Event Contracts: What They Are, How They Are Used

What Are Event Contracts?

Event futures contracts allow people to speculate on the outcome of a specific event, such as the result of a political election, the winner of a sports championship, or the closing point value of a benchmark average like the S&P 500. Most are formatted for putting money on “yes” or “no” outcomes before expiring.

The existence of these products is contentious, and for good reason. There have always been event contracts, but they were considered gambling and barred in the United States. In countries where they are allowed, as in the United Kingdom, they fall under their gambling laws.

Unlike traditional futures contracts, which are staked to the expected prices of commodities, financial instruments, or indices, event futures are priced according to the perceived likelihood of particular events winning or losing. The Chicago Mercantile Exchange (CME) has been offering event futures since 2022, allowing clients to choose “yes” or “no” on the predicted closing price of Bitcoin, commodities, and indexes. Kalshi is another major purveyor of event contracts; the online platform has been the most out front defending event contracts’ legitimacy while offering a far wider variety of them than the CME.

Key Takeaways

• Event futures contracts pay out if a “yes”/“no” event comes to pass; otherwise, it’s worth zero.
• Event futures contracts allow investors to speculate on the outcome of future events, ranging from economic indicators to geopolitical occurrences.
• They have been controversial and were previously barred as games of chance, not investments.
• The value of event futures contracts fluctuates based on market sentiment on the likelihood of the occurrence.
• Kalshi and the Chicago Mercantile Exchange (CME) are among the major purveyors of event futures contracts, offering platforms regulated by the Commodity Futures Trading Commission (CFTC).

When Kalshi received approval to trade from the Commodity Futures Trading Commission (CFTC) in 2020, CEO and co-founder Tarek Mansour called it a “paradigm shift,” then added, “This designation opens a new chapter in U.S. financial history, one where investors can hedge and mitigate everyday risks.” That can be hard to square with the platform’s offerings a few years later, which include some finance-related “yes”/“no” contracts (“Big tech layoffs this year?”), though many are related to not-very-hedge-seeming contracts, like those on the Oscars, the number of Transportation Security Administration (TSA) check-ins for specific two-week periods, and the chances of assorted pop stars releasing new albums this year.

Kalshi’s Samantha Schwab says critics have it wrong. “Every contract has a hedging use case, even the less obvious ones.” She pointed out that historically speaking, each new investment product has faced challenges that it was nothing other than games of chance. “People used to say grain futures were gambling products before the Supreme Court approved them and said they were ultimately needed for hedging purposes,” Schwab said. “Some people will, of course, speculate on these contracts, but speculators are needed to make a market for those that need to hedge their risk.”

Regulators, market participants, and researchers will continue to grapple with the blurring of the lines between investing and gambling while working to ensure the integrity and fairness of the futures markets. Though event futures can provide a means for hedging risk and information gathering—after all, the CME has been offering weather futures for decades—they also raise important questions about the boundaries of speculation and the potential for firms releasing products to profit from problem gambling in the financial markets. Time will tell if Schwab was right or too optimistic when she told us, “One day we’ll look back on the skepticism of these contacts as a hedging tool the same way we look back on how the public viewed grain futures.”

Below, we detail further some of the debates and history around events contracts, how they work, and how they are traded. As the interest and money put into event futures contracts increase, the odds are that the controversies surrounding them will also increase.

Understanding Event Contracts

Event contracts are part of long trends coming together in the financial markets and the wider culture. Let’s set out some of them:

1. The “financialization” of options, futures, and other forms of financial trading that were once mostly used for hedging or insurance has meant that speculation keeps growing compared to the traditional hedging in these and other investment vehicles.
2. The legalization of sports gambling in the late 2010s resulted in betting app advertisements becoming ubiquitous. This occurred around the same time as free investment trading apps helped dramatically increase retail trading on futures, options, and other instruments. Many individuals tell researchers they simply switch from their betting app to their trading app and back again, which can account for the increasing numbers of people who confuse investing with gambling.
3. There has been the growing gamification of investing, which some now term “gamblification,” which refers to how some investment apps are designed to match the fake-points-earned, colorful formats encountered first on gambling platforms.
4. There has been a massive rise in futures and options trading over the last decade by retail investors—often with little financial knowledge—trading in sometimes-complex derivatives. A 2022 Financial Industry Regulatory Authority (FINRA) study found that almost two-thirds used online platforms for trading. Still, the average investor couldn’t answer more than half of 10 basic financial knowledge quiz questions.
5. Since the establishment of the CFTC in 1974, futures contracts have gradually expanded their scope well beyond agricultural commodities. The 1970s saw the introduction of currency futures, followed by the emergence of stock index futures in the 1980s, which marked a crucial step in connecting the major exchanges of New York with the options and futures trading on the Chicago-based trading floors. In the 1990s and 2000s, contracts became available for a still-wider range of assets, including interest rates, energy, weather, telecommunications bandwidth, and more abstract forms of “underlying assets.” In this context, the rise of event futures can be seen as a natural progression.

