A Behind the Scenes Look at ForecastEx Events Contracts

Resources:

https://forecasttrader.interactivebrokers.com/en/home.php

https://forecastex.com/

Interactive Brokers recently launched its event contracts platform in conjunction with ForecastEx LLC, a Chicago exchange specializing in making markets on economic data points. ForecastEx CEO David Downey explains the conception of the project and why he built it.

Summary – IBKR Podcasts Ep. 181

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.

Andrew Wilkinson 

Welcome to today’s podcast. My name’s Andrew Wilkinson. Many of our audience will be familiar with sports betting, for example, whereby fans bet on the outcome of a football or basketball game or wager on the total number of points scored by both teams.  

And as a former trader, I’m familiar with that concept of spread betting and in particular taking the over under on a specific outcome, such as an economic data point. 

For example, will next month’s unemployment rate match or exceed last month’s 4. 3%?  

In this episode, my guest is David Downey, CEO at ForecastEx LLC, an Interactive Brokers affiliate. Welcome, David.  

David Downey 

Thank you.  

Andrew Wilkinson 

Now, ForecastEx has just launched a new breed of trading on the Interactive Brokers platform. And before I begin, I should mention that clients can log into forcasttrader.interactivebrokers.com to access live event contract pricing and request trading permissions.  

David, first of all, can you tell the audience what event contract trading is all about please?  

David Downey 

We started the exchange to allow people to begin to learn macroeconomic theory and through the use of probabilities, we believe, and this is Thomas, with the idea, Thomas believes that many of his customers around the globe do not have developed economies yet.  

They want to develop those economies. He wants to help them along by teaching them what types of reports come out of these capitalistic economies. How to find those numbers and how to interpret them, and how to use them to forecast future events. 

And all trading is, especially in the derivatives world, it’s about assigning probabilities to an event. So, the concept of ForecastEx was to, let’s list contracts where people can assign probabilities to various outcomes. It looks like a price, but it really is just a probability. So we built that exchange to list contracts and we applied for those licenses and got them. 

But Andrew, the important part of it is, is the very novel nature of the product. Both the product itself and the way its executions take place. If you don’t mind, I’d like to just delve into it.  

First off, what we’ve created here is a new type of derivative. It’s not a future. It doesn’t have characteristics of a future, aside from futurity. It’s certainly not an option. There’s only one other type of derivative recognized by the regulator, and that is called a swap. But, everybody knows the term swap. It doesn’t meet the definition of a swap. And we’ve discussed this with the regulator, discussed it internally, and we decided in the end what we’ve come up with is a brand-new type of derivative, and we call them Forecast Contracts. 

We came up with it, we named it. These Forecast Contracts have unique characteristics. One of them is, this goes to the market structure novelty, is there are no sellers in our market. There’s no a buyer passing a premium to a seller who is asking the customer to pay a premium to enter into position. We don’t believe in that anymore. 

We don’t believe that the time and space dislocations between buyers and sellers, which used to exist, and that’s why exchanges arose, and that’s why exchange memberships arose, we don’t need that structure anymore. The technology brings buyers together, and they bid on the yield, the yes or the no. 

Interestingly enough, the yes and the no are two completely separate contracts. So when our algorithm is when the bid for the yes plus the bid for the no is equal to a predetermined threshold one on one, we pair those contracts together. Critically, the two parties are not counterparties to each other. They don’t trade the same contract. 

They never share the same price. Because of that, as it goes through the clearinghouse, another novelty, there is no need for novation. This is the first derivative in the world that doesn’t go into a clearinghouse requiring novation, which is a legal concept. But we were able to achieve that. That’s what separates us from other products. 

So it’s really peer to peer activity, taking probabilistic viewpoints on whether an event will or will not occur at some point in the future. Does that make sense?  

Andrew Wilkinson 

It makes perfect sense. And David, tell us the ultimate vision for this market then.  

David Downey 

We’re very different. You know that there’s been a rush to what they term zero days to expiration activity. And that is everybody wants to trade what’s the closing value of a contract that day.  

We have taken the exact opposite approach.  

