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Sell Certainty, Buy Doubt

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If you're selling when they're buying, you'll be laughing when they're crying.

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Each spring in certain parts of the country where people care about such things, hope pushes up through newly thawed horse pastures in slim, green threads. In Kentucky, the thoroughbred capital of the world, they call these threads Bluegrass. Of course, Bluegrass is not really blue, at least as far as blue goes, it's actually green. The word "Bluegrass" is nothing more than a funny mixture of literary conceit and deception. Not coincidentally, money is green, so is envy; two sides of the same coin, but there it is.

By the end of June, after the last of the Triple Crown races have run, these threads of hope will have been cut down to size dozens of times by expensive Bush Hogs, soon-to-be-grazed-upon by horse flesh often worth more than a hundred times the price of the expensive machines used to cultivate it. By the end of June, the Triple Crown races will be over, and so too the promise of hope will become a distant memory, not gone forever, but tattered and worn, the newness of its spring appearance replaced by the familiarity of business as usual.

The Triple Crown races, for three year old colts and the occasional ferocious filly, are about hope and optimism. By sharp contrast, there is considerably less hope and optimism about Breeders' Cup Day, that strange day in the fall when thoroughbred racing's elite gathers for what is ostensibly the Thoroughbred World Championship. The Breeders' Cup is business. By comparison, the Triple Crown is cute.

Each year on the first Saturday in May, no shortage of unsuspecting rubes will make their way to Louisville for the Kentucky Derby to lose the content of their wallets, and in the infield most of their clothes, to a savage mob of gamblers-cum-bootleggers who have been forced by letter of the local law to smuggle in hundreds of thousands of gallons of liquor to avoid the steep cost of Churchill Downs concessions; $15 for a mint julep, $7 for a cup of warm beer. But it's all in good fun, a wink and a smile, a nudge and a tout, which is why no one ever complains about the fleecing. That and the fact the fleeced innocent only discover the larceny days later safely back home in Chicago, or Detroit, or the Bronx. "Hey, where are my shoes? Have you seen my wallet? Why do I have Stephen Foster's business card stapled to my underwear?" Good, clean fun.

But no casual fan goes to the Breeders' Cup. The Kentucky Derby is the next to last race on an 11-race card with nobody much paying attention to what happens save for that two minutes of the day the Derby race is run. Imagine the World Series played in a single inning with lots of batting practice, tobacco spitting, a hot dog eating contest and beer chugging to fill the dead time and you have an image of any three of the Triple Crown races. But not the Breeders' Cup. The Breeders' Cup is eight straight races in less than five hours featuring the fastest, most dangerous horses on the planet each running for more than a million dollars within their own specialized world; sprinters, two-year old colts, milers on the turf, classic distances. The Triple Crown is glitz and glamour and a lottery ticket to the world of six-figure stud fees. The Breeders' Cup is strictly business. It is a day of reckoning.

In the world of high finance, they say hope is not a viable investment thesis, nor optimism a viable trading plan. Those nuggets of financial wisdom are perfectly crystallized in the path to the Breeders' Cup. The optimists make their foals eligible for the Breeders' Cup just after birth by paying a nominal $500 fee to the Breeders' Cup organization, a bit like a far out of the money call option. Those who are less optimistic wait for some sign of talent to develop. And the longer they wait, the more they will pay as their call option moves closer to being at-the-money. This year, the owners of Starcraft, a New Zealand-bred who was three-year-old champion in Australia, paid $800,000 to enter their horse in the Breeders' Cup Classic race. The purse is worth $4 million. Sometimes optimism crosses the threshold of hope and doesn't look back. Starcraft appears to be a case of having long ago missed the investment and now over-leveraging the trade.

Of course, as every good trader and investor understands, how you approach hope and optimism determines how you approach your business, no matter whether it's horses or credit spreads. Sell hope, buy fear, they say. Indeed. At the racetrack, I want to sell certainty and buy doubt.

