That’s an interesting question. I don’t have a good theoretical resource on that point. Anyone else?

~alex

Anyway, when you buy on InTrade, you spend money, and get a conditional asset. If the asset pays off, you get some money when it closes. That’s the entire story for buying (going long.) There are no variable reserves in this story

When you sell, you get the proceeds up front, and have a conditional liability. If the bet goes against you, you have to cover the loss. InTrade reserves a portion of the potential liability to ensure you’ll be able to pay it back. If you read their FAQs, the one on What is trading on Margin says (in part) This basically means that the Exchange does not freeze the total worst case loss on all positions but rather a proportion of the total potential loss is frozen. This frees up funds for these members allowing them to trade on more contracts. The Exchange sets margin rates based on a statistical analysis of each market.

What you’ll find if you monitor your positions closely is that for long term contracts, the reserve increases over the period of the contract. If you have multiple positions on a many-outcome market (candidates in an election, or league champion) they don’t hold as much, since they know only one candidate can win, but many can lose, so most of the shorts will win. This effectively means that the reserves in a sports league is only taken once for whichever is your largest short position. But this is still quite different from the effect of betting long.

The difference between creating new contracts and borrowing existing contracts is interesting, but doesn’t seem like the essence of “going short” to me. Perhaps we should call this a matter of terminology and agree to disagree. My impression is that on commodities futures, contracts can be created by traders, and don’t require the existence of actual commodities. (Since the commodities may only be pumped, harvested, or manufactured later, this makes senses.) There’s still a short side and a long side. The short side has to make up the value at the close, regardless of whether they borrowed an existing share or created a contract out of whole cloth.

Wouldn’t a market be more predictive (or volatile) if there really were assets pressuring the market with supply and demand. If I think Hillary will win and she’s selling at only 33%, then of course I’ll buy at 34% even if I’m willing to pay 66%. If there were limited shares then I’d have to convince an owner with some doubt and we’d negotiate a price very close to our perceived probability. Then again, maybe there’s no reason to ever sell a low position.

I can see that the system you describe gives liquidity and profit to the market but it seems too loose to me. Would it make a difference predictively? Do you have some a theoretical resource on this point?

Alex

Thanks for your comments. I think you both make good points about following the money.

I would say two things. First, I just want to reiterate that part of the process of shorting on the stock market requires you to borrow something. While money is frozen in your account on InTrade, nothing is actually borrowed from anyone. The contract is created for you.

Secondly, when you buy something on InTrade, money is set aside (“frozen”) in the same manner as you describe when “shorting” on InTrade. While the percentages may differ, the process appears to be exactly the same. I may be wrong in some of the details, but I think that’s generally true, or at least that’s how it appears to me when I trade on InTrade.

To me (and perhaps to InTrade as well, since they sometimes refer to what they do as “person to person” betting), it’s better to think of the process on InTrade as two sides of bet, with InTrade just making sure that you have money on hand to cover the bet if you lose (regardless if you went “long” or “short”).

~alex

Each trader pays a positive sum, and gets an asset with a positive expected value. It might turn out to be worthless, or it might have a positive value.

In short selling (which, BTW, InTrade/TradeSports supports), the trader accepts a payment at the time of the trade, and takes on a liability. The liability might turn out to be $0, or it might be up to $1. In any case, the trader gets an immediate payment, and has a conditional liability.

In the stock market, your broker will monitor your holdings, and if they aren’t sufficient to cover your potential liability, they may make you deposit extra money. TradeSports does the same thing, but additionally, they reserve some proportion of your cash (some of which may have resulted from the short trade) to cover your potential liability. You aren’t allowed to withdraw the reserves, or invest them in other issues.

TradeSports varies the amount of required reserve at their own discretion. The fact that you sometimes get to spend the proceeds shows that it is really a short sale, and not just funny bookkeeping.

For example Bob borrows “pays $1 if nuclear strike” and sells at market price on time T for $0.6 with the agreement to pay back at the market price on time T2.

He knows that the nuclear strike will not happen on time T2 (the price will drop to $0), therefore he pays $0 to the bank. On the other hand, if the outcome happens, the price increases to $1 and he has to pay this.

If he was going to trade on the opposite outcome, he would pay the market price (say $0.4). So the trade at T1 is different when buying the opposite outcome than when doing a short-sale. In short-sale you receive everything at once, and it stays that way if you turn out to be right about the outcome.