Bookmaking is a name for a class of enterprises in which the entrepreneur attempts to set both the purchase price and sale price for some event or set of events, or for a financial instrument. The entrepreneur, let’s call him the
“bookie,” may or may not be able to set absolute buy/sell levels, but will in almost all cases have near-absolute control over the spread between the buy and sell prices, and he will earn his profit principally from this spread.
There are all sorts of widely different entrepreneurs who use bookmaking as their method of making money with money. They range from the local guy who takes bets on football games, to the absolutely state-of-the-art sports
books housed in casinos, to the specialists on the New York Stock Exchange (NYSE), to the market makers on the Chicago Board Options Exchange (CBOE), to every insurance company in the world.
There are thousands of variations on bookmaking.Terminology matters. Specialists, market makers, and insurance companies are in fact bookmakers by any reasonable definition. If you happen to be a little bit surprised at this statement, it’s probably due to the unrealistic and negative connotation that the word “bookmaking” has acquired, particularly in America. Consider what the NYSE specialist firms do. At bottom, they guarantee liquidity to the market.
The specialist guarantees to step up and buy shares when most are selling, and to make shares available when everyone wants to buy. In return for undertaking such a responsibility, specialists are allowed by the rules of the exchange to control the bidask spread for NYSE-traded stocks. Ergo, they are bookies by precise definition.The function of the market maker on the option exchange floors is similar, although the rules under which the market maker operates differ considerably from those governing the specialist.
Both these groups of entrepreneurs earn the bulk of their profit from the spread between the bid price and the offer price of the markets in which they participate, the markets they make. Naturally enough, they do have and will employ other means of increasing their earnings, certainly including trading for their own accounts,but we’re concerned here with their primary function and method of making money with money.
Insurance companies are bookies also, but their bid-ask spread is much more complex and far less immediate than the spread to be found on the exchange floors. Insurers do not ordinarily make the bulk of their profit by buying policies at $1,000 and selling them at $1,100 in lots of five, a hundred, or ten thousand. Rather, they use what might be called a “deferred” bid-ask spread. An insurance company’s bid is the sum total of all possible liability to the company as specified in the policies it writes for you, me, and who knows how many others.
Their offer is the sum total of all premiums that you, I, and others pay them—but with a twist. While you and I pay the policy premiums on a known date, the insurance company, in some enormous majority of cases, pays out their liability for our auto crash or hospital bill or storm damage only much later, if at all. Therefore, in addition to the bid-ask spread, the company can (and does, you bet your life) also earn investment return on a tidy chunk of the premium dollars collected.
Now, all this is merely ordinary business practice for insurance companies,but this is once again bookmaking, just as sure as sunrise. The only differences here between insurance bookmaking and specialist or sports bookmaking are the time frame and number of variables involved, and the very convenient notion of being able to use other peoples’ money to increase their profits. Nice work if you can get it, eh?
To be sure, specialists are also highly leveraged. Specialists use other peoples’ money, too, with the major difference that the people lending money to specialists will at least be making a market rate of return on the dollars lent.Bookmaking Versus Gambling:In comparing bookmaking to gambling, it’s useful to note that the profile of profit differs considerably in both amount and frequency.
The low-skill gambler usually attempts to make a very infrequent profit well out of proportion to his stake, his capital. The high-skill gambler attempts to earn a profit generally proportionate to his capital over a healthy majority of (usually varied) propositions.
The bookmaker, however, attempts and intends to make a small or smallish but consistent profit over a pre-defined set of propositions within a more or less specific time frame. The sports bookie, in particular,should and will usually know his profit on a given proposition very nearly to the exact dollar even before the game begins. The specialist and the market maker know from long experience how much they are likely to earn from each day’s market activity.