News & Events

Rietz Describes Accuracy of Iowa Electronic Markets

A small Chicago futures exchange aims to be the first regulated U.S. market to offer legal betting on the outcome of a U.S. presidential election.

The North American Derivatives Exchange is set to ask the Commodity Futures Trading Commission on Monday for its stamp of approval on contracts tied to the winner of the 2012 presidential election as well as on which political party will dominate the U.S. House of Representatives and Senate.

The contracts could start trading as soon as next month, when a series of Republican nominating contests kicks off with the Iowa caucuses on January 3.

"We think politics and elections matter," said Yossi Beinart, CEO and President of Nadex. "We think (the contracts) will be very, very popular."

Former Massachusetts Governor Mitt Romney, Texas congressman Ron Paul, and former U.S. House Speaker Newt Gingrich are leading a crowded Republican field seeking to unseat President Barack Obama next November.

Bettors can currently pick their favorite candidates at Intrade, a Dublin, Ireland-based electronic exchange that also offers betting on whether the United States' economy will go into recession next year and whether "The Artist" will win the Academy Award for Best Picture.

And for 20 years the University of Iowa has run a small electronic market that one of its managers, professor Thomas Rietz, says is a better predictor of election outcomes than polls.

Both markets provide real-time snapshots of which candidates are gaining or losing ground.

After presidential hopeful Mitt Romney earlier this month tried to settle an argument with Republican rival and Texas Governor Rick Perry by offering a $10,000 wager, for instance, the price of Intrade's Romney contract fell on speculation voters would be turned off by what seemed to be Romney's cavalier attitude toward a large sum of money.

Candidates "obviously follow polls very, very closely, and would like to see what the American public is thinking," Beinart said. "I have no doubt they follow Intrade today and I think they will follow this as well."

Nadex currently offers contracts on currencies, oil and stock indexes, with nearly a million contracts traded this year. That makes it small potatoes compared with market leader CME Group Inc's three U.S. futures exchanges, where 13 million contracts change hands daily, each with an underlying value of as much as $1 million.

By contrast, Nadex is squarely a retail deal—individual traders can open accounts with as little as $100 in the bank.

Place Your Bets

The market would work like this: Say the Romney contract is trading at $49—suggesting that market participants overall see a 49 percent chance that the former Massachusetts governor wins.

Buy it there and if he does win, the contract will be worth $100 once the vote count is in, netting you $51 less the 90-cent exchange fee. He loses and you are out your original $49.

But here is where it gets interesting. Say the Romney contract rises to $80, perhaps for example, as one of his opponents makes a gaffe. You could then sell your contract at a profit, even before the election takes place.

Or suppose you are working on the Romney campaign. Even though you think your candidate will win, you can hedge your bets by selling Romney contracts that will pay out if he loses.

However, under Nadex rules, Romney or any other candidate would be prohibited from buying or selling contracts.

Pitfalls

While futures contracts tied to commodities like grains or butter have been around for centuries, contracts tied to events have a much shorter, and contested, history.

In 2003, the Pentagon closed down an effort to use futures contracts to predict acts of terrorism after the project drew a public outcry. Last year's Dodd-Frank Act specifically outlaws futures contracts tied to assassinations, war and terrorism.

But other, less-controversial contracts linked to events remain on offer in the United States, like futures tied to the snowfall in Minneapolis or the severity of the hurricane season at CME.

Beinart, whose sparse office is just down the street from CME's Chicago headquarters, expects political contracts to be equally acceptable to regulators, who have yet to issue definitive rules on event contracts.

"We believe they are perfectly legitimate and good contracts and should be approved," he said.


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