I'm doing some research into how electronic options markets work - and specifically those used primarily for prediction purposes. I'm familiar with them (previously wrote about prediction markets and political contracts).
The two big exchanges that I'm looking at are the Iowa Electronic Market (IEM) and TradeSports.com. Both are "real money" markets. The IEM is focused on political events and on using the market as a "petri dish" that the associated business school can analyze to learn how markets work. TradeSports.com is strictly a business focused on making money by acting as a broker. They take fees for various events - trading and withdrawing money. TradeSports.com also provides their data to educational institutions, probably for marketing reasons, and have been reviewed and cited by the respected finance professor Jeremy Siegel.
I plan on writing more on Prediction Markets over the next months and here is a bit of a roadmap for things I know I want to talk about. You can find new articles by going to prediction markets page or by using the prediction markets rss feed.
Reason for Markets
The basic motivation for these markets is twofold: for the individual traders to make money and for the spectators to get high quality predictions about complex events. Both of these are easier said than understood. So, I'd like to gather resources and citations that make it clear how the fundamentals of trading work and why these markets are successful at predicting events.
Major Events in Markets
The major events in any options market are basically the same:
- Initial Issues of Contracts - similar to an Initial Public Offering or IPO
- Trades of Contracts the bread and butter day to day activity
- Contract Expiration - where fortunes are made
Each one is relatively simple in theory - issuing contracts is when they first become available for trading, simple enough - but the reality of how these are structured and function can be complex - for example, the IEM uses contract bundles to create a market which is different from Tradesports margin based system. The possible ways to place a trade are myriad and complex as well - market order, "fill or kill", "stop/loss" - what do they mean and how do their differences impact a market?
Problems with Markets
Aside from the most obvious problem - the complexity of markets for every day users - what other structural problems can markets face? How can different decisions in constructing markets lead to more - or less - efficient marketplaces. And of course what technical and housekeeping decisions need to be made to ensure smooth functioning of the markets.