ForecastEx, event contracts, and a new way to think about markets

It was a chilly Saturday afternoon in November 2021, and David Downey wasn’t sure what his next move was going to be. OneChicago—the exchange of which he was the CEO—had closed a year earlier. Downey had fought the good fight trying to bring single stock futures to the forefront of finance, but for a variety of reasons (not entirely related to performance), there were too many stars aligned against OCX.

Maybe after almost four decades in finance, it was time to fully embrace enjoying the fruits of his labor and retire. But in a scene that was eerily reminiscent of how he landed the CEO gig at OCX, Thomas Peterffy knew what was next for Downey, even if Downey himself didn’t know it just yet.

So, as the Covid-19 pandemic was raging, Peterffy, founder and chair of Interactive Brokers, gave his friend David a ring: How would he like to create a new company that would bring to the world a new type of derivative? Oh, and these contracts would be fully collateralized and there aren’t any sellers, only bidders—what do ya think?

To convince Downey to sign on for OCX, Peterffy had appealed to his competitive nature: “No one thinks it can be done,” Peterffy said. This time around, to get him on board with this new venture, Peterffy appealed to Downey’s curiosity: Create a market that can teach people to think in terms of probability, and help people to read and understand economic reports, while also helping people the world over to understand the benefits of capitalism. Lofty, idealistic goals, to be sure—but the billionaire was willing to put his money where his mouth is to see if people would be willing to put their money where their mouths are in terms of the economy and climate change.

Downey was, quite frankly, scared to take on the seemingly Herculean task. Peterffy told him that he had to build this company from the ground up, which meant building the exchange, while also finding a clearinghouse and a market maker. And he’d have to do this without the use of any resources or people from Interactive Brokers.

After several very long walks over that weekend, Downey called Peterffy and accepted the challenge—ForecastEx was born. 

Forecast contracts

Events contracts and prediction markets are not new ideas. Think the Houston Texans will win the Super Bowl come February? There’s an app for that. Think Gladiator II will do what the original movie did and win the Oscar for Best Picture? That’s a bet you can make. And much more controversially, think Donald Trump will beat Kamala Harris to become the next US president? Well, yes, there are outlets for that—and that universe could soon explode.

For the purpose of this column/profile, let’s focus on prediction markets, but let’s largely ignore the conversation of betting on presidential elections (and the likes of other prediction markets, like Kalshi, Polymarket, and PredictIt). While an interesting topic, that’s not the main focus of ForecastEx—though it could become one in the future—and it will bog down this conversation.

Here’s the premise of ForecastEx: Again there are no sellers, only buyers. When it comes to the capital markets, this is quite the novel idea. The parties that transact on ForecastEx bid either yes or no on an outcome occurring (see Box for examples)—the yes and no are two separate contracts. Parties do not trade the same contract—though the event is the same—and they do not ever share the same price. As a result, they are not counterparties. They share execution and go through the same clearinghouse, but separately, so there’s no need for novation.

These yes and no bids range from 2 cents to 99 cents, with 2 cents being the lowest level of confidence of an outcome occurring. When the sum of those yes/no bids equals $1.01 (99/2, 51/50, or anywhere in between), a contract is formed. When the event takes place, the contracts are resolved, with the winner getting $1 and the loser getting nothing. At that point, ForecastEx takes that extra 1 cent—and that’s the only fee it charges. While that might not sound like a lot, it represents 100 basis points on (they hope) thousands and thousands—eventually millions?—of trades made each day. 

“Don’t be confused about this term called a penny—it doesn’t sound like much, but it’s 100 basis points,” Downey says. “To put that in perspective, at OneChicago, I was charging 4 basis points and we became profitable.”

And in another wrinkle, ForecastEx is offering interest on contracts for each day they are held (and assuming interest rates aren’t at zero). Short-term positions will not receive interest. “The shorter timeframe that you hold a position, the less interest you’re going to make; the longer you hold that position, the more interest you’re going to make,” he says. “So it’s no longer a zero-sum derivative.”

Going back to the original idea behind the market, Downey is trying to encourage people to hold long-term positions for events that won’t settle for another 10 or 15 years. (Currently, there are contracts that will settle in 2035 and 2036 on the site, though, Downey acknowledges that at this point, the most interest is for shorter-term events, like the Federal Reserve slashing interest rates by 50 basis points.)

We’re going to be refining this thing as it goes along, that’s for sure

David Downey, ForecastEx

“We are asking people to begin to put their money where their mouth is and then we gain a consensus view, which we will put out to the world,” Downey tells me. “We believe that as this asset class develops, this new market structure will take hold. We believe that a lot of the lagging indicators that are put out by the government will become forward indicators, because the participants in our market will give us guidance.”

