Forecast & Event Contracts Explained

Forecast and Event Contracts are relatively new to the financial market scene. What makes up the contracts? What can you trade and how? We are going to discuss all that and more with our guest Jose Torres, Interactive Brokers’ Senior Economist.

Summary – Cents of Security Podcasts Ep. 69

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement:

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, Senior Manager of SEO and Content and Interactive Brokers. And today I’m your host for your podcast. Our guest is Jose Torres, Interactive Brokers, Senior Economist. Forecast and Event Contracts are relatively new within the financial market scene. What makes up an Event Contract? How can you trade it and where? We’re going to discuss all that and more in today’s episode. Welcome back, Jose.

Jose Torres:

Hi, Cassidy. Great to be here. Hello, everyone.

Cassidy Clement:

So, just to dive right in, what exactly are forecast and Event Contracts and how do they differ and how are they similar?

Jose Torres:

Sure. So Forecast Contracts, essentially offer customers questions on economic indicator outcomes, as well as outcomes related to elections, government indicators, and environmental factors, right? So some of the most popular economic indicators like the Consumer Price Index, payroll employment, unemployment rate, those are covered.

Most of the indicators are stateside, but we also have Hong Kong and Singapore. We’re looking to roll out more global indicators in the coming weeks and months. This is a relatively new product, ladies and gentlemen. So far, the most popular contract has been Trump versus Harris. And the way that these contracts work is the price is associated to the probability of an event occurring, right?

So right now, for example, former President Trump is at 60% versus Vice President Harris, who is at 40%. Now for a pairing to occur, a trade, we call them pairings in forecast contract universe. The forecast contract world. For a pairing to complete then the yes answer and the no answer have to add up to a dollar and one cent. Effectively, that extra penny is the fee paid by both sides, effectively, half a penny on both sides. So when the yes and no meet, that’s when a pairing occurs. The losses for the investors are limited to the contract price laid out. So if you bought the yes on Trump for 60 cents, then the most you can lose is 60 cents. The most you can win is a dollar. Remember that extra penny? They do add up to 1.01 when paired, but that extra penny is the fee collected by the exchange. Additionally, if you lose, you don’t lose everything because there is an incentive coupon that is part of the forecast contract universe. This incentive coupon serves similar to an income stream like interest, that gets paid. It’s currently, the annualized rate is the same rate that Interactive Brokers pays out cash that’s idle in brokerage accounts, 4.33%. Right, so, against that backdrop, there is an incentive to hold longer duration contracts, and we have that in Forecast Contracts. That’s a key difference between Forecast Contracts and Event Contracts.

Event Contracts, they expire the same day, and they’re more about equity indices, like the S& P 500 or the Russell 2000. Also, commodities, like crude oil, copper, and gold. Bitcoin is there as well. But notice that Forecast Contracts don’t have any of those asset prices or commodity prices, or again, economic indicators, election outcomes, and environmental and governmental statistics, right?

So, environmental and governmental, so the two most polarizing ones today are the national debt and climate change, right? Roughly half the population, give or take, they feel that the government debt or climate change are grave threats to society today. Debt’s too high, deficit is too high, eventually that’s going to lead to higher interest rates, inflation, and deteriorated quality of life. Climate, weather, too hot, not sustainable, going to make natural disasters more prevalent, and it’s going to, similarly to the national debt, decrease the quality of life on earth and make things more expensive, right?

On the other side, there are folks with national debt that think, well, it’s okay that our debt is that high. A lot of it was due to the pandemic. Other nations around the world, like Japan, Italy, a lot of countries in Europe, Latin America as well, have much higher debt to GDP levels than the U. S., right? So we can manage these debt loads, right? Similarly with climate change, a lot of folks think that it’s a natural cycle of Earth, right? If you go back thousands of years, you’ll notice that some decades, some centuries, temperatures were a little higher. Others, they’re a little lower. It’s one of those things. It’s a natural cycle. It’ll remedy itself. We can find solutions in the medium to long term. We don’t have to do things right now. So the answers to those questions, right, if you feel strongly on one side or the other, you come into the ForecastEx, IBKR Forecast Trader Market, and you can put your money where your mouth is, right?

