Drawing the Line Between Gambling and Finance: Part I—Meet the Aleatory Contracts

Randolph Duke: "Now, some of our clients are speculating that the price of gold will rise in the future. And we have other clients who are speculating that the price of gold will fall. They place their orders with us, and we buy or sell their gold for them."

Mortimer Duke: "Tell him the good part."

Randolph Duke: "The good part, William, is that, no matter whether our clients make money or lose money, Duke & Duke get the commissions."

Mortimer Duke: "Well? What do you think, Valentine?"

Billy Ray: "Sounds to me like you guys are a couple of bookies."

Randolph Duke: "I told you he'd understand."

~ "Trading Places"

Whenever talk turns to the legalization of online gambling or real-money daily fantasy sports leagues—issues confronting several state legislatures this year—one fairly common argument raised is that if we allow people to sit around in their underwear at home and day-trade stocks on E*Trade, we should let people sit around in their underwear at home and play fantasy sports or online poker. After all, isn’t the stock market just a big, legal casino?

Norman Chad, long time color commentator for ESPN’s broadcasts of the World Series of Poker, made this argument in a recent Washington Post column regarding real-money fantasy sports websites:

FANTASY SPORTS IS GAMBLING.

Now, I have nothing against gambling; I’m quite pro-gambling. I just hate it when people pretend something is not gambling. Poker players and sports bettors are labeled gamblers and often scorned by non-gamblers. Yet Wall Street – essentially the biggest casino in the nation, plus it’s kind of rigged – is not labeled gambling.

(People always worry about point-shaving in sports, when a player might throw a game to benefit bettors. How about insider trading? Heck, comparing point-shaving to insider trading is like comparing a rain shower to a monsoon. Hardly any game is ever fixed; by contrast, nefarious stock machinations occur on a daily basis.)

So, yes, stock trading is gambling and, yes, fantasy sports is gambling.

It’s not just daily fantasy sports. The argument regularly pops up whenever legalization of traditional sports betting or online poker is the topic du jour. And it’s hardly shocking that many professional daily fantasy sports and online poker players got their start in the world of finance.

So why are the trillions traded on Wall Street legal, while the billions bet online on sports, fantasy sports, or poker remain illicit? The answer is more complicated than might be imagined.

Aleatory Contracts

Gambling wagers closely resemble contracts such as insurance policies and financial securities because these transactions all fall within the same family of legal contracts—the aleatory contracts. The legal term “aleatory” derives from the Latin words aleator which means gambler, and alea, a dice game. “Aleatory”is defined as:

1: depending on an uncertain event or contingency as to both profit and loss

2: relating to luck and especially to bad luck

An aleatory contract, then, is “a contract whose execution or performance is contingent upon the occurrence of a particular event or contingency or an uncertain (random) event beyond the control of either party.” Any traditional gambling wager is clearly an aleatory contract—whether betting on a football game, a roll of the dice, or a hand of poker or blackjack, the outcome of the wager depends on the occurrence of a contingent or uncertain future event.

But the law also recognizes other types of aleatory contracts. For example, insurance is a classic aleatory contract in which a premium is paid in exchange for a promise of monetary benefits in the event of an uncertain (random) future loss (e.g., a house burns down). Similarly, many options, futures, and other financial derivatives are also aleatory contracts in which performance is tied to future conditions in the relevant financial market.

The underlying structure of each of the different classes of aleatory contracts is identical, though the terminology specific to each class of contracts may differ. But whether it is a gambling “wager” or an insurance “premium”, all of the aleatory contracts are based on the identical legal foundation: Party A pays $XX to Party B as consideration for Party B’s promise to pay $YY to Party A if a particular future contingent event occurs. So, from a purely analytical standpoint, there is no legal distinction between Party A paying Party B $5,000 in exchange for Party B’s promise to pay $100,000 to Party A twelve months in the future if:

1. Party A's house burns down or he dies (insurance); 
2. the price of corn rises or falls (futures); 
3. the price of Apple stock rises or falls (options);
4. interest rates rise or fall (swaps); or
5. the New York Jets win the Super Bowl (gambling).

Yet, of these examples, the first four contracts are generally legal (and regulated to varying degrees) throughout the United States, while the last contract is currently legal only in Nevada (and then only in a licensed sports book). If all of these contracts are functionally equivalent, why are some aleatory contracts legal and others illegal?

To answer that question, we first need to look at how the legal, non-gambling aleatory contracts function. In many cases, these contractual functions closely parallel certain aspects of gambling, both legal and illegal. Once the functions of the legal aleatory contracts have been examined, we can then look at how and why the law draws a distinction between gambling and other aleatory contracts.


Coming up (links will be added as each section is posted):

Part II—Insurance: Gambling on Catastrophe

Part III—The Reinsurer, the Bookmaker, the Poker Pro Staker

Part IV—Derivatives and Daily Fantasy Sports

Part V—Hedgers and the Law

Part VI—Speculators and the Law

Part VII—Risk Creation v. Risk Management