The TV advert shown in February ahead of Ladies' Day at the Cheltenham Festival invited viewers to spot the "stallions" from the "mares".
The ASA investigated 92 complaints that the advert was offensive and condoned harmful discriminatory behaviour.
The advert stated: "...we're going to make Ladies' Day even more exciting by sending in some beautiful transgendered ladies. Spot the stallions from the mares".
The advert showed a series of brief shots of people at the event while the voice-over tried to guess their gender.
In one scene, a woman was shown holding a dog while the voice-over said "woman" then hesitated while the shot changed to show a woman walking out of a men's toilet, then said "dog, I mean man".
A Paddy Power spokesman said the company was disappointed with the ASA's ruling.
He added: "This decision is especially frustrating given that the commercial was pre-approved by British television advertising clearance body Clearcast, who then considered the humour in the advert, while not to everyone's taste, fell short of causing offence.
"Additionally, we reached out to leading UK transgender group, The Beaumont Society, for feedback on the script.
"Furthermore, we exclusively cast members of the trans community in the various transgender roles in the commercial.
Would you class the advert as offensive: https://www.youtube.com/watch?v=1XZ5MOB3nww