We’re less interested in what’s going to happen today. We’re very much interested in what people think is going to happen six months from now, a year from now, five years from now, ten years from now, fifteen years from now. 

This is where we can start to deal with some of the society’s existential questions. Are we going to be gone in fifteen years? Yes or no? Because a lot of the policy that’s being made right now is based on that fear, not only in the United States, but globally. So we’re asking people everywhere around the globe we’ll be expanding to where they were allowed to trade these contracts. 

What do you think the probability really is from your perspective? And then we’re going to aggregate all of that information. We’re going to make that information publicly available to be used by policy makers and other decision makers, businessmen who are trying to forecast what exactly they need to do in the future. 

Will tax rates be above or below a certain rate ten years from now? Will polar ice caps be above or below a certain volume? Will the temperature across the globe be rising above the algorithmic anomalies that are put out by the agencies? All of these things are hotly contested. They have real meaning in terms of what’s going to happen in the future, and it directly affects policy makers. 

In terms of the economic numbers, there are three types of economic numbers. There’s a lagging indicator, there’s a leading indicator, and then there’s a, I forget what the term is, but it’s now an indicator. We believe that the use of these products, the use of these Forecast products, will turn all those lagging indicators into leading indicators.  

Andrew Wilkinson 

Right.  

David Downey 

Something that is not currently put out by any government, and we think the potential for these products is to have a value-added component. So the end goal is to get as many people as possible in as many jurisdictions as possible giving their opinions through the probabilities of our contracts. And as we aggregate, and then we keep track about who was right and who was wrong, we’ll be able to begin to post these aggregated probabilities to everybody in the world, and they can begin to be relied upon going forward. 

And at some point, we may actually take over for some of these bureaus, who collect information, aggregate it, and then they post it in arrears. We want to be out in front with that data, with that forecast.  

Andrew Wilkinson 

Another way that I think you’re saying this is that people with better information, or at least those who have a better way of aggregating information, about a future economic event should stand to do well from this? 

David Downey 

There is no doubt an educational structure associated with trading these contracts. You started this by mentioning traditional trading, betting, I understand why people use the term bet. I understand why they do that in sports stuff, and I don’t view what we’re trying to achieve as betting. We’re looking out into time. 

We want people to hold these positions for term. How do I get someone to give me their collateral where the outcome is not going to be decided for ten years? That’s where we have come up with this incentive coupon. Part of the Forecast Contract, which is what no other derivative does is, is that when customers do enter into a position. It’s a fully collateralized position, and I invest that collateral in an interest bearing account. 

And we’re going to take all that interest and we’re going to pay that back to the FCMs as an interest incentive coupon to incentivize those customers to hold those positions up to time. And what’s critical to understand is, let’s say they enter into a position at 50-50, for instance. If the market goes their way over time, and that the first couple days they’re collecting interest on the 50 cents, but if over time it begins, the consensus estimate says, it’s really a 75-25 probability at this point. 

The person who bought it at 50 on the first couple days is now getting interest on the 75, which is the closing price of that contract. Critical for everybody to understand that they’re now earning interest on money that is not technically there. It’s sort of like unrealized P& L. But that is to incentivize people to hold, to use their cash, which they may be holding in a bank, which might be paying them six to eight basis points. 

They could be earning, at this time, 480 basis points instead, while that cash is in a very safe spot, very safe broker, and with the potential that this is going to earn them interest above and beyond the original collateral. And then at expiration date, if they want to get out that they can. But if they want to hold it, they may be able to see their collateral amount initially double in value from 50 cents to a dollar. 

So, it’s a very attractive, brand-new type of investment vehicle. I don’t really look at it as a bet. I look at it as an investment.  

Andrew Wilkinson 

Can you just explain the pricing a little bit more at expiration? You mentioned earlier the 50-50 one, so everything sums to 101.  

What happens if you buy an outcome, a yes outcome, for 50 cents? It only has one of two outcomes, right?  

David Downey 

There’s a threshold value. So what is the CPI going to be in December of 2025? So that’s one of the threshold values. So between now and December of 2025, when those numbers are released, the probability of the numbers being above or below our threshold is going to change. 