 If you have a particular portfolio that is vulnerable to interest rate risk, right? Let’s say you have a very rate sensitive portfolio. Let’s say you have a lot of Russell 2000. You like to run a small cap shop. Well, maybe you come into the ForecastEx market, and you start hedging that portfolio by buying yeses or the over. The yeses are like the overs for those that are familiar with the over and under mentality. The nos are like the under, right? So if you think that climate and government debt, either combination are a problem and you want to take the over, you come in and you buy your yeses. If you want to take the under, you come in and you buy your nos.

So back to the Russell 2000 small cap example, rate sensitive. You think rates, could go higher and you’re scared that your portfolio is going to be negatively impacted by that. You come in, you buy overs on the CPI, you buy overs on the national debt, because those are things that are correlated to higher interest rates.

 Against that backdrop, you collect that incentive coupon if you go out long term. So that’s another, you know, benefit of Forecast Contracts, right? You can really speculate, invest, and hedge with these, and they’re available for folks of all walks of life, right? If you’re not a major financial institution, if you’re just a retail investor, like the many retail investors that love to use us here at Interactive Brokers, right? You can come in and you can, even if you haven’t followed a lot of these economic indicators, you can come and you can get involved. A lot of these indicators, they come out at 8:30 in the morning, you can wake up early, you know, place some orders if you’d like, look at the news, get familiar with the indicators.

On Traders Academy, I built a long list of videos that explain each indicator, right? One of the reasons I was brought here, the major reason I was brought here, is because our founder and chairman, Thomas Peterffy wanted me to come in and help run the ForecastEx program, and essentially, teach folks about economic indicators and really, it’s been a long three years and we’re really happy that we finally launched this product and we’re having a lot of success, particularly with the election contracts. But we want everyone to know if you’re engaging in the election contracts once the election is over, we have a lot of other contracts that are just as interesting, right. About economic indicators, about the environment, government debt, a long list of things that you can engage in once the election is over.

Cassidy Clement:

So, I just wanted to point out to the listeners that if you do go to our Forecast Trader website, there is a page that is labeled Learn that will compare for you the differences between Event Contracts and our Forecast Contracts. That way, you could see the various pieces. Whether, like Jose said, you’re going for a specific type of contract or you’re just looking to get some information. But to get into something a little bit more, I guess you could say informative for people to really sink their teeth into, could you give an example of how one of those trades would work? Whether it’s like an Event Contract, a forecast contract, either or both, just so people can understand how it works. I know you mentioned a bit of the daily versus, you know, non daily, weekly, monthly, et cetera, how that can differ.

Jose Torres:

Absolutely. So the cost of the contract, remember with Forecast Contracts, they add up to 1.01, that extra fee is paid collectively on both sides. So effectively, half a penny on each side. As the probability of the event occurring on the over or the under starts to increase, then the price of the corresponding contract begins to gain value as well. So for example, right now you have Trump versus Harris at 60 versus 40. If in the next few weeks, folks believe that Trump’s odds are increasing, then that contract is going to go from 60 maybe to 61, 62, 65, right? On the contrary, if folks think that Harris’s odds are improving, right, then her numbers will start to increase from 40 maybe to 45, 50. We already saw, you know, a lot of movement based on how things have changed in the political arena. You know, early October, Trump was not the favorite. Trump was around 48. After a few weeks, now Trump is the favorite. We also have House and Senate races. Let’s say you buy the Trump yes contract at 60 cents, right?

Each contract pays out a dollar. Your maximum loss on this contract on all of our Forecast Contracts is the premium that you laid out. So in this case, 60 cents. Now, what’s your gain? If you’re correct, your gain is a dollar. So, you know, a pretty decent return, especially a strong return, rather, especially if you were have a really strong hunch or strong belief of an event occurring. 60 cents gets paid at a dollar. Remember too, when you go out long duration, you collect incentive coupons along the way. It’s an incentive. You want to buy T bills? Why not come into the Forecast Contract universe. Check out the contracts that are longer term that you like collect the T bill like yield, and get paid out at the end, right? Assuming that you’re right.

