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Sunday, August 22, 2004

Political Futures Markets 101

A lot of people have been asking me recently how these political futures work. Here is a basic synopsis taken from Intrade's website.

Tell me what I'm trading
We've created an exchange for you to trade (speculate on) events that directly affect your life, like politics, entertainment, financial indicators, weather, current events and legal affairs - these are our trading categories.

Within each category we list a set of contracts, a contract is an event that will have an unambiguous result.

For example, some of our political contracts are: "Will George Bush be re-elected in 2004" or "Will John Kerry win the Democratic Nomination". Each one is an event with an unambiguous result, either George Bush will be re-elected or he won't.

You are trading (speculating on) what you think the outcome of that event will be.

Let's use one of our political contracts as an example - Will George Bush be re-elected President. There are only two possible outcomes for this contract - Yes, he will be re-elected or No, he will not.

When the election is over and the result is official, if George Bush gets re-elected that contract will close at 100. If on the other hand he fails to win the general election, the contract - Will George Bush be re-elected President - will close at 0.

However, until the election is over that contract will fluctuate in value between 0 and 100 just like a stock, reacting to the news of the day and buying & selling by you the trader.

Tell me what the prices mean
Since our contracts trade between 0 and 100, you can think of the price at any time to be the percentage probability of that event occurring. Let's go back to our George Bush example, on December 1, 2003 the George Bush re-election contract was trading at 63, meaning, traders gave him a 63% chance of being re-elected.

If you thought President Bush will be re-elected you would expect that price to go up - towards 100. In that case, if you bought one contract at 63 and Mr. Bush did get re-elected you would make the difference between your purchase price - 63 - and the closing price - 100 - or 37 points. How much profit would that be? Click here.

It's important to realize that you don't have to hold your contracts until the result of the event is decided - you can get out of your position at any time until the event is over. So if you change your mind about the outcome you can come back to the exchange, enter an order and close out your position, whether it's for a profit or loss depends on you.

Who determines the prices?

You do - along with thousands of traders around the world. Just like the price of Microsoft stock is determined by the buying & selling activities of thousands of traders in the financial markets, the price of our contracts are determined by traders, like you, who are confident enough to back up their opinion by risking real money.

How do I calculate profits and losses?
Think in terms of points, when a contract trades from 63 to 73 - that's 10 points. Each point is worth 10¢.

If you bought one George Bush re-election contract at 63 and he does win the election, that contract will close, or settle, at 100. Your profit will be 37 points x 10¢ per each point or $3.70.

Settlement price – purchase price = your profit


100 – 63 = 37 points X 10¢ per point = $3.70 a profit

On the other hand, if he does not win re-election that contract will settle at 0 and your loss would be 63 points.

0 – 63 = – 63 X 10¢ per point = – $6.30 a loss

Remember, you do NOT have to hold onto any contracts you buy or sell until the election, you can trade out of them any time!

Let’s take another example, you buy 6 contracts at 50 in the morning and sell them out at 73 later that day. You collect 23 points (73 – 50) times 6 contracts times $.10 for each point or $13.80 in profit.

23 points X 6 contracts X $.10 = $13.80


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