munger-stay-away-from-complex-math-theories/.

    However, instead of his throwing out the baby with the bathwater, one may consider an alternative, being how Quantitative Relativity (or QR) merely requires a paradigm shift. QR modifies contemporary quantitative correlating processes by preceding any such formulation(s) with rules-based condition precedent assimilation(s). By doing so, state-input-state (or state transition) domains may generate the very valuation-formulation constructs of indicator and function relativities that Buffet so implies as being either obfuscated or completely lost via the linear digressions away from true market constituent-parts (or components) of valuation (including speculation, I would maintain).

    In the study of rules-based (or legal) systems, one may discern how complexity is aligned with the productivity of fee and commission generated pricing models. Complex math is rewarded in the marketplace not just when attempting to provide insight into efficiencies and the effectiveness of valuation theories; an alternate or even primary goal is to construct progressive schemes for increasing rates or expanding domains of the vig.

    Why were toxic derivatives toxic? Both recourse and valuations were increasingly, geometrically detached from linear pricing (or costing) assumptions by duplicitous (or circular) transaction (or exchange) cycles. However, those of the vig prospered well, indeed, very well…

    It is this realization that provides a touchstone for program trading and portfolio management system design. System development and operation should be evaluated based on a representative vig quotient between corresponding elements of costing and frequency.

    Thus, when one analyzes electronic exchange market charting, any chart, consider that space represented by time and price, constituting the area between a given price action (line or array) and zero (0) of the x/y axis. That mass (or accumulated displacement) is aggregate valuation; accordingly, the vig functions similar in form to gravity, whereby pricing (e.g., drifts) is affected by continual increases and decreases of that force (or transaction cost ratio) operating during any given exchange process (be it represented by a sequence or combination or trades).

    Thus, Jeff’s truism (that “the vig will always be around”) is just that, circular in nature, thus a constant be it during linear progressions or digressions in the charting of price action. The metacircularity of exchange (or trade) pricing a la the vig tells us so.

    dr

  13. vic on May 10, 2009 9:28 pm

    Is there a conflict of interest in investing in the old line companies that one never has to sell, and a role as adviser to the important parties on which old line versus new line industries and financial institutions should be saved? Or does anyone ever say anything based on principle rather than self-interest these days?
    vic

Archives

Resources & Links

Search