If they hold that position out until the expiration date of December 2025, either they will resolve to a yes or resolve to a no. And the person holding the yes contract will get the dollar and the person holding the no contract will get zero if the CPI is above that level. In between that, as those probabilities are moving around between now and December of 2025, customers can see that they bought it at 50, it is now trading at 70. 

If they want to get out, they simply have to buy the opposite position. In our case, I bought the no at 50, I want to now get out of that position, so I buy the no at 31, because I want to take advantage. It’s like selling at 70, which is really what I’m trying to achieve. But instead of selling, you buy the opposite position. 

And because of our rules, which I put in place, you cannot hold a yes and a no position in the same contract at the same time. What they call, we net them out. And we pay them out. And if the price that they pay for the yes, plus the price that they pay for the no, greater than one, they get nothing. If it’s less than one, we pay them out the dollar. 

They get all the collateral plus the profit that they were looking for. So they can exit those positions prior to expiration.  

Andrew Wilkinson 

Now, I’m also joined on the call by Interactive Brokers’ Senior Economist, Jose Torres. Welcome, Jose.  

Jose Torres 

Hello. Hello. Great to be here. Hi, Andrew. Hi, David.  

Andrew Wilkinson 

I wanted to ask you how representative of actual economic data do you think these contracts are? 

Jose Torres 

Very representative. I mean, you know, these are the most important economic indicators that are watched by Wall Street. And forecasted weeks and months in advance. We’re talking about payroll employment, unemployment, retail sales, GDP, corporate profits. And then we also have other indicators on sovereign debt measures, like the national debt.And then climate indicators, like global temperatures, right?  

So we have a wide breadth of economic, financial climate data. And it’s very representative. However, there are some arbitrage opportunities, generally speaking. For example, when you look at the Fed Funds Futures Curve, and then you look at the Probabilities and Forecast Trader, the futures curve for Fed Funds is actually more dovish. 

Fed Funds Futures, they think that there’s a higher likelihood that the FOMC is going to reduce rates by 50 basis points in September, whereas in the Forecast Trader, it’s a little more balanced, more tilted towards a 25-basis point reduction. And we see those kinds of arbitrage opportunities across our markets pretty much every single day. 

Andrew Wilkinson 

Now, if you were able to trade these contracts, what would you be taking a view on today? What piques your interest on the screen?  

Jose Torres 

Sure. So, they do change a lot in real time. So I’m just going to pull up my screen real quick and I’m going to kind of tell you what I like. So, will the U.S. unemployment rate exceed 4% in August, 2024? 

The yes here is at 85%, but I think that the odds are closer to 95% or 100%. So I think the yes here, it has a good likelihood.  

Fed funds, I’m of the view that they’re going to reduce by 25 rather than 50, so I actually like the yes at 64%, with not with that much high conviction, but I do like the yes. 

National debt exceeding 35 trillion by the end of fiscal year 2024, I like the yes there at 33%. Will the CPI exceed 2.5% in July 2024? We’ll get that number next week. The 95% odds here on the yes. I think it’s more like 100%. I’m forecasting at 3%. Rarely am I wrong by that much on a year-over-year calculation. 

I know, Andrew. I’m so great, aren’t I? Just kidding, folks.  

Building permits. 1.5 million seasonally adjusted annualized units in July 2024. That’s a big jump on a month-over-month basis. Recently in the real estate sector, we’ve been seeing inventories start to increase. Sellers are now getting a little more impatient. 

They’re looking to unload. They want that liquidity. Against that backdrop, builders aren’t going to rush to add units if inventory is already elevated. You know, the great financial crisis of 2008 brought in a lot of discipline to that sector. So building permits, 1.5 million July 2024 seasonally adjusted annualized units. 

I’ll be on the no side there. That’s 72%, but I think it’s more closer maybe to 85% or 86%.  

Andrew Wilkinson 

You’ve connected a lot of dots there. Give us an example of the typical trader here at Interactive Brokers and how they would use these contracts. You know, they’re looking at stocks, indices and so on.  

Connect the dots with the economics there for us. 

