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Wanna bet? Hedging for rookies
Firm offers "hedgelets" that let small investors take positions on gas prices, mortgages, etc.
September 26, 2005: 1:17 PM EDT
By Grace Wong, CNN/Money staff writer
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NEW YORK (CNN/Money) - An online trading platform wants you to stop griping about skyrocketing gas prices and start trading.

HedgeStreet operates a kind of futures exchange in which customers can take a position on where they believe gas prices, mortgage rates and inflation, and other indicators are headed by buying contracts called "hedgelets."

As its name suggests, San Mateo, Calif.-based HedgeStreet aims to provide tools for investors to hedge, or reduce risk, in their portfolios.

For instance, if your daily commute requires you to fill up at the pump often and you want to reduce your exposure to rising gas prices, you can take a "yes" or "no" position on whether gas will exceed, say, $2.32 a gallon by the end of the month. If you make the right call, you take home a fixed payout of $10 for each hedgelet you own; if you make the wrong call, you lose your original investment.

Some experts say such contracts can be dangerous for those who don't understand the principles of investing.

But according to Mark Longo, a trader and former member of the Chicago Board Options Exchange, these products offer everyday investors insurance against market risks, such as a housing bubble or interest rate hike.

"In many ways, it is making a bet, but it is a very specific tool really meant for specific people to hedge products," Longo said.

Ready for retail?

Investment banks were among the first to offer event-based futures, auctioning them so traders could hedge against surprises in the outcome of important economic reports.

But unlike bank auctions, which are aimed at more sophisticated investors and require high trading minimums, HedgeStreet operates a retail market aimed at ordinary investors. Its requirement for opening a new account is only $100, and hedgelets have a maximum trading price of $10.

Russell Anderson, co-founder and vice president at the exchange, said only about 1 percent of the 25 million Americans who own online equity brokerage accounts trade in derivatives, or assets that derive their value from other assets.

But the market is poised for growth, and the company has already seen an impressive increase in trades, he said.

HedgeStreet didn't disclose figures for overall trading volume but said growth had surged since it began trading at the start of this year. The volume of energy contracts, one of the company's most actively traded sectors, rose 39 percent in July from the previous month and 195 percent on a quarter-on-quarter basis.

However, derivatives may find difficulty gaining popularity because they don't hold as much allure as stocks, said Brad Barber, a professor of finance at UC Davis Graduate School of Management. "Our culture centers around stocks, and stocks have a story that is uniquely about a company or product that incites widespread interest."

Risky business

For mom-and-pop investors who may hesitate to make the jump from trading stocks to trading derivatives, HedgeStreet said it has simplified what's involved to encourage experimentation.

"By making the process inexpensive, simple, and by providing the right kind of education, we think the everyday investor will get comfortable and participate in these products," Anderson said.

Some experts say investors shouldn't delve into financial instruments they don't understand.

"It's a very complicated world out there. Economic variables can change direction in unexpected ways," said Walter Torous, professor of finance at UCLA Anderson School of Management. "You wonder how much information an individual has" of how these contracts work.

Economists also warned that investors who trade online may mistake readily available information on the Internet for knowledge, which can fuel overconfidence and speculation.

"Most people should buy and hold a well-diversified portfolio," said Terrance Odean, professor of finance at UC Berkeley's Haas School of Business. "They should do their bet placing in Las Vegas and investing in stock markets."

Anderson said speculation drives economic growth and that by offering people the opportunity to trade in the economic events that materially affect their lives, HedgeStreet is acting as a "democratizing" agent.

"It lets people express their views directly [and] put their money where their mouth is."

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Click here to read about how people are coping with rising gas prices.

Click here to read the latest about consolidation in the online brokerage industry.

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