Market Trading in Weather

Market Trading Instructions

Introduction

You have been given money to trade in a market where the value of the objects (contracts) being traded depends upon the some event in the future. The following describes how the market will work in general using the example of the high temperature in Philadelphia on a certain day.

All units of account on the market website are denoted in “experimental dollars” (we still use the $ symbol in these instructions for brevity). When you decide to end your participation in the Penn State Prediction Markets, your earnings will be paid to in U.S. dollars on your student account at the rate of 1 U.S. dollar for every 10 experimental dollars. Further information regarding redemption of your earnings can be found in a subsequent section.

Defining the Contracts

In every market, a number of contract will be created based upon some well defined future event. For example, we may set up five contracts, in “bins” of degree ranges, for the reported high temperature at the Philadelphia International airport on a particular day.[1] For example, for January 30, we might have contracts defined as follows:

Contract 1: Less than 31 degrees;

Contract 2: Between 31 and 33 degrees;

Contract 3: Between 34 and 36 degrees;

Contract 4: Between 37 and 39 degrees;

Contract 5: Greater than 39 degrees.

The seller of a contract will agree to pay $1 if the relevant event occurs, and will receive the agreed-upon price for the contract. The buyer of the contract will pay the agreed-upon price, and receive $1 if the relevant event occurs.

For example, assume Trader 1 sells one Contract 2 to Trader 2 for $0.20. $0.20 is then debited from Trader 2’s account, and Trader 1’s account is increased by the same $0.20. (In trading terminology, Trader 1 is now “short” one Contract 2, and Trader 2 is now “long” one Contract 2.) Should the actual high temperature on January 30 be 35 degrees, no further action is taken on the contract, as it is “out of the money.” Thus, Trader 1 will profit $0.20, and Trader 2 will lose $0.20. Should the actual high temperature on January 30 be 31 degrees, however, Trader 1’s account will be debited $1, and Trader 2’s account will then be credited $1. Thus, Trader 1 would lose $0.80, and Trader 2 would gain $0.80.

Since no one knows for sure what the weather will be in the future, you will have to make decisions regarding the likely value of the contracts based upon what you know about the weather. For example, suppose that you are quite certain that the temperature will fall in the bin for Contract 4, but you see that someone is willing to sell Contract 4 for $0.35. Then you might decide to buy Contract 4 at that price since you feel it is likely to be worth $1. On the other hand, you may decide to sell a contract if you think the price is high enough and the temperature is unlikely to fall in that bin. Of course, the final determination of what is a “good deal” is to be made by you!

The contract markets will be open to trading for a fixed period of time. Once the market has closed, no new orders or trades will be allowed. Shortly after the market closes, the market moderator will determine the final value of the contracts and all trades will be conducted at that price. At that time, you will notice your cash balance change to reflect the value of the contracts you have traded.

Buying and Selling Contracts

Traders can buy or sell contracts in one of two different methods. The first is what is called a limit order. In a limit order, the trader requests to buy (or sell) a desired number of contracts for a certain period. For example, Trader 3 could place a limit order to buy 5 Contract 2 for one hour at a price of $0.27. If this trade can be filled (that is, there are outstanding to sell at $0.27 or less) from the current “order book” (see description below), Trader 3 buys 3 contracts at the best prices available, and the relevant amount is debited to Trader 3’s account. If this trade cannot be filled from the order book, it goes into the order book until either the order is filled, the order is removed from the market, or one hour elapses. (See how to place a limit order to BUY or SELL in the system)

The second method of buying (or selling) a contract is called a market order. In a market order, a trader orders a certain number of contracts at the best price available in the market. (See how to place a market order to BUY or SELL in the system)

Whether such transactions take place, and at what price, depends on the state of the relevant order book at the relevant point in time. Here is an example of what such an order book might look like.

	Contract 2 Temperature Between 31 and 33 degrees
Offer PriceOrders to Buy Contracts		Asking PriceOrders to Sell Contracts
$0.26/contract for 5 contract(s)		$0.28/contract for 12 contract(s)
$0.25/contract for 10 contract(s)		$0.29/contract for 3 contract(s)
$0.24/contract for 11 contract(s)		$0.30/contract for 4 contract(s)
$0.20/contract for 5 contract(s)		$0.31/contract for 10 contract(s)
		$0.32/contract for 3 contract(s)

(Note that the contracts are ordered in terms of their “attractiveness.”)

