and came up with optimized blackjack play. Thorp named the optimal play of cards Basic Strategy.
He wrote the best-selling book, Beat the Dealer. It is, even today, regarded as a classic work, and blackjack players the world over rely on Basic Strategy to optimize their card play.
In the 1960s, casinos offered single-deck blackjack and dealt the entire deck.
Thorp calculated that players who counted cards and scaled their bets based on the residual cards left
in the deck had an edge over the casinos. He used the Kelly Formula to figure out how much
of your bankroll you ought to bet each time based on how favorable the odds were.
For example, if the deck had an overrepresentation of tens and aces, that was good for the player.
If the odds were 52:48 in the favor of the player, the Kelly Formula suggested that the player bet
4 percent of his bankroll. That’s what Thorp would endeavor to do with every hand.
For Thorp, this wasn’t an academic exercise. He started frequenting the Nevada casinos and cleaned up.
The casinos didn’t understand why he was consistently winning, but, with the mob running the casinos,
they didn’t wait to understand. They simply showed him the door and made it very clear that if he ever returned,
the reception wouldn’t be so civil.
When Thorp published Beat the Dealer, players the world over started cleaning up.
Casino owners also read Thorp’s book and began to make changes to the game.
Over the past four decades, the game has gone through numerous changes.
Each time the casinos made a change, some smart gambler would figure out a way to beat the system.
Then the casinos would figure it out and make another change.
Today, most casinos deal from a shoe of six to eight decks.
They don’t play the last couple of decks and pit bosses watch the action like hawks.
In some casinos, auto shufflers recycle the used cards back in real time—ensuring that
the card pool never has an over- or under representation of any specific cards.
Thorp reflected on this changing reality (along with the onerous threats) and decided that
he’d be far better off if he applied his talents to a casino where:
There were no table limits.
The offered odds were vastly better.
The house was civil about taking large losses.
The mob wasn’t running the casino.
He found that such a casino existed, and it was the New York Stock Exchange (NYSE)
and the fledgling options market. Rumor has it that Thorp figured out something along
the lines of the Black-Scholes formula years before Black and Scholes did.
He decided not to publish his findings. The Black-Scholes formula is, effectively,
Basic Strategy for the options market. It dictates what a specific option ought to be priced at.
Because he was one of the only players armed with this knowledge, Thorp could buy underpriced options
and sell overpriced ones—making a killing in the process.
Thorp set up a hedge fund, Princeton-Newport Partners. Over a 20-year span, the professor delivered
20 percent annualized returns to his investors with ultra-low volatility.
One of his potential investors was actor Paul Newman.
Newman once asked Thorp how much he could make playing blackjack full-time.
Thorp could still beat the casinos with his skilled card counting and replied that it would be
about $300,000 a year. Newman then asked him why he wasn’t pursuing it.
Thorp looked at him and said that the NYSE and options market “casinos” made him over $6 million
a year with miniscule risk. Why pursue $300,000 and take on added risk to life and limb?
In investing, there is no such thing as a sure bet.
Even the most blue-chip business on the planet has a probability of not being in business tomorrow.
Investing is all about the odds—just like blackjack.
Thorp is the most vivid example of a human who has mastered these concepts fully.
He has repeatedly played the odds on the Strip and Wall Street over the decades and won handsomely
on both fronts—creating a huge fortune for himself and his investors.
When an investor approaches the equity markets,
it has to be with the same mind-set that Thorp had when he played blackjack:
if the odds are overwhelmingly in your favor, bet heavily.
Excerpt from : Dhandho Investor
Picture from Amazon
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