“This has led to what some traders term a “volatility kink” around the November vote”

Volatility Markets Brace for Election Drama Like Never Before
by Katherine Greifeld & Liz McCormick  /  August 28, 2020

“Traders across major asset classes are sending the same message: Prepare for what could be the most-contentious U.S. presidential elections in decades. One measure of hedging in the stock market is higher than at any point in the past three presidential elections. In the interest-rates market, implied volatility is well above levels reached in 2016 or 2012. And three-month implied volatility in the dollar-yen pair — a classic haven trade — has risen above the two-month tenor by the most in two decades, signaling demand for protection from turbulence near Election Day. Trades protecting against election-induced volatility have been around all year, with “unprecedented” levels of hedging seen as early as January.

Yet the potential for drama has only grown since then as the coronavirus leaves the U.S. mired in a recession and President Donald Trump rages against mail-in voting, raising concerns about a prolonged dispute over vote tallies. That uncertainty is complicating more conventional topics, such as how the results will affect tax policy and the trade war with China. “You have a global pandemic as your backdrop, which speaks for itself, and then you have a president that’s in a term, volatile, and you have the things going on with the Postal Service,” said Zachary Griffiths, a rates strategist at Wells Fargo. “All these factors that don’t typically play into an election are impacting things now and that’s clearly got people concerned. And vol has bid up tremendously in rates and equities.”

The November election is shaping up to be the most-contested in modern U.S. history, as changes to balloting prompted by the coronavirus fuel legal challenges that could stall the outcome for days or weeks. A recent count by Loyola Marymount University law professor Justin Levitt found 154 cases already filed across 41 states and the District of Columbia. Many more are expected in the months ahead. One area that highlights how much traders are bracing for election drama is swaptions, or options on interest rate swaps, which typically mirror the overall direction of Treasury yields. Wells Fargo analysts found that Election Day is priced for four times the volatility of a “typical” trading day in this market, based on the difference between at-the-money volatility on two-month and three-month swaptions on 10-year interest rate swap contracts. That compares to roughly two times at a similar point in the 2016 election cycle and about 1.7 times during the 2012 campaign, they wrote in a note.

The election premium in swaptions is most pronounced in contracts for longer maturity swaps, such as those with 30-years to maturity, according to Goldman Sachs Group Inc. However, interest-rate markets may not be adequately pricing the possibility of a change in party control, according Goldman strategist William Marshall. Democratic nominee Joe Biden leads President Donald Trump by 7 percentage points in a national average of polls, and holds an advantage in several states seen as key to winning the White House.

Since 1968, a “switching” election has led to higher realized volatility in the months after the vote and the absolute average yield change has been greater, Marshall showed in a report. “All of the vol premium around the election comes from the event itself and following week, suggesting a market underpricing the potential for a sustained pick-up in vol in the event of a Biden victory,” Marshall said in the note. A Democratic Party sweep of both Houses of Congress likely would cause the largest increase in volatility, he added.

Though the Cboe Volatility Index — known as the VIX — has been grinding lower since March’s dizzying peaks, anxiety is building for contracts tied to it that are meant to protect against stock-market losses. October VIX futures — which reflect the market’s expectations for volatility from Oct. 21 to Nov. 21 — are elevated relative to both September and November contracts. That “kink” in the term structure is roughly 3 volatility points higher than the average VIX curve at this time before past presidential elections, according to UBS Group Inc. The spread between September and October VIX futures is already higher than at any point in the past three presidential elections.

Currently, the October contract is trading 3.75 vol points above September’s — in 2012, the gap was 2.5 percentage points at its widest point, according to Susquehanna Financial Group LLP. Some traders are bracing for a drawn-out fight rather than just a single burst of turbulence on Election Day. “As we get closer and more expirations are listed, people will begin to feel a Nov. 4 expiry date is too short,” said Stuart Kaiser, head of derivatives research at UBS. “People are looking at the results may take longer than a month.” The dollar-yen pair also shows signs of larger-than-normal election hedges, with the spread between two- and three-month implied volatility touching its highest level since November 1999 last week.

