Aug

2

Originally posted May 2, 2009:

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

Archives

Resources & Links

Search