This bet has been analyzed to death but it came up in my feed recently and I couldn't find an actually intuitive explanation anywhere. Black-Scholes and simulations are cool and all, but what's the ELI5 for why Do Kwon got picked off?
1. A few weeks ago we witnessed a duel between @Do Kwon 🌕 and @Algod in a public wager on LUNA's future price action. In this piece written with @Paradigm we analyze how this bet could be priced using options pricing theory + who got rugged on this trade…
Let's say LUNA is worth $X right now. Markets are random, but in expectation, LUNA's price a year from now is $X (assume zero interest rates and shorting is easy). The price can't go negative but can be arbitrarily high. So the one-year return might look like one of these curves.
The important thing is, the bet here is an over/under as opposed to a typical trade where one side buys and the other sells. That is, Do made a good bet if and only if 50% of the time LUNA is above $X in a year. It doesn't matter by how much!
But look at these graphs: the price distribution is right skewed, i.e. the median (50% mark) is left of the average. Since the market is pricing in that the average is $X, the median must be less than $X. Therefore Do made a bad bet.
So next time you make an over/under bet on the price of a financial asset, maybe set the threshold to less than the current price. Not financial/gambling advice, just some plain English analysis without fancy math formulas.