We can see how far futures have come by comparing traditional and event futures. Here’s a table summarizing their differences below:

Event Contracts: A Contentious History

There has been a long history of bans and restrictions on event contracts in the U.S. In the late 19th and early 20th centuries, bucket shops were where individuals placed bets on stock prices without owning the shares. These were eventually banned because of concerns about fraud and price manipulation. In the modern era, the CFTC has moved many times to halt efforts at trading what it believes are games of chance, which it defines as purely speculative and lacking any economic purpose.

In 2012, the North American Derivatives Exchange (Nadex), a designated contract market (DCM), listed political event contracts for the results of the different 2012 federal elections. However, the CFTC prohibited Nadex from listing these contracts, citing three main reasons, which remain relevant when the CFTC reviews proposals:

1. The contracts involved “gaming,” which is prohibited under its Rule 40.11 (TAWGA), as some state statutes connect “gaming” and “gambling” to betting on elections. The CFTC regulation also “prohibits event contracts that reference terrorism, assassination, war, gaming, or an activity that is unlawful under any state or federal law…and that the CFTC determines by rule or regulation to be contrary to the public interest.” 
2. The contracts didn’t serve an economic purpose, as the economic consequences of an election are so unpredictable that the contracts could not reasonably be expected to be used for hedging purposes.
3. The CFTC said the contracts were contrary to the public interest and could negatively affect the integrity of elections by providing incentives to vote in certain ways because of them.

It wasn’t until the late 2010s and early 2020s that regulators allowed event futures contracts, with the CFTC granting DCM status to exchanges like Kalshi, marking a significant shift in the regulatory landscape. Other exchanges, like PredictIt, are run under so-called “no action letters,” meaning they don’t have DCM status. The CFTC is allowing them to run, essentially punting on the issue as the courts, changes in this area of trading, the actions of other regulators in both the U.S. and abroad settle in this financial area.

Event Contracts Features

An event contract pays its face value if the event happens and $0 if it does not. The pricing of event contracts is based on other speculators’ judgments on the likelihood of an event. Traders can buy event contracts at prices from a few dollars to $25,000 to $7 million for very specific economy-wide hedging contracts, depending on the exchange.

For example, a contract priced at $0.70 suggests a 70% probability (as perceived by those trading) of the event occurring before the contract’s expiration.

Here are further features of event futures contracts:

• Expirations are event-driven: Instead of expiring on a fixed calendar date, event contracts expire based on the outcome of the underlying event.
• All-or-nothing payout: Event contracts have binary (“yes”/“no”) payouts equal to the total price of the contract if the event occurs or $0 if it doesn’t.
• Settlement daily: Event futures also settle daily in cash, based on whether the event happened on that date. New contracts are then listed for the following day.
• Capped risk: Given the definitive expiration once the event happens and daily settlements, the maximum risk is limited to the initial premium paid.

Which Events Are Covered?

Here are just a few types of events listed on the relevant platforms:

• Central bank meetings: Federal Reserve, European Central Bank, etc. rate decisions
• Entertainment: Which film will win the Academy Award, etc.
• Earnings releases: Quarterly corporate reports, earnings misses
• Macroeconomic data: Gross domestic product (GDP), inflation, consumer sentiment, etc.
• Regulatory decisions: Government/regulatory rulings
• Sporting events: Which team will win the Super Bowl, World Series, etc.
• Weather: What will be the highest temperature in New York City this year? How much rain/snow will fall in Chicago before 5 p.m. today?
  

Pros and Cons of Event Contracts

Pros

• Access to event-driven volatility

• Limited risk exposure

• Portfolio diversification

• Simplicity and transparency

Cons

• Addiction

• Insider trading

• Market unpredictability

• Liquidity concerns

• Volatility slippage

• Threats to democratic processes

Benefits

It’s worth reviewing what proponents argue are the benefits of trading event futures:

• Access to event-driven volatility: Elections, central bank meetings, economic data releases, and corporate earnings all drive heavy price swings. Events contracts let traders speculate on this volatility.
• Limited risk exposure: The definitive expiration and daily cash settlement of event contracts allow traders to cap their potential risk exposure. The most a trader can lose is the premium initially paid to enter the contract.
• Portfolio diversification: Because event contracts allow speculation on real-world outcomes, they could offer non-correlated returns distinct from typical asset classes like stocks and bonds.
• Simplicity and transparency: Their most notable characteristic is their simplicity—it’s clear what the payoffs are and what triggers the expiration.

