Back to top

Prediction Markets - Issuing Contracts via Unit Portfolios vs. Buy/Sell

The first order of business in any options exchange is getting options onto the market.

Issuing new Contracts

Tradesports achieves this (as far as I can tell) by allowing every member of the exchange to either buy or sell any option. Everything is done on margin until the option expires. If you "buy" a position, (i.e. there is an offer order at or below your bid) the price at which your order was bid multiplied by the number of contracts you purchased is placed into a holding status in your account. If you "sell" a position then the sale price minus the expiration value is also put into holding status in your account. When the contracts expire - "buy" accounts are given a dollar if the event occurred - "sell" holders are given a dollar if the event didn't. Frankly, that makes my head hurt

IEM has a simple process for issuing contracts: unit portfolios. If your contracts are about whether a coin toss will produce a 1) heads or 2) tails or 3) land on its side then they issue a new "unit portfolio" by selling all three of those for the expiration price. Since they represent all possible outcomes, the total value is defined as the expiration price (generally $1). Then it is up to the trader who buys the portfolio to determine what price they want to sell an individual option. If you want to "short" a particular option, you simply 1) buy all of the rest of the contracts that comprise that unit portfolio or 2) buy the unit portfolio from the exchange and sell the one contract that you wanted to short.

In practice these systems are amazingly similar. The question then becomes - which is simpler to explain, understand, and count?

New Options within a Series

One question I have is how each handles a new outcome that becomes possible within a series. Looking at the IEM again, initial contract portfolios include a bundle that represents all possible outcomes. The 2008 Democractic Nominee Market opened with 4 possible contracts: Clinton, Edwards, Obama, and "Rest of Field." What happens if a new candidate not in the initial list becomes the most likely winner? In that case the "Rest of Field" contract comes to basically represent that candidate. The IEM provides the possibility of a "spin off". They declare a point in time to spin off that candidate from the Rest Of Field contract - all holders of a "Rest of Field" contract at that time would receive one additional contract for the new candidate. They could then trade that contract as they saw fit and from that point forward any unit portfolios purchased would include this new option.

TradeSports uses a system where they begin a new series and accept suggestions within that series for some amount of time. They will then stop accepting suggestions and add a "Rest of Field" contract. Given the ability of an individual to make a late dash for a race that seems like it could be limiting.

People Involved: