How to bet on American Pharoah during the Preakness

Jockey Victor Espinoza celebrates as he guides American Pharoah to win the 141st running of the Kentucky Derby at Churchill Downs on May 2, 2015, in Louisville, Kentucky.
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The massive favorite in Saturday's Preakness Stakes is American Pharoah, who won the Kentucky Derby two weeks ago. The nature of the horse's status as such a big favorite will actually allow bettors an interesting opportunity on a free option.

Even if you think he's going to win, make a place bet instead. You'll make more money that way—even if he loses.

This is the advice from Bill Hessert, the founder of Derby Games, a social platform for the public to legally bet on horse racing, through their desktop or mobile apps.

Be thankful for the dumb money

As CNBC has written about previously, the Preakness will cause a lot of "dumb money" to be wagered—which means people who aren't professionals and don't know what they are doing. By avoiding some basic mistakes and looking for smart opportunities, you can gain an edge here. Hessert advised the public to take advantage of these casual fans to have a better chance at profit.

Derby Games has compiled data on thousands of historical bets, which is how they know what will work.

American Pharoah has 3-5 odds to win the Preakness. The smart money suggests it's not a bright idea to bet on a favorite this big, because the returns aren't usually worth the risk. The more money wagered on a horse, the shorter the betting odds, reducing the payout for each dollar bet.

But in any case, a lot of people are determined to bet on him, regardless of the slim payouts. For those people, Hessert has advice to make a slightly smarter bet than everybody else. "For the believer, my advice is to bet that American Pharoah places, not that he wins."

Don't bet on a win: bet on a place

Making a place bet means you think the horse will finish in the top two. A show bet pays off if the horse finishes in the top three. Hessert compares this to last year: "When California Chrome won the Preakness in 2014, a place bet paid the same as a win bet. If you bet that he was going to finish first—or that he was going to finish first or second—the wager paid out the same!"

2014 Preakness bet returns on California Chrome
50 percent Win
50 percent Place (notice Win and Place are the same!)
20 percent Show

As opposed to traders in the stock and bond markets, horse race bettors don't know their exact payouts when making their wagers. The final payouts are only officially calculated when the race ends, after all the bets can be totaled. That makes it difficult to immediately spot a pricing difference and arbitrage it away.

The arbitrage exists because most race fans will bet on American Pharoah to win, not finish second. When those same bettors then look to find second-place horses to bet on, they will ignore American Pharoah, looking for other choices instead. As a result, the total pool of money bet on American Pharoah finishing first is so big that the per-dollar return is lower on win bets.

That leads to the good side of the trade: the lack of money bet on American Pharoah to finish second is the key factor in increasing the payout of place bets. These two concepts create the skew that Hessert described above: The amount of money somebody wins on American Pharoah's finishing first is the same as on American Pharoah finishing in the top two. If American Pharoah ends up losing by a nose, you'll be happy you made that place bet, which will still pay off. You really are getting the option of second place for free.

It's worked before

Consider another example backing up this approach: In the 20 most recent Triple Crown races, there was another winner with short odds similar to Chrome's. Big Brown paid $2.40 to win the 2008 Preakness, and $2.60 to place in the same race. That's even more skewed—you would have made more money betting on Big Brown to place rather than to win. Higher payouts with shorter odds—that's a compelling enough trade anybody should want to take.

2008 Preakness bet returns on Big Brown
20 percent Win
30 percent Place (notice the Place bet returned more than a Win!)
20 percent Show

This scenario is likely to arise only when you have an extreme favorite in a race with a lot of irrational bettors, like American Pharoah in the second leg of the Triple Crown. That makes this year's Preakness unique: It's a rare opportunity to bet smarter.