On Saturday at the Breeders' Cup, there are three races where a relatively high degree of certainty is being conferred on a single horse. In the Sprint, at six furlongs on the dirt, the even money morning line favorite is Lost in the Fog, which means the public is likely to give the horse a 50% chance of winning the race. There are 11 horses in the race. When I look at the performance figures I use for each of the horses in the race, the fastest horse in terms of raw numbers is, of course, Lost in the Fog. But, unfortunately for the concept of certainty, the fastest horse does not always win the race.

On any given day, any number of weird things can happen to interrupt certainty; wind, crowd noise, a bird, rain. Also, because horses are athletes, their performance on any given day can be affected by prior performances that on the surface don't appear to have any relevance whatsoever to the race in question. They are not machines. They are athletes, and top athletes frequently perform below their maximum level both as a means of self-preservation, and as an unintended consequence of a peak performance that the body needs time to recover from.

Lost in the Fog performed at his peak capability in his last race. His running line shows that the last time he ran at that level he reacted physically in his next race by running at a level that, although still good enough to win the race, was about average compared to the championship company he will face on Saturday. In fact, although Lost in the Fog is undefeated in 10 starts, in five of those starts, and in four of his eight starts this year, he ran at a level that is about average compared to most of the horses he faces Saturday. That's good enough for me to look for someone else in the race.

My "style" of betting is to look for a horse that is value in the pools, and then use that horse as a "key" horse in exotics. I don't care who is most likely to "win" the race. Pari-mutuel odds aside, as the fastest raw number horse in the race, Lost in the Fog is the most likely winner of the race. The wrinkle, or the genius, of pari-mutuel wagering is that the bettors at the track are each betting on who will win the race, most often without realizing that in doing so, they are creating a separate reality apart from who the most probable winner is. I work backwards. I start by allowing the public to formulate their reality of who will win. Then I compare their reality to my own reality. If there is a big difference, then I sell their reality and buy my own. If there is no difference, then I pass the race because, by definition, the only way to win at the racetrack is to sell to the public since the public is wrong, statistically, 66% of the time.

I am a seller of Lost in the Fog on Saturday. The way I do this is to take a position in another horse, then wrap that horse up in exotics wagers that to varying degrees use the other horses the public is not buying. My key horse is Attila's Storm. I don't need Attila's Storm to win. Because I use leverage (also called exotics wagers) I just need Attila's Storm to finish in the top three. I don't care who wins as long as it is not Lost in the Fog. And, of course, as long as Attila's Storm finishes in the top three.

The second race featuring a high level of public certainty is the Breeders' Cup Mile on the turf. The 7-5 favorite is a horse called Leroidesanimaux. Similar to Lost in the Fog, Leroidesanimaux is the fastest horse in the race in terms of raw numbers. However, his history shows that peak physical performances take a toll on this horse, meaning he typically needs a long time to be able to return to a peak level. This is not a problem when he's facing ordinary competition. But on Saturday, against 12 of the best turf milers in the world, things become less certain. Leroidesanimaux in his last start ran a race that far exceeds any prior peak physical effort. My thesis is that there is a high probability that he will not be able to duplicate that effort on Saturday. And that means he is just another horse in the race, certainly not fairly valued at 7-5.

A horse that is nearly as fast, with a better post, and whom the public is not buying, is the European shipper Whipper. Again, using exotics, I just want Whipper to finish in the top three.

The Classic, a race on the dirt at a mile and a quarter, features another very fast horse that recently ran a peak performance, but whose other, more typical races are just average in the field: St. Liam. The public is likely to give St. Liam a better than 33% chance of winning the race. A horse the public is ignoring is Sir Shackleton. Again, using exotics, I just need Sir Shackleton to finish in the top three.

Other horses that I believe may be undervalued by the public on Saturday, by race:

Juvenile Fillies:
Along the Sea
Original Spin
Knight's Templar

Juvenile Colts:
Steviewonderboy
Private Vow
Dawn of War

Filly/Mare Turf:
Sundrop
Luas Line
Angara

Sprint:
Attila's Storm
Wildcat Heir
Silver Train

Mile:
Whipper
Majors Cast
Valixir

Distaff:
In the Gold

Turf:
Shirocco

Classic:
Sir Shackleton
Perfect Drift
Oratorio
No positions in stocks mentioned.

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