Regruntled.com

I’ve been on Intrade for a year now, since Selling Ron Paul short.  I’ve traded Hillary and Biden and Palin.  It’s been a lot of fun, and now that the election is over, it’s a good time to look back.

It’s much easier than I expected.  Every single trade has been profitable.  Not every single transaction, but every single group of related transactions.  I’m up 60% for the year.  Not much in dollar terms, but the percentage is amazing.  Obviously I should have cashed out my retirement account and put everything in Intrade.  Hindsight is 20-20, but it’s too late.

There are very few true arbitrage situations.  They do happen, like the Republican VP selection, and they can be profitable, but mostly the commissions and margin requirements make it difficult to do arbitrage.

Most of my gains follow a pattern: people overpay for a long shot and I take the other side of the trade.  For example, on the day of the election, the polls had already started to close and the first returns were coming in… and McCain was still at 6%.  So I short McCain for 6% or go long Obama for 94%, depending on what’s available.

Going forward, I don’t know if I’ll stay with Intrade or not.  For my strategy to work, I need someone to take the other side of the trade, someone with just the right combination of cluelessness, delusion and stupidity that leads them to bet on things that can’t possibly happen.  Politics produces such people in droves, but the election is over.  Intrade is very innovative and creates contracts on hurricane landfalls, the Academy Awards, and the capture of Osama bin Laden, to name a few.  So Intrade will create the contracts, but I’ll have to wait and see how delusional people get.

Imagine, if you will, a movie that doesn’t end when it should.  The hero gets the girl, wins the big game, triumphs over his adversary…  and the movie won’t stop.  The audience is uneasy, suspecting a False Ending.  Maybe the villain isn’t really dead, and will pop up out of the bathwater with a big knife like Glenn Close in Fatal Attraction.

And so it is with the Presidential election.  The contest is effectively over, but the ending is eleven days away.  Note that everyone has a vested interest in prolonging the suspense as long as possible:

• McCain: We still have a chance to win, so get out and vote!
• Obama: We could still lose, so get out and vote!
• Media: This could go either way, so keep watching!

All of this suggests a systematic bias towards believing that the contest is closer than it really is.  We’re starting to hear rationalizations to support the bias: polls are inaccurate, Truman vs. Dewey, the Bradley Effect, underpolling of cell phone users, young people won’t turn out, voter fraud, yada yada yada.

You can probably see where I’m going with this.  The systematic bias should show up in McCain’s Intrade odds.  McCain is currently at 13% or so.  Some of that is the delusion of true believers, some is the gambler’s tendency to overpay for long shots, and some is the dramatic bias.  The idea is not to try to separate these, but to point out that the biases are all in the same direction.  Some of the 13% is a realistic estimate of a Black Swan event, but that probability should decline as time runs out, while the psychological and dramatic biases should remain constant.

A few weeks ago, Intrade had Obama at 60%.  Believers in the efficiency of prediction markets see the Intrade price as  the best estimate of the probability that Obama will be elected.  At 60%, I think that’s reasonable.  Now Obama is at 85%, McCain at 15%.  Is this still a reasonable prediction?  Is there really a 15% chance that McCain will do something mavericky in the next two weeks and turn the campaign around?

We know that Intrade is inefficient at the extremes.  The reasons are partly structural and partly psychological.  For example, the “Hillary for President” contract held at 5% for a few months after Obama locked up enough delegates to win the nomination.  Even after the convention, I was able to sell Hillary short at 3%.

I’m not interested in flipping a fair coin.  I’m interested in the free lunches, the inefficiencies.  If Obama-McCain is anywhere near even odds, I don’t want either side of the bet.  However, this looks like a one-sided election, and at some point, McCain will be trading at X percent, where X mostly represents delusion.  The closer the election gets, the less time for mavericky surprises, and the more delusional the long odds.  The problem is recognizing X when I see it.  Is X 15%?  How delusional are Republicans?  Ron Paul got close to 10% delusion.  It’s hard to say, but somewhere between 5% and 10% I think I will short McCain.  This stuff is always more obvious in retrospect.

Intrade created a contract on the economic bailout. Thursday morning, it was trading at about 80, meaning an 80% chance that there would be a bailout by September 30th. I decided to try out a new theory. Suppose we look at the economic crisis not as economists, but as writers. How would a writer finish this story? The answer is obvious: everybody lives happily ever after, BUT: first, there will be some kind of last-minute problems that have to be overcome. The writers will jerk us around a few times, and the deal will be on again and off again.  No problems, no drama.

