I love markets. Just think of all the things they make possible. Whenever there’s a way for people to trade with each other, they always find ways to make money and reduce risk. So whenever market principles get applied in new ways, the world becomes a better place.
Right now it’s happening in the realm of politics. Readers of this column know I believe that politics is the number one force acting on the stock and bond markets — but this is something else again. It’s a market in politics itself.
It’s called Tradesports.com. When you first visit the site, don’t make the mistake of thinking that this is some online betting parlor. This is a sophisticated futures market. No, you won’t find contracts on pork bellies. You’ll find contracts on an astonishing variety of events — sports events, market and economic events, news events, and political events. Even terrorist events!
Let’s take a look at the most actively traded futures contract on Tradesports.com, the contract on George Bush winning the 2004 U.S. presidential election. Right now that contract trades an average daily volume valued at about $1 million.
Here’s how it works. The day after the November elections, the contract will expire. It will be priced at 100 points if Bush is reelected, and zero if he is not — and 100 points equals $10 per contract.
As of this writing, it’s trading at 71. If you bought the contract at 71, and Bush is reelected, you’d make 29 points (because then the contract would expire at a value of 100). Those 29 points represent $2.90 per $10 contract — so if you had bought 1000 contracts your total profit would be $2,900.
Of course, as in any futures market, for every buyer there has to be a seller. Or more precisely, for every long there has to be a short. In this example, the short would lose 29 points, or $2.90 per contract.
But suppose Bush loses. Then the contract would expire at a value of zero, so the long would lose $7.10 per contract, and the short would gain $7.10 per contract. By the way, both sides pay a commission of 4 cents per contract for every trade.
Tradesports.com trades similar contracts on dozens of political events. For example, there are contracts on every Democratic hopeful, so you can speculate on which one will win each state primary, and other contracts for the party’s nomination.
What can you actually do with these contracts? Well, if you’re smart, you can make money.
Small fortunes were made by people who dared to buy a penny-stock called John Kerry just before the Iowa caucuses. After the upset, his nomination contract went from two to 65 — a 3,250% return in a matter of days (now, after New Hampshire, Kerry is trading at 68). At the same time, after Iowa, the Howard Dean contract went from 78 to 11 (they don’t call him “the Internet candidate” for nothing — that was a genuine dot-com-style stock crash). He’s now at 8.5.
But as with all markets, there’s more than just the speculative profit motive. All of society benefits from the information embedded in prices at Tradesports.com, because these prices reveal the world’s best estimate of the probabilities of various future events. It’s the ultimate poll.
For example, that Bush reelection contract priced at 71 points is telling us that, right now, Bush has a 71% probability of being reelected. Traditional opinion polls tell you only what percentage of voters say they will do in the future; polls don’t give you the probabilities of various outcomes.
Knowing the probabilities helps people make better decisions about how to invest and how to hedge. That’s why Admiral Poindexter assigned the Defense Advanced Research Projects Administration to develop a futures market in terrorist events. He thought that would be the best way to help Homeland Defense, national security and intelligence officials get a handle on what the risks are out there.
When the media got wind of Poindexter’s idea, they made it seem so whacky that it was immediately abandoned. Yet Tradesports.com is up-and-running right now with exactly the same concept. Before the US-led coalition invaded Iraq, Tradesports.com listed contracts on whether Saddam Hussein would be in power as of particular dates in the future. Today there are contracts on whether Osama bin Laden will be apprehended, and on the color-coded terror alert level in the US at year-end 2004.
What use is all of that to investors? For one thing, Tradesports.com’s contracts are an objective barometer of what the market is thinking about various risks. A year ago, when the US was still undecided about whether and how to invade Iraq, the markets were buffeted by volatile moves that the media never failed to blame on imagined investor perceptions about the chances of a war. Well, with Tradesports.com, there’s no need to imagine. Just look at the changes in prices of the Saddam contracts, and you can see for sure whether the market’s assessment of the probability of war went up, down or sideways that day.
Remember that this election year as the media begins to attribute market moves to the market’s perception of Bush’s reelection chances. The Tradesports.com contracts will tell us for sure what the market really thinks about that — so when we see the Dow rise or fall 150 points on a particular day, we can start making more intelligent judgments as to why.
Of course, the most straightforward use of the Tradesports.com contracts is simply to trade them. Let’s say you think Bush will be reelected, and that the market will go up as a result. So ordinarily you’d buy stocks based on that — and that would be an entirely legitimate investment strategy.
But that’s two propositions in one, isn’t it? You could be right on Bush, but wrong on the market for any number of reasons. But at Tradesports.com, you can separate those two propositions, and just speculate on Bush (or against him, if that’s your call). Of course, when you separate the propositions that way it feels more like “gambling” and less like “investing,” but if you think about it rigorously I defy you to articulate any real distinction.
Speaking of gambling, I won’t offer an opinion on whether it’s legal for Americans to use Tradesports.com. Tradesports.com is domiciled in Dublin, Ireland, where it’s entirely legal. There, it isn’t regulated either as a gambling site or as a futures exchange — it falls in between the regulatory cracks, as all great innovations seem to do. As chief executive John Delaney put it — invoking an Irish expression — “The law doesn’t come within an ass’s roar of knowing what to do with us.”
Let me just say that I am unaware of any specific legal reason for Americans not to participate. I’ve opened a Tradesports.com account, but I haven’t used it so far. I don’t have any particular legal concern about it. I just haven’t found the contract I want to invest in yet.
But believing as I do that politics moves the market, it’s only a matter of time before I fire up my laptop, go online and put my money where my mouse is. I love markets!
The above is an “Ahead of the Curve” column published January 30, 2004 on SmartMoney.com, where Luskin is a Contributing Editor.