 It doesn’t have to be all or nothing, right? It can be part of what you were going to put in T bills. You come into the Forecast Contract universe and you put in some funds there. Also, when folks are buying downside protection in the equity markets, you can also now consider buying some downside protection through our Forecast Contract market, right?

Again, if you’re interest rate sensitive and a high inflation reading is bad for you, then you can come in and you buy the yeses. That way, when your portfolio takes losses, if inflation readings strengthen, at least you can collect the dollar payouts in the Forecast Contract universe.

Cassidy Clement:

So correct me if I’m wrong here, but it seems like, you know, the Forecast Contracts are a little bit more, yes or no on your view of an outcome of an event where the Event Contracts are a little bit more, they’re aligned with key futures markets. So they’re up or down. It’s essentially yes or no is a binary one or the other, but that’s kind of the main difference, correct?

Jose Torres:

Yes, and remember with the Event Contracts, it’s going to be more about the NASDAQ 100, gold, crude oil, silver, Bitcoin. It’s going to be more about financial market metrics, whereas the Forecast Contract is going to be more about economic indicator outcomes, climate, environment, government statistics. So, less about what’s this price going to be by the end of the day, more about what’s this outcome going to be. Yeah, we have contracts that expire tomorrow, and on Friday and on Monday and on Tuesday, but we also have contracts that expire 2,3,4,5, 10 years out, offering you an incentive coupon, right. The Event Contracts don’t have that.

 Another important point here is when you go out, you know, long term like that, you can also close out your contract if you want, right? There are no sellers. In that market, there’s only buyers of yes and no. But let’s say you initiated a position in CPI, let’s say three months out, four months out, started off at 52 cents. Inflation is starting to pick up steam. That contract now is gaining value. Now it’s up to 80 or 90.

The incentive coupon paid, right, that income stream that gets paid, gets proportionally adjusted as the odds increase or decrease in your positions, right? So if you have yeses and they increase in value, then the daily income stream that you receive starts to increase as well. Similarly with the nos, right, if you bought a lot of nos, and then those nos start to decline in value or increase in value, then the income stream does adjust based on that. So, sometimes, if you’re out 5, 10 years and your probability increased to 98 or 99, right, you don’t have to close that contract by buying the opposite. if you got in at a yes at 50 cents, it goes up to 90, right? To get out, you would buy the no for 10 cents. So you paid 50 for the yes, and you paid 10 cents for the no, and you collected a dollar, right?

So you paid 60 cents and you collected a dollar. So that’s how this works. If you want to get out of a position, you buy the opposite contract. You bought a no, you want to get out? Buy the yes. You can also do that to limit losses. If you feel like, probably it’s going too low. It’s going to 25%, 20%, 15%, and you don’t want to stay in the trade. Then you buy the opposite contract to get out.

Cassidy Clement:

So, really, like, we’re talking about all the mechanics here of these orders or placing these trades, if you will, on the contracts but what exactly goes into finding a place to trade these? Because they’re relatively new, you know, how and where can investors trade them? Because most times when you go into a new investment platform or have an idea for an investment strategy, you know, you’re going to look for your platform, your broker, how you’re gonna execute the trades, and then, you just mentioned how the mechanics are to close out the positions. You know, where exactly should people be looking or where can they be looking in the first place?

Jose Torres:

Well, interactivebrokers. com great place to start, but also we’re advertising a lot. You’ll see Harris versus Trump in a lot of the magazines that a lot of y’all read, on the websites that y’all go to, you’ll see some advertising of course, and you can click that, open an account. If you already have an account, you just have to get the permissions, doesn’t take long, takes about a day, you know, and then you can immediately start trading the next day.

I write a lot of commentaries, they’re integrated in there as well. There’s a ForecastEx video, with our Director of Trading Education, Andrew Wilkinson. We also have a podcast with Chief Executive Officer David Downey of ForecastEx, Wall Street Veteran. Also, Director of Trading Education. Andrew Wilkinson is on there as well as Senior Economist, Jose Torres.

