Elections are interesting to us as macro traders. High-profile political election results can move the markets in a big way, Just look at how crazy the E-mini S&P’s traded during the US’s 2016 presidential election…
They had a 5.5% crash and rally when the cash markets were closed!
The magnitude of a macro market move after a political event depends on how much the results surprise traders. It works just like a stock’s earnings announcement. If results come in way above expectations the stock will rip hard. If results come in way below everyone’s expectations the stock tanks.
Up until recently, we’ve had to rely on sub-par polling models created by people who have no real money backing their predictions. These models did not give us a good indication of the true positioning of traders in the market.
Now, prediction markets like PredicIt allow us to get a glimpse of how people around the world are judging the odds of global political events (and backing those judgments with real money).
PredicIt operates based off a simple contract priced between $0.00 and $1.00. Traders have the option to either purchase “yes” or “no” shares on any given question or event. The market operates exactly like a futures market where for every “yes” contract there exists another trader holding “no.”
At the end of the event, the winners are each paid out $1.00 a share and the losers receive $0.00 a share. Leading up to the event the prices for “yes” and “no” fluctuate depending on supply and demand of the market. This floating opinion allows us to use PredicIt to assess how various political outcomes will impact markets.
Let’s look at a quick example.
PredicIt already has a market for the 2020 US Presidential Election.
If a trader thinks Trump will win again he can purchase “yes” shares on Donald for $0.30.
- If Trump wins the trader will receive $1.00 for a net profit of $0.70
- If Trump loses the trader will receive $0.00 for a net loss of $0.30
Now if the trader wanted to bet against Trump he could buy “no” shares for $0.71.
- If Trump wins the trader will receive $0.00 for a net loss of $0.71
- If Trump loses the trader will receive $1.00 for a net gain of $0.29
How does this help us handicap the actual event? It’s easy, simply take the price of the “yes” shares and use that as the implied probability of Trump getting elected. Do the opposite if you want to calculate the implied probability that Trump will not get elected.
In the Trump example, since “yes” shares cost $0.30 there’s a 30% chance that Trump goes on for a second term. There’s also a 71% chance that he will not get elected because “no” shares cost $0.71.
Here is a rule of thumb for quickly gauging the likelihood of an event using PredicIt:
- If the “yes” shares are expensive (close to $1.00) you know that the probability of the outcome happening is high
- If the “no” shares are expensive (close to $1.00) you know that the probability of the outcome happening is low
As the 2020 US election nears, the price of these contracts will fluctuate based on new information that materializes similar to how stock prices fluctuate based on the most recent earnings announcement.
Once election time comes we’ll have a more clear indication of how markets will react to another Trump victory. If Trump “yes” shares come into the event cheap, then we know another Trump victory will rattle the markets since it was priced in as a low probability event.
We prefer using prediction markets over polling or bank forecasts. Why? Because in the prediction markets participants have skin in the game, while the modelers and pundits typically don’t. Without financial downside forecasts tend to suck. You need that potential for pain to get a real price on what will likely play out in the future.
Besides using PredicIt as a trading indicator it can actually be a fun way to separate the annoying political loudmouths in your life from their money. We all know a handful of people at work, on Facebook, or at the dinner table who babble on non-stop about their favorite candidate. And no matter what you say in response they won’t waver from their conviction because they are emotionally attached.
The trick here is finding someone who’s obsessed with a polarizing candidate even though that candidate is a cheap “yes” on PredicIt.
For example, let’s say this coworker, friend, or family member is adamant about Trump winning reelection and Predict it has Trump “yes” shares offered for $0.30 (30% chance of winning).
Here’s what you need to do.
- Buy “yes” shares for Trump on PredictIt for 30 bucks.
- Now go to the political loudmouth and bet 50 bucks against Trump. (Most people unfamiliar with betting will always accept 1:1 odds because it’s mentally simple and intuitive.)
- Once both bets are locked in you have guaranteed yourself a $20 (minus PredictIt fees) no matter what happens with Trump
- If Trump wins, you lose 50 bucks to your political loudmouth, but gain 70 bucks on PredicIt
- If Trump loses, you win 50 bucks from your political loudmouth, but lose 30 bucks on PredicIt.
You can pull this arbitrage off again and again by finding more passionate Trump supporters in your circle to wager against (assuming they have no knowledge of PredicIt).
Or if you have a whale/ultra passionate person in your circle you can 10x your bet, $500 against him, $300 on PredicIt and lock in a nice $200 for yourself — an entire free night out for a fancy steak dinner and a show with your significant other!
I’m always on the hunt for this type of stuff, it’s fun, and it helps train your mind for trading.
Just make sure before you wager your friend at 50 you can buy for cheaper than 50 on PredicIt. The lower the number on PredicIt the better the trade!