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.