Those are some resources you can use. Of course, this video is also a resource. So we’re really, we have it all over the place, right? And you know, we want folks to engage. We think it’s a novel product. It’s new. In fact, in the regulatory space, folks really didn’t know, you know, what kind of classification Forecast Contracts were going to be under, right?

Is this a future? Is it an option? Right? So then they kind of just labeled it a swap to really be, you know, broad and stuff. Cause you know, there’s no sellers in the market. There’s only buyers of yeses and nos. So we really encourage everyone to come in, folks of all walks of life, come in and engage with these products, you know. They’re novel, they’re interesting, they help whether you’re investing, speculating, or hedging, whether you’re someone who’s just looking to get involved.

Let’s say you’ve never invested before, and you want to start small and just learn about economic indicators, you know, it’s a really good way to get started. Like I said, a lot of my commentaries and other videos cover a lot of these topics.

Cassidy Clement:

Yeah, and I mean, when it comes to the economic indicators item, you know, it’s important to understand those core pieces before just getting into it, especially whether you decide to go with an Event Contract, which is more futures aligned or, the more opinion aligned, or economic indicator aligned, Forecast Contracts. Just because as you said, you know, you might think you have a hunch, but you know, it’s important to understand the underlying pieces of that contract or of that idea. So that leads me into my next question. So, we mentioned interactivebrokers.com. Of course, IBKR Campus also has a ton of information but, what are some questions that investors should ask themselves before entering the futures or Event Contract space? And how exactly should they go about looking for resources or supplemental research if they decide to go into the space?

Jose Torres:

Sure. So what’s the goal, right? Is the goal education? Is the goal investing? Is the goal speculating? Is the goal hedging, right? Identify what the goal is first, right? But I think those four pillars are probably a great way to start, right? Are you doing this to invest? Are you doing this to speculate? Are you doing this to hedge? Are you doing this to learn?

We feel that our incentive coupon is something that most of our competitors, if not all, I’m going to say all here, I believe it’s all. None of them have an incentive coupon, right? Sometimes the probabilities are adjusted for an extra fee collected by our competitors. With us, it’s not like that. It’s just one penny and the, the odds are dictated by the participants. We’re never, you know, raising the odds on the yeses or the noes, right? We’re not doing a house edge kind of thing, right? So it’s really a good, a good way to get started. And like we spoke about earlier in terms of where to find information on this or where to get started, right? You have IBKR Campus, you have Cents of Security Podcast, IBKR Podcast, Trader’s Academy, Trader’s Insight, you know, Steve Sosnick, Chief Strategist. He writes a lot about this as well. And really interesting things, right? That really are pivotal to, everything that goes on, right?

Retail sales, whether folks are shopping at the malls or not, they’re buying stuff or not. How’s construction activity, right? Inventory is a big deal. Home prices are high. Folks care about how much construction activity is there. Are we adding more supply to the market? Folks care about that. Folks care about the national debt, right? If the national debt keeps rising, does this mean that taxes are going to go up? Does this mean that inflation is going to go up right? These are all important topics. Folks can come in here, engage with these products and, and get involved. And, you know, ideally, maybe make changes in their lives and go out into the world and make the world a better place.

Cassidy Clement:

Yeah, I mean, there’s definitely, because it’s a newer area, there’s definitely a little bit more, a little bit more of an accessibility factor, where people may not feel as, I want to say, it doesn’t feel as daunting, I guess, than just saying, oh yes, a stock and a bond, and I’ll just go do all the research. But there’s still a huge relevant piece to this, which is, it’s an investment, you could still lose money, you know, you have to make sure that you put in, the amount of understanding. While there’s an opinion element, there’s definitely still, you know, you have to keep in mind, I think you said it best, your financial goals here. You don’t want to do any large detriment to that, so you want to keep that in mind. But you brought up some great points, here today, Jose, so thank you for joining us.

Jose Torres:

Absolutely. Cassidy, always a pleasure. Looking forward to the next one. Goodbye, ladies and gentlemen.

Cassidy Clement:

All right. So as always, listeners can learn more about an array of financial topics for free at interactivebrokers.com. Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening.