NEW YORK (CNN/Money) -
Stocks didn't take kindly to news Thursday that U.N. weapons inspectors in Iraq had found empty chemical warheads in "excellent condition."
The market, which had traded in the green for much of the morning slipped decidedly into the red in the afternoon as investors worried about the possibility of impending war.
But other markets showed an opposite reaction to the news. Gold, a traditional safe haven during times of trouble, rose to its highest level in six years. Oil rose to its best level on the New York Mercantile Exchange since Nov. 2000. And Saddam futures for March delivery, which had been posting declines in recent sessions, spiked nearly 50 percent higher, to 44 from 30.
Yes, Saddam futures -- a futures contract based on the notion that the Iraqi leader doesn't have much of one. You think Saddam Hussein will be out as his country's president by Mar. 31, you can buy a March contract. If you think he'll hang on a bit longer, you can buy the pricier June contract.
Administered by Dublin-based Tradesports.com, the Saddam contracts are one of the latest entries in the growing market for all-or-nothing futures, in which, through the trading of contracts, participants place odds on the chances of an event happening. The only restriction is that an event's outcome be quantifiable and that there be enough interest to make a market. Will John Kerry be the Democratic nominee for President, will "Chicago" win an Oscar, will the U.S. unemployment rate rise above 7 percent by year end -- all are contracts that are being traded.
Future's so bright...
Founded by former traders on the New York and London exchanges, TradeSports' primary concern, as the name implies, is trading on the outcome of sports events.
"The simple idea was: What do people talk about when the markets are quiet?" says CEO John Delaney. "Respectfully, it's sports and women. Now, you can't trade women, but could you trade sport?"
Indeed you could, through futures contracts that trade between zero and 100 (cents, dollars, euros, whatever), paying off 100 if an event comes to pass, zero if it doesn't. Traders who think the event will happen buy, those who don't sell, and the price they agree on gives you the percentage odds the market as a whole is giving for the event to happen. Unlike a bookmaker, which tries to make money by fixing the odds so it will come out ahead, TradeSports makes its money through trading fees, just as traders in more traditional markets do. (Yes, it's legal.)
Since its primary clients are traders, TradeSports started offering futures based on other events that were close to Wall Streeters' hearts, like the daily close on the Dow and economics. In the early fall, as the U.S. rhetoric on Iraq heated up, the company came up with the Saddam contract.
Now some might argue that such futures contracts don't constitute investing, but betting. What's the difference? If Johnny Punchclock goes down to the OTB and puts a tenner on Winthrop's Pride to win the Kentucky Derby, that's betting. If Winthrop Thaddeus Biddle Watson III buys a promising young colt with hopes that it will one day win the Derby, giving him back all the money he's spent, and more, on stud fees? That's investing.
Bet or investment, a day may be coming when investors and businesses use such contracts as a hedging mechanism. Let's say you had bought oil for June delivery on the view that a pick-up in global demand is going to keep prices high, war or no war. You might worry that a quick resolution in Iraq would prompt a psychological shift in the energy market and that, despite the fundamental factors you think are in place, oil prices could turn sharply lower. To help protect yourself against this outcome, you could buy the Saddam futures as insurance.
Such futures exchanges are also good for predicting event outcomes. There's an old experiment where people try to guess how many jelly beans there are in a jar. Typically, none of their answers are particularly accurate -- but take the mean of all their answers and you'll be much closer to the mark. Moreover, with very little lag time between when something happens and when prices move in reaction to it, markets provide an extremely efficient method of passing on information.
This was born out by early research by California Institute of Technology professor Charles Plott, whose work was later expanded on by a group of University of Iowa professors who started a futures exchange in 1988 called the Iowa Electronic Markets. It's best known for its political futures markets, which are widely watched by Washington types and have given good reads (despite occasional attempts at manipulation by some candidates' backers) on election odds.
One reason the Electronic Markets work well, explains Iowa associate professor of marketing Tom Gruca, is that it is a cash market. "Our markets represent the best guess of informed people who are willing to back up what they think with an investment," says Gruca.
The Electronic Markets don't, for example, have nearly as many participants as the Hollywood Stock Exchange, an Internet site where people play money on how they think movie box office receipts will do. More participants should make for a more predictive market, but in fact when the Electronic Markets has offered movie contracts its been as accurate at predicting domestic box as the Hollywood Stock Exchange.
Along the same line, TradeSports' Delaney notes that in the fall, the December Saddam contract (which expired worthless at the end of last month) didn't give nearly the same odds of an early exit than a CNN poll given during the period suggested. "There was a huge divergence," he says. "Very often people will say what they think they should. When real money is at stake, that's something different."
By some lights, however, putting money on the Saddam contract is like trying to win at 3-card monte. The problem: There could be market participants (U.N. inspectors, Saudi diplomats, Navy SEALs) that have significantly more information than everybody else. Futures markets may be a swell way of transmitting information, but if you're the last one to hear, you could be left holding the bag. This information asymmetry makes Arnhold & S. Bleichroeder economist James Padinha (who probably spends more time in Las Vegas than is healthy) unwilling to participate.
"I would rather bet on something like 'Joe Millionaire,'" he says. "I just put money on Eminem's movie to win Best Picture, 26-to-1. Who wants to see a Meryl Streep movie ever win again? 'About Schmidt'? Give me a break."