Every year, there are three days that I look forward to more than any others.
Sadly, both were disrupted this year by the outbreak of COVID-19, leaving those of us who “rely on it to buffer the passage of time” – as former commissioner A. Bartlett Giamatti once put it – wandering aimlessly through the days and weeks.
For me, it’s because when the producers happen to turn off the fake crowd noise, the game makes a joyful noise I haven’t heard in meaningful quantities since I played in college.
It sounds like practice.
And if I’m lucky, I might be able to hear a little bit of that noise on my third favorite day of the year – Game 1 of the World Series.
You Bet I Love Baseball
If you’ve been reading along these last few months, you’re probably familiar with how data-intensive my analysis tends to be. As such, it probably won’t surprise you very much to learn I gained a lot of that statistical intuition from baseball.
In seasons past, I’ve participated in as many as 10 different fantasy baseball leagues. And in fact, I’ve been a card-carrying member of the Society for American Baseball Research – or SABR – for more than half my life.
Back in the day, I used to try and parlay what I thought was a statistical edge into friendly wagers on the World Series games themselves. But since the Supreme Court ruled in favor of commercial sports betting back in 2018, enthusiasts in 19 states to date have had the opportunity to make those friendly wagers more official.
The map below shows where, with dark green states representing those with legislation already in place, while light green indicates pending legislation, and light blue indicates active bills.
But in total, more than 75% of states have some kind of bill before their legislatures – some of which are being fast-tracked after watching New Jersey rake in $4.5 billion in wagers early in the year.
That success has led to casinos like Penn National Gaming (NYSE: PENN) ponying up $450 million to acquire brash sports brand Barstool Sports, and even blank-check IPO’s like that of daily fantasy sports (DFS) pioneer DraftKings (NYSE: DKNG).
While the professional sports shutdown earlier in the year pushed each stock down to incredibly low prices, they rebounded incredibly, with DKNG up as much as 605% off the lows, and PENN rallying an incredible 2,043% trough-to-peak.
That’s worthy of a green hammer courtesy of Barstool Presidente Davey Day Trader Global himself.
Those runs have pulled back of late, which provides us an opportunity to examine the driving forces behind them.
Of course, part of those moves is made possible by a growing market, and insatiable pent-up demand from enthusiasts during the lockdown.
But another, arguably larger, part of these massive returns ironically overlaps with a key concept in both sports betting and DFS themselves.
Robinhood Levers Up
Now, for those unfamiliar, the word “leverage” means slightly different things in sports betting vs. DFS vs. investing.
In sports betting, it simply means borrowing money to place bets – which I’ve done in the past on certain occasions where an outcome or total is grossly miscalculated.
Just as an example, the total for the November 2018 Rams-Saints NFL game – at the time the two most explosive offenses in the NFL – was set at 50. I levered up to take the over, and the teams beat that total in the first half. Even better, I got to watch my victory whilst sipping Sazeracs at Muriel’s in Jackson Square… a highly recommended experience.
In DFS, however, “getting leverage” on the field means putting a certain player in a greater percentage of your lineups than the rest of your competitors.
And in the investing world, it generally means making use of financial instruments like options.
In the case of the post-COVID market melt-up, it is that latter definition that has really been driving the bus, so to speak. Stimulus funds that hit retail investors’ bank accounts earlier this year caused a ton of strange action, from mass purchases of beleaguered cruise stocks to bankrupt “zombie” companies posting huge daily gains.
But once that trend died down, they also piled into options (represented in orange below) at a huge clip in June, pushing the S&P 500 up almost 20% in the process.
And if you were to look at total open interest in options across the entire market, you’d see that it is back at an all-time high.
Source: The Market Ear
The thing that most people don’t know, however, is that the market reacts to this the same way a sports book would when it receives too many bets on one side of a line. In order to incentivize wager flow in the other direction, they’ll just move the betting line.
Similarly, when a call option is issued to retail investors, the market maker has to go buy stocks to hedge their book.
So extreme option flow can drive prices – especially when market makers don’t “control” the bets.
If we apply this to individual stocks like PENN and DKNG, we see two different trends. With PENN, for instance, we see that price has pulled back 10% recently, but so has option activity.
That’s not good for near-term price movement, and absent a significant change in volume, I’d expect it to perhaps move back down and test support at $60 per share.
DKNG action, on the other hand, tells a very different story.
Here, option volume is increasing, and it’s skewing heavily toward calls. Moreover, it appears to have successfully defended near-term support at the $41.50 per share level.
Because of how huge sports betting is going to become over the coming years, these are both stocks I’d like to own for the long haul. But right now, one is way closer to a reasonable entry point than the other.
Given that it’s still 4x over its IPO valuation, I don’t want to get too heavy here, but I’m OK with picking up a ¼ tranche below $42 per share, with an eye to add more if a pullback brings it down closer to $30.
Although I still think it is unlikely to happen before the election, both sides of the aisle are trying to hammer out a stimulus agreement at the last minute.
Should my instincts be wrong, and Congress passes a bill tonight or tomorrow, these stocks are likely to soar in the near-term.
But if we’re lucky enough to get a chance to buy either of them on sale, you can bet I’ll be levering up to take advantage.
All the best,