Schwab summarized what supporters of these markets say are the gains they offer: “On Kalshi, users can trade directly on the things that are relatable to them. Users can hedge their risk directly, rather than via a proxy, and users have access to a risk management tool that was previously only accessible to the wealthy.” Schwab also discussed something that has been heard with the rise of previous investment products and follows from the view of financial markets as superior aggregators of information—a claim that dates at least to the work of Friedrich Hayek but doesn’t come out very strong when looking at the data. “Whether you trade on these markets or not, everyone gains a lot more truth from event contracts via the power of the market.” 

Drawbacks and Risks

Here are several drawbacks, constraints, and areas of risk to consider:

• Addiction: The gambling-like nature of event futures contracts, combined with their accessibility through online platforms and mobile apps, may lead to addictive behavior among some users. Like traditional gambling activities, the potential for quick profits and the excitement of betting on high-profile events can create a compulsive desire to trade these contracts.
• Insider trading: Events such as whether a CEO will resign, a basketball player will score a certain number of points, and the timing of product releases are among the events susceptible, with enough money on the line, to entice those involved and other insiders to trade on that information.
• Market unpredictability: Unexpected outcomes occur frequently, meaning event contracts carry unpredictable market risk.
• Liquidity concerns: Since some event contract markets remain relatively new and untested, they pose some liquidity risks when few active parties are interested in a contract.
• Volatility and slippage: Surprise news can trigger unpredictable swings, making event contracts susceptible to gapping prices and slippage in contract payouts. For instance, if news changes, a contract priced at $0.90 could easily fall to $0.10.
• Threats to democratic processes: Kalshi has spent the early 2020s working with the CFTC to offer election contracts—efforts that have thus far proved fruitless. Groups like the Center for American Progress have strongly backed the CFTC’s efforts to block Kalshi’s efforts. In 2023, the center argued, “If there is the possibility of acquiring material gain with the result of an election, participants may interfere with the electoral process.”

Stop-loss orders are a crucial risk management tool. These can help limit potential losses by automatically closing out positions if the market moves against your positions.

How to Trade Events Futures Contracts

Here are the steps when trading event futures:

• Choose a reliable platform: Select a reputable futures exchange like the CME, Kalshi, or an online broker with a background you trust. Many operators—especially those off shore—are fly-by-night operations to steer clear of.
• Open a brokerage account: Apply for a brokerage account and meet any specific trading-future requirements.
• Analyze and execute trades: Research upcoming events, analyze potential market impacts, and then place well-timed trades.
• Close out positions or wait for expiration: Prices will change as the likelihood of “yes”/“no” outcomes develop and approach maturity. You can either sell out of a contract before it expires or wait to see if you are correct and earn the full payout.

What Is the Difference Between Event Futures and Prediction Markets?

Event futures and prediction markets both involve speculating on the outcomes of future events. However, they operate in slightly different contexts and sometimes under different regulations.

Event futures are financial derivatives traded on regulated exchanges, primarily engaging those with a financial investment perspective. By contrast, prediction markets are broader in scope, offering speculative opportunities on events, including nonfinancial audiences. The regulatory oversight for prediction markets depends on whether they are viewed as gambling platforms, research tools, or financial instruments.

What Is the Difference Between Event Futures and Binary Options?

Event futures and binary options are both financial instruments that allow for speculation on the outcome of future events, but they differ significantly in payouts and regulatory environments. Binary options pay either a fixed monetary amount or nothing at all. Traders speculate on whether an underlying asset will be above or below a certain price at a specific time. Unlike event futures, binary options are tied to the price moves of assets like stocks, commodities, or currency pairs rather than external events.

What Were the First Event Contracts?

In more recent history, the establishment of formal prediction markets and the introduction of contracts based on political, economic, or other non-commodity outcomes have blurred the lines between gambling, speculation, and hedging strategies. An early and notable example of an organized market for event-based speculation is the Iowa Electronic Markets, formed in 1988 by the University of Iowa’s Tippie College of Business. The market continues to allow people, for research purposes and with trading limits, to buy and sell shares based on the outcomes of political elections—effectively operating as a prediction market.

The Bottom Line

Event futures, which have been banned for much of American history, allow participants to speculate on the outcomes of future events. Unlike traditional futures, which are based on commodity or asset prices, event futures hinge on the occurrence of specific events like market outcomes, economic data, sporting events, or entertainment award winners.

Read the original article on Investopedia.