Jose Torres 

These markets these days are wild, they’re erratic, they’re volatile. What David was talking about earlier, the 0DTE, a lot of times, I was speaking about this last week, these folks, they don’t necessarily care about macro headwinds or indicators or anything of that sort. In fact, today, it’s August 9th, we saw a big ramp at 1 o’clock Eastern, you know, in the S&P 500. 

Just a lot of call buying coming in in the afternoon, looking to take advantage of that Friday expiration, looking for a Gamma squeeze. Again, these folks don’t necessarily care about macro headwinds or indicators.  

So, what does that mean? So many times, traders, they feel like a CPI is going to come in hot, a payroll is going to come in hot, and they think that’s going to push rates higher and stocks lower. 

But, because of technical factors, sometimes it goes the other way. We expect rates to shoot up and they actually go down, or they just don’t move at all. And the trader that put on that position feels a little deceived by the market. They thought that, wow, I got the economic data, right? I should be making money, but I’m actually losing money. 

So what ForecastEx offers is you are actually isolating your investment. You’re isolating into the economic event itself. Okay, I’m not worried about, oh, are rates oversold? Are they overbought? What’s going on with stocks? Are they near a pivotal resistance or support level that may change the reaction? I don’t have to get the economic data and the market reaction right. 

I just got to get the economic data right.  

And I think that’s huge, huge, huge in these kinds of markets. Final point here. Sophisticated investors are having a tough time managing this market. This year, I’ve been hearing from a lot of our customers, they can’t believe they haven’t had enough Nvidia and they’re underperforming the people that have the automatic ETF kind of investing on their phone. 

And they can’t believe it because they’re working so hard. They’re working on the weekends, they’re doing everything they can and they can’t outperform, right? But here with economic data, you have an isolated investment.  

Andrew Wilkinson 

And I’m going to come back to David for my final question. David, can you talk a little bit about using these contracts as a hedge for your portfolio?  

David Downey 

Well, listen, if you’re a municipality looking out in the time that you’re going to be floating some paper in six months or eighteen months, you’d like to know what is the consensus estimate of interest rates going to be that you are going to need?  

And you should be hedging yourself that if you believe that those interest rates are going to rise, that municipality would be able to hedge purchase these contracts that will pay off if the interest rates rise, which will take the edge off when they float the paper, and it’s going to cost them more money to raise funds. 

Businessmen, looking to see if they want to grow or they want to build on the southeast shores of Florida, if they see that the climates are going to change and the sea levels are going to rise, it’s going to give them some pause that why would I be starting an environment that’s going to take me two to five years to build? 

And within five years later, it’s going to be underwater and then no one’s going to be able to live there. It’s those types of very large, very heavy questions that we’re trying to solve for. The trick is to get masses to participate. We believe that the very low fee and low transaction friction to actually enter the marketplace is quite low. 

And the fees are quite low. And that is designed to attract as many people as you possibly can, so we get as many opinions. Even the eccentric opinions mean something to me. Like, as in the aggregate, we all know more than we think we know. And that’s what we’re trying to detangle in ForecastEx.  

Jose Torres 

It’s a great learning experience, a great educational experience, even for folks that haven’t really been acquainted with Wall Street or the economy, right? Folks from all walks of life, it’s a great place to come in, get involved, right?  

Wake up early, 8:30am EST, a lot of these indicators come out. Read into the indicators, learn the indicators, participate in the economy. So much of what goes on in politics, in government, in private institutions, nonprofits, corporations, everything, so much has to do with these indicators. 

So I really encourage everyone to come in and check out what we got.  

Andrew Wilkinson 

David Downey, CEO of ForecastEx LLC. in Chicago and IBKR’s own Senior Economist, Jose Torres. Thanks to you both for joining me in this episode.  

David Downey 

Thank you.  

Jose Torres 

Thank you, Andrew. Thank you, David. Pleasure to be here.  

Andrew Wilkinson 

And as a reminder to the audience, you can see all available events and pricing at forecasttrader.interactivebrokers.com.  

And thank you very much for listening to today’s episode. And don’t forget to subscribe to all IBKR podcasts wherever you download your podcasts from. 

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