Understanding the EV Factor of Financial WagersAdded - Oct. 13, 2014 Financial
In financial betting, you have to understand certain aspects of mathematics if you want to be able to do the proper analysis to have a chance at developing models that can beat the markets that you're interested in. One of the most important concepts you need to learn is that of expected value, or EV for short, and while it's an extremely important topic to learn, it only uses basic multiplication and addition if you organize your work correctly. We're going to show you how to do this organization and how to make sure that everything works out like it's supposed to.
There are certain pieces of information that you need to know or approximate if you want to find the EV of a specific bet. That information is a list of every possible outcome for the bet, the chance of each outcome happening and the profit for each of those outcome (whether positive for a gain or negative for a loss). We're going to use an example of a binary option type of bet where a certain market closing above level M will give you a win of $100 while that market closing below level M will give you a loss of $135.
Let's suppose that our analysis tells us that this bet is going to win about 42 percent of the time. Our two outcomes are the market closing above M and the market closing below M. We think there's a 58 percent chance that it closes above, and the profit for that is $100. That means we think there's a 42 percent chance that it closes below, and the profit for that is -$135. Note that we have every possible outcome, the chance of those outcomes and our profit for each outcome. From there we can determine the EV which is our average profit from the play.
You find the EV of the bet as a whole by finding the EV of each individual outcome. The EV of an outcome is its chance of happening multiplied by its total profit. So the EV of the market closing above M is 0.58 * $100 = $58, and the EV of the market closing below M is 0.42 * -$135 = -$56.70. We add these outcomes together to get $58 + -$56.70 which is $1.30. We then have to decide if this is an acceptable risk to take for $1.30.