In the June press release announcing that ForecastEx had received the necessary designations from the CFTC to operate a contract market and derivative clearing organization, Peterffy put it this way: “The more perfect information we have about the state of the world, the more perfectly we can plan and coordinate our actions. Markets are the most direct ways of expressing our unbiased expectations, and market prices tell us the prevailing consensus. We may adjust our plans based on consensus forecasts or express our disagreement to earn a profit or hedge our exposures.”

Baby steps

Going back to that original conversation from 2021 between the two, while still deciding if he’d say yes or no to starting what would become ForecastEx, Downey acknowledges that he was taking those lengthy walks because—frankly—he was scared. It was Peterffy’s idea, but it would be his job to execute on that vision. Downey understood the concept, but pondered how to build this market in a way that would entice people “to put their money where their mouths are” when it comes to complex and, even, controversial subjects.

At first, Downey was in a fog, but the long walks brought him to daylight—that, and a scene from the movie The Martian starring Matt Damon. 

“You have to solve one problem at a time,” Downey tells me. “You solve one problem, then you solve another, and then you solve another, and then you get to go home.” (Damon’s character is stranded on Mars and has to figure out how to get back to Earth. Spoiler alert: He does.)

Downey assembled a team: Graham Deese serves as the company’s chief regulatory officer. He is also a OneChicago and Interactive Brokers alum. Andrew Naughton is the CFO and enterprise risk officer.  He was formerly CFO of the Options Clearing Corp., and worked at Interactive Brokers for 15 years before retiring in April 2021.

It tapped Connamara Technology to build ForecastEx’s tech stack using the former’s EP3 platform as the base, and then the vendor built out surveillance and compliance modules. The clearinghouse is ForecastEx DCO, which received regulatory approval from the CFTC in July. BMO and JP Morgan are the market’s settlement banks. And the affiliated liquidity provider is an algorithm on a server that is “overseen by some experienced personnel from IBKR,” Downey says.

To come up with events, Downey does quite a lot of reading and studying to create contracts that, he hopes, are based on numbers that will be perceived by the market as being 50/50 bets (though he doesn’t love that term). He will only chose metrics from sources that are trusted by him, his team, the industry, and regulators.

To release a new contract, ForecastEx needs to receive approval from the CFTC, but then it can add new thresholds as it sees fit if the yeses or noes rise above one standard deviation after two days. If a contract immediately shoots up in one direction that is two standard deviation points above the originally listed number, the company will release a new threshold.

“This is a new derivative and a new market—we don’t know what’s going to happen,” Downey says. “We’re going to be refining this thing as it goes along, that’s for sure.”

It’s also important to remember that the market only went live eight weeks ago on July 31, so it still has a long way to go as it looks to convince potential investors on the benefits of the company’s philosophy. As of yesterday, fewer than 200 parties from not just the US but from all over the globe have placed bids on the platform, and there have been 46,820 pairs made.

In the beginning

As is true of any startup, finding a path to profitability takes time and adjustments. While the original concept that Peterffy came up with—and which Downey is executing on—is altruistic in nature, it’s also not a charity.

Now, I’m one of those people who needs educating when it comes to thinking in probabilities, and reading an economic report might make me want to turn my lights out. But I do understand capitalism and the value of data, and if this venture works out and takes off, the market sentiment data will potentially be quite valuable to regulators, policymakers, and—for my audience—portfolio managers and traders.

Right now, ForecastEx makes its data available on its website, and you can see the market on IBKR ForecastTrader. Data—and sentiment data from a global pool of investors—could be used as one indicator in a larger model used by portfolio managers and traders to influence the bets they’re making on more traditional markets.

So I asked Downey, is ForecastEx considering packaging the data it collects into a commercial product?

“We have not ever discussed selling data; we give it away,” he says. “We want everybody to see the results of our questions, because that’s part of the education process. It’s not just a crude data point; it’s a real crowd data point that the masses are putting real money on the line.” After a bit more explanation of the company’s strategy, however, he notes that he’s “not going to put a nail in that coffin” just yet.

The key is getting people to the marketplace. That will require a fair amount of educating—not just for individuals and institutions, but for regulators around the globe, some of which have made binary options (yes/no) illegal because of predatory gambling outlets.

And then, of course, there’s the controversy over allowing people in the US the ability to bet on events like presidential elections, and even local elections. It’s the headline-grabbing subject when it comes to prediction markets. I’m uneasy with the idea, but there’s a fair argument to be made that markets are more accurate predictors than polls.

But, again, this column isn’t about that—ForecastEx may get into the presidential prediction game, but its main focus is economics, government, and climate. Or, as Downey puts it: “We’re not interested in who is going to win the Oscars—we’re focused on more serious stuff.”

I have no prediction on the future of ForecastEx, but it is an interesting concept and worth keeping an eye on. What I will say is that I’d bet that Gladiator II will not win the Oscar. The future of US housing starts? I’ll leave that to y’all.

The image accompanying this column is “The Four Markets: The Fruit Market” by Richard Earlom, courtesy of the Cleveland Museum of Art’s open-access program.