Translating the drama into a price scenario, I decided that the price would drop, and then go back up. I put in a buy order at 70 and waited. Sure enough, “stuff happened”. McCain got all mavericky and rushed to Washington for a photo op. The price went down and I got the contract. I put in a sell order for 85. The next day, the bailout was back on, and the contract sold. Could I do it again? Just before the debate, the price went down again and I bought the contract back for 67 and put in another sell order for 85. After the debate, the price started up again and by Saturday evening the contract sold.

So here I am after two round trips and a 30% gain.  It’s Sunday morning and the price is around 65 again.  The temptation is to go for a third round trip, but the closer the contract gets to expiration, the riskier the trade.  I’d hate to have a contract expire at zero on September 30th only to have Congress approve a bailout on October 1st.

Enough excitement.  Time to reflect.  Psychologically I’m more comfortable with arbitrage.  In other words, I trust math more than drama.  On the other hand, the drama trade was dramatically more profitable.  Maybe there is some middle ground with enough risk management to make me comfortable, but still with a greater return than arbitrage.

Intrade has a contract that pays off if Joe Biden withdraws, voluntarily or involuntarily, his Democratic VP nomination.  (This contract appeared a few days after the Palin withdrawal contract, so I suspect that someone shamed Intrade into it.)  Thursday morning I noticed that the contract had been bid up to 7.5, meaning a 7.5% chance that Biden will withdraw. 

Biden said on Wednesday:

Hillary Clinton is as qualified or more qualified than I am to be vice president of the United States,. She is qualified to be president of the United States of America. She is easily qualified to be vice president of the United States of America, and quite frankly, might’ve been a better pick than me.”

I interpreted this as a roundabout way of implying that Sarah Palin is not qualified, not because she’s a woman, but because she’s not Hillary.  And maybe Biden was sucking up to the Hillary supporters just a bit.  Apparently others interpreted this as an indication that Biden would step down, making way for Hillary to ride in on a white horse and save the election for the Democrats.  Well, of course I sold a few contracts short, but what fascinates me is that the rumor is not really about Biden.  It’s about Hillary.

Hillary looms over this election, larger than life.  When she lost the primaries, people thought she could capture the nomination with the help of the superdelegates.  People thought her supporters would do something at the convention.  Now that Obama has chosen Biden, they think that Biden might step down.  Intrade still shows Hillary with a 3% chance of winning the Presidency in November.  The recurring theme is that somehow Drama will trump Reality.  People are waiting for the writers to introduce the last-minute plot twist that will elevate Hillary to the position she rightfully deserves.

Intrade has a contract for “Palin VP Withdrawn”.  It pays off if Palin voluntarily or involuntarily relinquishes her VP nomination by Election Day.  After watching Palin’s speech at the convention, I decided to short the contract, betting that McCain would not dump her.  I don’t know if I want to hold this contract all the way to the election, because stuff happens, and you just never know.  But it seemed like a good bet for a few days.

As for the speech itself, I thought there were a few places where her rhythm was off, like she was reading something written by someone else..  She’s no Barack Obama, but she didn’t have to be.  All she had to do was not put her foot in her mouth.  If I had known how well she would do, I would have placed my bet before the speech instead of after it.

In other news, the Hillary contract is still active, and someone is bidding it up.  A 3% chance that Hillary will be elected President in November?  I’ll take the other side of that bet, thank you very much.

My Intrade contracts for the Democratic nomination just expired (short Hillary Clinton and Al Gore).  Looking around for my next bit of edutainment action, I added up the bids for the top 8 Republican VP candidates and found that there was a 120% chance that one of them would be chosen.  Can you say “arbitrage”?  Sell all 8 for +120, lose one for -100, for a net of +20.

It’s not quite that easy.  With this many contracts, the commissions really add up.  In fact, they eat up about half of the +20, leaving me with +10.  I have to put up margin for all 8 contracts, even though at most one of them will lose.  This dilutes the +10 to a little over 1% return on investment.  It’s hard to get excited over a complicated trade that nets a 1% return.  On the other hand, these contracts will expire in about a week, and 1% in one week is 50% annualized.  Alternatively, I can think of this as “topping off” the Hillary-Gore trade with an extra 1%.

I’ve over-simplified the numbers a bit.  I make the worst-case assumptions on the commissions going in, then I try to improve on that in practice.  I also find that prices are volatile enough that I can trade against my position a bit.  I’m short 8 different candidates, but it doesn’t matter which 8.  All that matters is that 120 is more than 100.  If it’s suddenly advantageous to cover Mike Huckabee, for example, and short Fred Thompson, I end up with 122 being more than 100.  I’m having fun with this.  It’s easy to be decisive when you’re tweaking a sure thing.  As Nixon would say, I’m negotiating from a position of strength.

Update: the news about Sarah Palin is out, and it looks like I’ll be up almost 2%.  The short on Palin is a total loss, of course, but the gains on Romney and Pawlenty make up for it.

There is a new academic study of Prosper, the peer-to-peer loan platform, by economists Seth Freedman and Ginger Zhe Lin of the University of Maryland. Among the findings:

1. The average Prosper returns since inception were estimated at 6.05% with a 5.72% standard deviation and were trending up as credit quality continues to improve (see table 9 and figure 8.3).
2. The highest returns were in Near Prime loans (grades B-D) at an average of 8.27%, followed by Prime loans (grades AA & A) at 6.78% and sub-prime loans at 1.73%.

My own experience is that I am getting about 12.5% on AA and A loans. Mentally I discount my return to 10% to allow room for defaults, and attribute the extra 2.5% to luck. I suspect that it is not so difficult to beat the averages because the averages are lowered by clueless newbies bidding on loans that they will see as hopeless mistakes after they get a bit of experience.

Even though I think I could earn 9 or 10% on Prosper, I have not put in additional funds, mainly due to a lack of confidence that Prosper is growing fast enough to be viable.

See also:

• Prosper

On Tuesday, the day of the Montana and South Dakota primaries, I backed up the truck and shorted as much Hillary as I could. The pundits on TV were talking, not about what would happen, but how it would be staged. Obama’s superdelegates were timing their announcements so that “the voters” would put Obama over the magic number. And yet, Intrade gave Hillary a 6% chance at getting the nomination.

On Wednesday, I noticed that Hillary was down to a 4.1% chance of getting the nomination, but she still had a 6.1% chance of being President. Hello!? Do the math along with me, folks: Hillary has a 2% chance of becoming President without getting the Democratic nomination. Is this a market inefficiency, or Hillary going to run as an Independent? Can you say “arbitrage”? AR bih trahzh. I knew you could.

So the obvious trade is to buy back the short position on the nomination, and short the Presidency, for a net gain of 2%. The Presidency contract runs until November instead of expiring at the end of August, but still, 2% in months is 12% annualized.

I looked into the mechanics of the trade. Intrade has the peculiar practice of charging commissions on market orders but not limit orders. I’ve always used limit orders on Intrade, but this trade would require market orders, so I had to allow for commissions. I still had my Al Gore short position, which was linked to the Hillary short position for the purposes of calculating my margin requirement. After covering Al Gore and paying three commissions, the 2% would just about disappear, so I didn’t bother. Instead, I ran a single contract through the trade to verify that I understood the commission structure.

Intrade is an inefficient market. The anomalies are real, the opportunities are there. The mechanics are a bit complicated, but nothing a computer nerd can’t handle. Mostly I can’t believe how easy it is. Nice hobby.

Intrade gives Hillary a 10% chance at winning the Democratic nomination. Tim Russert gives her a 0% chance. Is there an opportunity here?

Hillary has two paths to the nomination. One is for Obama to self-destruct, and it has to be something a lot worse than Bittergate or Jeremiah Wright. The other is to persuade the super-delegates to take the nomination away from the first African-American to get within striking distance of the Presidency. The Democrats couldn’t possibly be that stupid. Or could they?

I’m looking for slam dunks with my Intrade account, and I’m not comfortable betting on the absence of stupidity. A few days ago I sold Al Gore short, of all people. Apparently people thought there was a chance that the Democrats would take the nomination away from both Hillary and Obama and hand it to Gore. I don’t think so.

Today I shorted a Hillary contract. Hillary and Gore can’t both get the nomination, so one or the other bet has to win. If Hillary somehow weasels the nomination away from Obama, my gains on the Gore contracts offset the losses on the Hillary contract and I break even. If Gore gets the nomination, I lose money, since I’ll lose more on Gore than I win on Hillary. If Obama wins, I make money on both bets, and more than if I had bet against only one candidate.

We’ll see what happens. As events unfold, and as the numbers change, I may adjust my Hillary/Gore ratio.