The uptick in three-month volatility is being driven more by the risk of a delayed result rather than a specific outcome, according to Canadian Imperial Bank of Commerce’s Bipan Rai. He wrote in a note that massive amounts of mail-in ballots raise the risk of a possible “constitutional crisis” should Trump refuse to concede defeat. Currency volatility is rising across the board as well. A recent jump in the JPMorgan Global FX Volatility Index, based on three-month at-the-money forward options, has knocked the gauge out of alignment with the grind lower in the VIX and the ICE BofA MOVE Index, which measures expected swings in Treasury yields. The divergence is largely thanks to the dollar’s July plunge, a slide that traders are anticipating may accelerate heading into November’s vote. Bullishness on the euro has lifted options trades known as risk reversals across tenors to between 60 to 80 basis points, a phenomena that’s only happened three times since Bloomberg began compiling the data in 2006. In all cases, the euro rallied by more than 5% within a few months. “A fall in the USD can be congruent with an uptick in FX vols if we’re talking about a U.S.-specific crisis,” Rai wrote.”

Prediction Markets’ Time Has Come, but They Aren’t Ready for It
by Brady Dale & Benjamin Powers / Sep 2, 2020

“This should be prediction markets’ moment to shine. In about 60 days, Americans will vote in a presidential election both sides consider pivotal for the country’s future amid a pandemic, civil unrest and the highest unemployment levels in a generation. Given how wrong traditional pollsters and pundits were in predicting the outcome of the 2016 election, it makes sense for anyone strategizing for the future to look for alternative forecasting metrics.

With coronavirus sweeping the nation, causing concern about voting in person, this election may be more unpredictable than the last. “The election is a huge event. It’s kind of the Olympics of prediction markets,” said Sam Kazemian, co-founder and president of Everipedia, which created PredIQt, a market running on the EOS blockchain. Conceived by a heretical professor in the 1980s, prediction markets harness the wisdom of the crowd and induce experts to put skin in the game to suss out what they really think will happen. These markets have much in common with those interested in cryptocurrencies and decentralized technology – a distrust of hierarchical systems, a penchant for iconoclastic thinking and the questioning of assumed authorities.

But prediction markets aren’t gaining as much traction as one might expect given the opportunity. Centralized ones like PredictIt are heavily regulated and charge high fees. Nascent decentralized prediction markets, which run on public blockchain networks, are sparsely used. And the ones that run on Ethereum, the second-largest blockchain, now face high “gas” fees for users to run computations  Even Robin Hanson, the contrarian economist who came up with the concept, said he is disappointed with prediction markets’ overall performance. “I thought if people make a claim and then they have a betting market on it, supposedly, those betting market odds are pretty reliable,” Hanson, an associate professor of economics at George Mason University, told CoinDesk recently. “Isn’t that how we should crush stupidity? At least, that was the vision.”

Experts like Rutgers University math professor David Pennock see a few trade-offs between centralized prediction markets and decentralized prediction markets, the most famous of which is Augur. Centralized markets tend to be more active and are highly liquid, meaning that a good number of shares, or bets, can be bought or sold without radically changing the price. On PredictIt, the most popular prediction market platform, over 90 million shares (valued from $0.01 to $0.99 each) have traded on the presidential election market. Shares of Democratic candidate Joe Biden traded at 57 cents Tuesday, signaling the market thinks he has a 57% chance of winning. The centralized markets have judges to adjudicate disputes and can ensure quality control, so the outcomes traders bet on are clearly defined, a notoriously hard thing to do among decentralized options. “Centralized markets are not immune to controversial outcome resolutions. However, at least the judging procedure is clear,” Pennock said.

But there are several drawbacks. For one thing, users have to trust the company hosting a market to deal out their winnings accordingly (minus its cut, of course).  Further, online gambling is largely illegal in the United States and that limits who can take part in prediction markets, which are essentially a form of gambling. PredictIt and the Iowa Electronic Market operate in the U.S. under the legal protection of a no-action letter from the Commodity Futures Trading Commission (CFTC). These markets are non-profits, and PredictIt, for example, only lets users purchase up to $850 worth of shares on each contract. So in the 2020 presidential winner market on PredictIt, for example, users can spend $850 max on Biden being elected, and the same amount on Trump not being elected. Both markets are run for academic purposes, one of the conditions allowing them to operate under the no-action letters.

By keeping out wide swathes of traders and limiting how much participants can wager, regulation undermines prediction markets’ ability to express what people truly believe, as Hanson envisioned. Centralized betting sites inflict a lot of “pain points” on users, such as harvesting a portion of their winnings and banning those who win too often, said Joey Krug, the founder of Augur, explaining the impetus for his project, built on Ethereum. (PredictIt charges a 5% “processing fee” for withdrawals, after a 30-day waiting period.) A perceived benefit of a decentralized approach is avoiding the legal gray area between markets and gambling that can get platforms shut down, though Pennock is skeptical it’s truly insulation against authorities coming after them if volumes get big enough.

On Ethereum-based Polymarket’s presidential election market, President Donald J. Trump is given a 50% probability of winning the election. In contrast, the forecasting site FiveThirtyEight gives Trump just a 31 in 100 chance of prevailing based, in part, on polling data. There are at least two ways to interpret the discrepancy. One is that the bettors on Polymarket know (or are willing to acknowledge) something about public sentiment that the Beltway pundits at FiveThirtyEight don’t (or won’t). Another is that the $52,686.06 wagered on the election on Polymarket as of Tuesday is too little for the odds to signal much. On PredictIt, the betting on who will win the election dwarfs Polymarket’s, with hundreds of thousands of shares, each worth at least one cent, traded daily. There, it costs 47 cents to buy a contract that pays $1 if Trump wins, meaning market participants see his chance of winning at 47%. Still higher than FiveThirtyEight, but not quite neck-and-neck.

Of the handful of decentralized platforms, only Augur has been around through a prior U.S. election, and that was a midterm.  “That was our biggest market in version 1.0,” said Peter Vecchiarelli, the operations lead at the Forecast Foundation, which develops Augur’s software. The market saw “over a million dollars in open interest” on the question of which party would win the U.S. House of Representatives. “That was where we came to this collective idea of rallying around the presidential election,” Vecchiarelli said. Over $100,000 worth of bets on the U.S. Presidential race have been made on the recently relaunched Augur across three different markets (anyone can create markets on the platform, even competing markets asking the same question). The leading one has 57% odds that Trump will lose.

PredIQt’s biggest market right now is on whether the President will be reelected, with 1.9 million IQ tokens (just $4,163) in bets. And there are TRUMP and BIDEN coins trading on crypto derivatives exchange FTX, each of which pays out $1 if its namesake candidate wins (currently running $0.44 and $0.54, respectively). If the candidate loses, the token goes to zero. Veil, a short-lived startup in the Augur ecosystem, created a version of the software specifically to support bets on the 2020 election last year but folded soon afterward, citing lack of demand. Prediction markets on Ethereum have encountered a blockchain-specific pain point: transaction fees. “That is absolutely a problem,” said Stefan George, a co-founder of Gnosis, which is leading the technical development of Omen, a prediction market on Ethereum. “Everything below a $1,000 bet is basically economically unfeasible.” Kazemian noted Ethereum’s gas problem as well. “For us, it’s free,” Kazemian said. “Truly for prediction markets, I think this was a sweet spot to be on EOS.”

