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Readers may have noticed an article on the TradeInformer website last week, looking at events contracts trading on Robinhood.
The US broker claimed over 200m US election event contracts were traded on their app in the week after their launch on October 28th.
Robinhood charges a commission of $0.01 per contract for the offering. This would imply revenues for the US election were over $2m, with the final number likely being higher than this given the contracts were still trading after the 200m figure was published.
This got me wondering how these are actually structured and offered.
With regard to the latter, Robinhood offers event contracts by trading via a company called ForecastEx.
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This is based in the US and is structured as a designated contract market (DCM). A DCM is an exchange that is regulated by the US CFTC and is permitted to offer trading in futures and options.
More interestingly, ForecastEx is owned by Interactive Brokers. Currently Interactive Brokers and Robinhood are the only brokers that are connected to the exchange.
The contracts are structured in a fun way.
They are priced from $0.02 to $0.99. You must pay the full amount – there is no leverage offered on them. You either pick ‘yes’ or ‘no’ and the payout is $1.00.
So for example, if you buy a ‘yes’ contract that costs $0.50 and you are correct, you receive $1.00 back.
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Contracts are executed when you have two buyers in opposite positions, where the combined value of the two contracts adds up to $1.01. ForecastEx then takes the additional $0.01 as commission.
Note that I say two contracts because one of the interesting features here is that there is, in theory, no ‘seller’. Both parties ‘buy’ a contract and then have a clearing facility operated by ForecastEx as counterparty. That means there is no novation. To use a different example, there is no one selling an option for a premium and then a buyer, with the counterparty for both parties then switched to a clearing house afterwards.
One other final point of note is that you receive interest on the value of your position until settlement. So if you held 1000 contracts worth $500 cumulatively, and held it for 3 months, you would receive 3 months worth of interest on the $500 value of those contracts. Also important to note here is that interest changes as the value of the contracts changes, for better or worse.
So to put this all in very simple terms…
- There is a an event, which you can buy a ‘yes’ or ‘no’ contract on
- You pay between $0.02 to $0.99 per contract
- If you are correct you receive $1.00 per contract or you lose your money
My initial look at this was that this a cool product but that you would have to do a huge amount of volume to make money from it. If you imagine from Robinhood’s point of view, if you sold a billion contracts, you would make $10m. Selling 1bn contracts requires massive scale, which they have but many other brokers do not.
The same was true for Interactive Brokers as ForecastEx is only making $0.01 per two contracts matched – so half of what Robinhood is doing.
However, Interactive Brokers operates another company called IB Global Investments that acts as a liquidity provider on ForecastEx. From what I can see, there are no other LPs on the exchange.
The implications of this are obvious. Although there are theoretically ‘no sellers’, you could become one in practice by buying opposing contracts to the ones customers are placing. Most of the popular contracts are on political events so are unhedgeable, so I guess for these contracts it’s more like book making than market making.
ForecastEx is not the only venue that offers these products. Polymarket has become very big in the run up to the election and has more products and trading volume. As noted, the CME also offers event contracts too.
Polymarket lets you bet on pretty much any event possible. In contrast, the CME – as you’d expect – has contracts that are all based on underlying financial markets.
These contracts look surprisingly familiar. You have the price of an asset. You buy a contract that is effectively saying that the price of the asset will or will not be above that level. If you are right you make money. If you are wrong you lose all your money.
I like to think the guys that came up with this were sitting around a table and going:
Person 1: ‘It’s kind of like an option and you buy a contract saying it will either be higher or low than a certain price.’
Person 2: ‘So you could almost say there is a binary outcome – either you are right and you make money or you are wrong and you don’t?’
Person 1: ‘Yea…actually that’s not a bad idea! Let’s call it a binary op….oh wait’
Person 2: ‘Yea we can’t call it ‘binary options’ bro, bad for branding’
Person 3: **takes long drag** ‘listen guys, there is like, an event, right? And then there are also options so instead of calling it ‘binary options’, why don’t we just call them ‘event contracts?’ **exhales**
All three of them high five and walk out of the meeting.
Joking aside, I actually don’t think binaries are bad. So many people in this industry seem to look on the product as inherently evil, rather than blaming the people who used them to commit fraud. It’s like saying you think buying stocks is ‘wrong’ because Bernie Madoff claimed he was an investor.
Anyway, the reason I always think they are good is that (1) they are intuitive and (2) they can help smooth out lower volatility periods. For example, try reading Investopedia’s explainer on CFDs and then ask if it’s easier to understand than me saying, ‘Yes or no, the price of Bitcoin will be above $80k next week? If you think ‘yes’ then you pay me $0.25 and you get back $1 if you are correct.’
Can brokers do something with event contracts? I would not be surprised if the bigger guys start offering them. Trading 212, for example, already has a relationship with Interactive Brokers, so presumably it would not be difficult to plug into ForecastEx.
The other point worth noting is that these contracts can be quite profitable. Keep in mind that the minimum per contract commission is effectively 1%. If you were charging a $0.01 per contract commission on contracts trading at $0.10, you would be getting 10% of the total trade value. It’s also possible you could keep the interest, or part of it, that you receive for holding the contracts.
The downside is that there does not appear to be a way you could offer these as counterparty because it would be…well…we all know what it would be. Plus, even accounting for commissions being high, you would probably need a lot of volume for these to be a good offering.
One company that is an interesting position with these is IG Group. This is because they already have a setup that is similar to that of Interactive Brokers and ForecastEx.
Like Interactive, IG operates an exchange in Europe, Spectrum Markets. This has similar permissions to a DCM. They then also have a market maker on Spectrum – Brightpool – which could make a market in these contracts. Then they have a broker to offer the products to clients. So in terms of having the complete set up and the potential to monetise these, they are probably in the best position – assuming you could actually offer them on Spectrum.
Plus500, AvaTrade, and others that are set up to offer futures could also presumably add these without much hassle. It would not surprise me if Plus500 began offering these in the US, for example.
A final point is that they could be a good marketing tool and way of bringing clients in, even if they are not themselves the most profitable product.