Mike Franz Wagers On The Midterm Election: How Binary Markets Work

Besides the stock market and sports, punters around the world are wagering the outcomes of the U.S. midterm elections on www.predictit.org.

A veteran of these markets, Mike Franz, joined the PreMarket Prep show Tuesday to discuss the price action preceding the election.

Binary Markets For The Elections: Keep in mind that “binary markets” differ from other trading instruments in one important way.

Binary markets are financial markets that come with one of two payoff options if the contract is held until expiration. If the wager placed is correct, the contract will expire at 100. If the wager placed is wrong, the expiration price will be 100. They are called binary options since there are no other settlements possible.

Franz's Approach: Franz, who is an active equity investor as well, is not participating in the election markets because he has a strong bias one way or the other.

Instead, he approaches it the same way market makers operate in the financial markets, based on “live orders” in the book that result in changes to the order flow.

In other words, an election market can be stagnant at a certain price for hours or days until a large one-sided participant comes into the market and places a wager.

On most occasions, that affects the liquidity, and market makers will adjust their markets to mitigate their risk.

In theory, once the newcomers' order has been satisfied, there is a higher probability the market will adjust and establish a new equilibrium price. What the markets are banking on is that the new equilibrium will be at a lower price than where a majority of the large order is fulfilled. Of course, there are no guarantees.

Glanz will approach the issue with no opinion and could care less about the actual outcome being zero or 100. His only concern is the fluctuations in price ahead of the actual expiration. In addition, market makers that will hold to expiration may have an offsetting hedge in place that offset the gain or loss on the expiring contract.

This Must Be The Last One: Much to Franz’s chagrin, this may be the last time he will able to participate in the election markets wagering.

A no action letter issued by the CFTC in 2014 is due to expire. If it is not renewed, or does not receive regulatory approval, the exchange will no longer be able to conduct transactions based on the outcome of the U.S. elections. 

Glanz certainly hopes that is not the case, but in the event that happens, he will have more time to explore inefficiencies in the quotes and attempt to profit from them.

The discussion with Franz from Tuesday’s show can be found here:

Photo via Shutterstock.