Augur wouldn’t go into detail, but Vecchiarelli said it’s close to a solution that should mitigate the fee situation. He wouldn’t say what the team is doing, but it’s not going to a layer 2, or off-chain, network, he said. Shane Coplan, Polymarket’s founder, said transaction fees were high for its users as well, and he plans to migrate Polymarket to a layer 2 scaling solution to reduce fees and speed processes. “Augur’s smart-contract architecture makes the transactions a lot more expensive,” he said. “Our automated market makers are cheaper, but still expensive given current ETH gas fees.” The Forecast Foundation still wants Augur to take advantage of the election, but George said the Omen community has learned a different lesson from 2020. “Initially, we were really fond of, ‘Let’s really push for this election.’ This view has changed a little bit, because basically what we realized is: The main users of Ethereum, what they really care about is Ethereum itself,” George said. Omen has seen a total volume of $87,470 on the presidential election versus $149,300 on whether Ethereum 2.0 will launch before 2021.

All the BUILDers CoinDesk interviewed expect the market depth for the election to improve, both in terms of bets and the number of markets, but most of them expect it to hew close to the national election. So there might be some markets on which presidential candidate wins which states, but there probably won’t be a lot of Senate or congressional seats with markets this year on the crypto platforms. In the bigger picture, prediction markets inventor Hanson said he doesn’t think people are asking the right questions on prediction markets. For this reason, he refused to highlight any one market as doing a good job. “I’d say that the most socially valuable questions would be the consequences of who you elect,” said Hanson. “So if you say we shouldn’t have Trump because we’ll lose democracy or nations won’t respect us, then let’s have markets estimating those consequences of the election. That’s more interesting than who will win.”

update: “A passage in an earlier version of this article misdescribed the limit for wagering on PredictIt. It is $850 per contract, not per market, meaning a trader could bet, for example, up to $850 on Biden/Trump winning and the same amount on Trump/Biden losing”.

PredictIt Owns the Market for 2020 Presidential Election Betting
by Zeke Faux  /  August 1, 2019

“…on a political-betting website built by a group of researchers in New Zealand, a shadow primary has already been raging for months. Former U.S. Representative Beto O’Rourke of Texas was the early front-runner, with traders giving him a 20% chance of winning as of January. California Senator Kamala Harris passed him later that month when she made her candidacy official, but by March, Senator Bernie Sanders of Vermont was the leader. Harris moved back into the front after calling out former Vice President Joe Biden in their first debate for praising the genteel segregationist senators of the past, but after their second faceoff on July 31 Biden regained a decisive lead.

Since it went live in late 2014, PredictIt has become the go-to place to gamble on U.S. politics. The site makes it as easy to wager on how many tweets President Trump will send this week as it is to buy a stock on ETrade. Trading volume has been running at about 250 million shares per year, estimates Jon Hartley, an economics writer and researcher, with each share representing a potential payoff of $1. (PredictIt says that figure isn’t accurate and won’t share its own numbers, but Hartley says it’s derived from data provided by the site.) PredictIt’s markets are routinely cited by the press as evidence of whom the smart money favors. Betting on politics is illegal in the U.S. PredictIt owes its existence to an exemption for academic research granted five years ago by the Commodity Futures Trading Commission (CFTC) to Victoria University of Wellington in New Zealand. To get permission to operate the site, the school said professors would run it for free and the data would be used in academic studies.

PredictIt is similar to a stock market: Gamblers post offers to buy and sell “shares” in candidates at prices up to $1. If you wanted to bet that Massachusetts Senator Elizabeth Warren would be the Democrats’ 2020 nominee after her second debate on July 30, you could have bought a share the next day for 21¢. If she wins, you’ll get $1. If she loses, her stock goes to $0, and you lose your money. The site collects a 10% fee on winnings and a 5% fee on withdrawals. Individual bets are limited to $850, per the agreement with the CFTC. But with so much politics to gamble on, that hasn’t put much of a damper on the action. Political day traders try to capitalize on swings in opinion long before votes get cast. Aaron Reese, a 34-year-old MBA student at Rice University, says he often makes enough money on PredictIt to pay his rent. He says Trump’s surprise victory created a group of bettors who don’t trust polls, which means easy money for him. “People don’t believe reality anymore,” Reese says. “People think every poll is fake and nothing matters anymore.”

Victoria University owns a small percentage of PredictIt and collects a monthly administration fee, according to Anne Barnett, who runs a program at the school that helps professors turn research projects into businesses. The site’s operations have largely been farmed out to a political software company called Aristotle Inc. John Aristotle Phillips, its founder, says the school was already running a similar site and he helped it expand into the U.S. But don’t call it gambling, he says. He prefers the term “forecasting.”

“It’s an antidote to fake news,” Phillips says. “If a trader makes a buying or selling decision on something that’s inaccurate or misleading, they’re going to lose their money.” A century ago, bookies openly took illegal political bets at New York City’s stock exchanges and hotels. With no public polls to report on, newspapers wrote about big bets placed on candidates. Election wagering fell out of favor once Gallup introduced a poll that accurately predicted Franklin Delano Roosevelt’s 1936 presidential victory and New York legalized betting on horse races, according to economists Paul Rhode and Koleman Strumpf.

Chances are that at some point this election season someone will tell you that prediction markets are a better gauge than polls. They developed this reputation after bettors on a similar site called InTrade correctly called the presidential election in 49 of 50 states in 2012 and 47 states in 2008. But one 2012 analysis showed that the prediction market had done no better than pundits who relied on polling averages—unsurprising, given most traders lean on those indicators, too. InTrade was based in Ireland and took bets from Americans until it became too well-known during the 2012 election and U.S. regulators sued it. The site closed the next year.

The Iowa Electronic Markets, another political-gambling site, got an exemption from antigambling laws in 1993, but its website is outdated and difficult to use. It offers just a couple of events to bet on and only allows gamblers to deposit $500. To justify the academic exemption that allows it to ignore gambling laws, PredictIt provides its data at no cost to researchers. Phillips says they study the data “to understand why markets are as predictive as they are.” A spokesman for Aristotle declined to say how much the company has made from PredictIt, but he said that the site has yet to earn back its startup costs. When Bloomberg Businessweek contacted dozens of the people listed on PredictIt’s site as “our research partners,” none said they had done any work of the sort Phillips described, though a handful had made use of the odds as a control variable in other studies. Several were surprised to see their names listed.

“That is a bit misleading,” says Paul Armstrong-Taylor, an economics professor at the Hopkins-Nanjing Center in China, who says he asked for the data on behalf of a student who never used it. The Aristotle spokesman said Armstrong-Taylor’s name would be removed and provided a list of 15 papers and presentations that made use of PredictIt data over the past few years. (PredictIt says all the researchers listed signed an agreement to receive data.)

Reese, the trader, says the best bet on PredictIt has been selling shares of Andrew Yang, the long-shot candidate who’s an internet favorite. His fans are driving up his stock price to show their support—up to 8¢, double U.S. Senator Cory Booker’s—and there’s not enough smart money to balance them out. “When prices start moving, people will assume other people know something they don’t,” he says. “You have to figure out what you think the real probability is.”

The `Election Futures’ Market: More Accurate Than Polls?
by Greg Burns / November 11, 1996

“Iowa seems an unlikely spot for the financial world to focus its attention. But the University of Iowa is host to what is arguably today’s hottest futures market–an electronic exchange that allows traders to bet on the outcome of the national election. What began as an Ivory Tower experiment in remote Iowa City is beginning to have an impact on stocks and bonds. When trading at the Iowa Electronic Market on Oct. 23 suggested that Congress might fall to the Democrats, the Dow Jones industrial average took it on the chin. The capital markets are paying attention because the IEM has forecast election results with surprising accuracy since its formation in 1988. It predicted the vote totals of the past two Presidential elections within two-tenths of a percentage point, outperforming national polls. It also has closely tracked elections overseas, never wavering from Boris Yeltsin, for instance, as he won reelection in Russia.

The market operates like a stripped-down model of the Chicago futures pits, except that all trading is conducted on the World Wide Web at http://www.biz. uiowa.edu/iem. Participants can open accounts with up to $500 and trade any of 16 contracts. Some 7,000 players have more than $200,000 riding on them. The most popular play is a winner-take-all bet on Clinton vs. Dole. Each contract has a Clinton unit and a Dole unit, which together costs $1 to buy. Traders make their bet by selling the unit they think will lose. When the contracts expire on election day, the winning candidate’s units pay $1 and the loser’s are worthless. Lately, traders have been snapping up Clinton and dumping Dole. In the lively aftermarket for units, Clinton was selling for 95 cents as of Oct. 29 and Dole for 5 cents. So if Dole pulls an upset, his supporters in the market can win a dollar for every nickel they wager.

That’s not the only Presidential contract. Traders in the “vote-share” market are betting Clinton will win on Nov. 5 by a wide margin–though not as wide as some polls indicate. From early March to late October, Clinton units have climbed from 51% to 57%. Rather than winner-take-all, traders who paid 51 cents would realize 57 cents per unit at expiration if Clinton gets that much of the vote. On the other hand, Dole holders have watched their contracts sag from 49% to 43% over the same period. In contracts involving House and Senate control, Iowa traders riled the stock and bond markets by bidding up the value of Democrats-take-the-House units to 44 cents–suggesting a 44% chance of Gingrich & Co. losing control of the next session. As of Oct. 29, though, the IEM’s view on Democrats seizing power had retreated to 37%. Track record. Interesting, but is it a legitimate indicator?

Some major-league traders think so. The idea that markets work better than polls appeals to folks toiling on trading floors. Bond analysts at Merrill Lynch & Co. and Lehman Brothers Inc. follow the Iowa exchange, and some market professionals have joined in the betting. At heart, traders see value in subjecting political winds to market forces, and even Iowa’s small stakes are an improvement on mere poll responses: “They’re putting their money on the line, and that means something,” says Chicago Board of Trade Chairman Patrick Arbor. Pollsters, meantime, typically have problems predicting turnout and getting representative samples, explains Robert Forsythe, associate dean at Iowa’s business school and a driving force behind the market. Voters who answer polls sometimes lie about their preferences or whether they vote at all.

Even as advocates hale free markets in action, critics attack the ballot-box bourse for its short history, thin capitalization, and alleged tendency to veer out of sync early on in the election cycle. Yet those gripes hardly matter if the market’s overall performance is good–and so far, the record favors Iowa. “We’ve yet to be disappointed,” Forsythe boasts. While the Iowa market is no doubt unrepresentative, it rewards those who are good at predicting elections. “The basic idea is right. People will do what’s economically rational,” notes Martin S. Fridson, chief high-yield bond strategist at Merrill Lynch. So if the Iowa market is gaining credibility, isn’t it also inviting manipulation? Why not sell short stock-index futures, then bet your Iowa account on Democrats retaking the House in the hope that your order will change the political odds and frighten Wall Street again? To be sure, the potential risks have caused the market’s founders some jitters. In 1992, they invited the Commodity Futures Trading Commission to regulate it.


They also take comfort in the $500 trading limit, which curtails the ability of single players to move prices: An avid Perot supporter tried it in 1992, but the market swung back within hours. In the beginning, the IEM was aimed at providing hands-on experience to students hindered by their school’s “geographic disadvantage”–a polite way of saying that, market-wise, it’s in the middle of nowhere. Today, the political market is set to grow. While its founders scoff at the Brazilian hedge-fund manager who tried to open an account with $12 million, they see nothing wrong with raising the stakes to, say, $5,000 per account. And since demand is strong for the Iowa approach in Russia, Turkey, and other nations where polling remains primitive, “You’re naturally inclined to think global,” says Gary C. Fethke, Iowa’s Business school dean.”




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