Event Contracts: What They Are & How They Work

Prediction markets are raking in billions in profit, growing with each year.

The whole concept around them is based on event contracts, which are essentially a type of binary option, with a “yes” or “no” outcome, offering a streamlined way to monetize your knowledge of all sorts of events around the world.

How Event Contracts Work

Each event contract has a fixed payout based on the outcome you chose, as they are based on the wisdom of the crowd and expressed in the chance percentage that other traders on the market believe that outcome will occur.

These contracts are focused entirely on the truth of each outcome, and therefore have set wins and losses that do not change after you’ve entered a position, even if the market sentiment shifts afterwards.

Most event contracts have a price range between $0 and $1, but there are those that go higher. Whichever price you currently see on the prediction market platform is a real-time reflection of the collective probability that an event will occur.

For example, if 90% of the people who already bought a position believe that an event will occur, you would get $1 for each dollar you bet on the same position. If you’d go the other way, against the crowd, you’d earn $9 for each dollar you put in.

Once the event is verified by an official reporting source, the contract expires for all participants in it. If the outcome is "Yes," the contract is worth $1.00. If the outcome is "No," it is worth $0.

This structure therefore limits your risk to only what you’ve already put into a trade, while successful predictions can provide you with significant winnings, especially when you beat the majority sentiment.

How to Trade Event Contracts

Trading these instruments is more about research and deeper knowledge of a specific market or understanding of cultural and economical events that shape our world rather than being based around technical analysis like most other trading spaces.

The process of trading is also extremely simple, and typically involves just a few quick steps:

1. The first thing is to naturally choose an exchange to trade on. Because this market is still operating in highly contentious legal waters, it is best to go for one of the few regulated Designated Contract Markets (DCMs), like Kalshi or Interactive Brokers (Forecast Trader).
2. After you’ve opened an account, it’s time to choose an event you want to trade on. The choices here are overwhelmingly vast, as you can trade on anything from political outcomes, economic data, climate events, crypto prices, to even some crazy predictions that include betting on the chance if Jesus will return next year.
3. Once you’ve parsed through events that you’re interested in, you should not simply enter a trade immediately but actually analyze the odds, as crowd sentiment is often wrong, and having a deeper understanding of a topic can lead to potentially higher value trades.
4. If you enter a position, it is also crucial to understand that you’re not actually locked in it until the event is confirmed to have happened. You can actually sell your contracts early if you’ve already made profit from shifting market sentiment before the event expires, or potentially reverses trend.
5. Lastly, collect the profits if your prediction was correct. The platforms will typically automatically credit your account with winnings or deduct your initial investment if you made an incorrect trade.

Event Contracts vs. Standard Futures

Both standard futures and event contracts are based on future events, but even though these are both derivatives, they serve highly different types of traders. 

Standard futures are linear, with your investment growing more and more with each price movement in a favorable direction. Event contracts are all-or-nothing trades, but also come with much lower risk levels.

For a better understanding of both, you can consult our quick overview right below.

Benefits and Drawbacks of Event Contracts

If you’re committed to trading event contracts, you should also weigh the pros and cons that come with this new and evolving trading space.

Advantages

• Defined Risk: The most significant advantage is that you can never lose more than you paid. Unlike futures, where a "Black Swan" event can lead to losses exceeding your account balance, event contracts are fully collateralized. There are no 3:00 AM margin calls.
• Precision Hedging: If you’re already invested or working in a specific market or event, you can use event contracts to hedge against potential losses much more easily than with other instruments. For example, if you are a crypto investor, you can bet on the price of Bitcoin dropping in order to offset the losses in your portfolio if the price drop does actually happen. 
• Accessibility: Because you can buy a single contract for cents, the barrier to entry is virtually non-existent. This allows retail investors to participate in macro-economic shifts that were previously reserved for institutional whales.

Disadvantages

• All-or-Nothing Risk: The simplicity is also a danger. We’ll use the same example as above. If you predict that the price of Bitcoin will drop down to $69,999 but it drops down to $70,000, you still lose the initial investment.
• Capped Upside: In a traditional stock or futures trade, your profit can theoretically grow infinitely. In an event contract, your profit is strictly capped at the difference between your entry price and $1.00.
• Liquidity: While major markets are highly liquid, niche event markets can suffer from wide bid-ask spreads. This means it might be difficult to sell your contract at a fair price before the event actually occurs.

Final Words

Event contracts are seeing rapid adoption, rapidly moving from the fringes to the center of regulated finance, turning data into a tradable asset class. 

While they do come with their own set of risks and are quite controversial for promoting the most potentially reckless and gamified approach to trading, they can still be used to your advantage if you’re responsible enough and have a deep understanding of current events.