Given this order book, we can determine what would happen in response to various limit and market orders.

Scenario 1: Limit order to buy 3 contracts at $0.25 for one hour. This order cannot be filled by the current market, as there are no outstanding orders to sell at $0.25 or less. So the order goes into the order book. Since this order is newer than the previous limit order, it will be filled after the older order (unless the older order expires or is removed).

Scenario 2: Limit order to sell 12 contracts at $0.25 for one hour. This order can be filled by order book, and is filled by the “best” prices first. So all 5 ordered contracts at $0.26 are sold at a price of $0.26, as well as 7 of the 10 offered contracts at $0.25, at a price of $0.25. (In this event, the contracts ordered at $0.25 are sold in order of their ordering time, with the oldest orders acted upon first.) As no contracts are now being offered to buy at $0.26, that line on the order book is eliminated. The number of contracts being offered to sell at $0.25 is reduced by 7, from 10 to 3.

Scenario 3: Market order to buy 14 contracts. You cannot do this. The market is set up so you can only make market orders in the size of the amount offered at the “best” price. Here that is 12 (at $0.28). So first you must make a market order for 12 units, which you get for $0.28 each. Then you make a market order for 2 units, which you get for $0.29 each. The first 14 contracts on the “sell” side of the order book are sold, 12 at $0.28, and 2 at $0.29 cents. The $0.28 sell line is now eliminated, and the number of contract offered to sell on the $0.29 line is reduced from 3 to 1.

Scenario 4: Market order to sell 4 contracts. The first 4 contracts on the “buy” side of the order book are bought, at a price of $0.26. The number of contracts on the order book being ordered to sell at $0.26 is reduced from 5 to 1.

Assuming no one has accepted your current limit order, you can also REMOVE a current order, and MODIFY a current order. However, once a trade has been conducted, it cannot be reversed so please be careful when you bid in order to avoid typos and other mistakes.

Margins

A crucial problem in any exchange like this, where there are future promises to pay, is to make sure that no trader runs out of money. To solve this problem, traders will be required to hold certain funds in their “margin accounts,” based on their trading positions. The trader’s remaining funds will be in his or her “available funds” account. If a trade would cause the available funds account to have a negative value, the market trading system will reject the trade. (At this point, you can probably stop reading about margins. But look below, if you insist.)

Earning Money

By participating in this market you may earn a substantial amount of money. You are free to end your participation in these markets at any time. Provided that you have met the following minimum criteria you will be paid the amount of money in your ‘Cash Available’ account. In order to be paid this money you must have placed a minimum of 10 limit orders in the current market.

If the market you are participating in is currently open, you may notice that your ‘Cash Available’ amount is lower than the `Total Cash’ amount. This is due to money that must be withheld due to margin requirements and standing offers. Since it would be unfair to other participants to cancel these amounts if you cease participation, you will only receive your cash available amount. After all markets are closed, your cash available amount should be equal to your total cash.

In order to be paid, all you need to do is go to ‘Manage Account’ on the main page and select the ‘Cash Out’ option. This will generate an email to the administrator of the market. Assuming you have met the minimum criteria above, the administrator will shortly credit your student ID with the funds (converted to U.S. dollars) listed in your cash available account. You will receive an email notifying you when this happens. Once you cash out, you will not be eligible to participate in future markets.

Since we will be conducting many weather markets, you may also decide to “rollover” your cash in order to participate in future markets. As long as you do not ‘Cash out’, your Total Cash will be rolled over to new markets in which you are eligible to participate. We may also provide you with added funds in your cash account in order to encourage participation in future markets. For example, if we conduct another weather market next week, we may add $10 to your current cash account. New markets will be announced periodically.

Appendix-How Margins are Set

Margins are set according to the following formula: Let X be a “vector” of a trader’s position in the five contracts, X therefore having 5 elements. Assume, for example, that Trader 3’s is long 5 Contract 1’s, long 3 Contract 2’s, short 4 Contract 3’s, short 6 Contract 4’s, and short 5 Contract 5’s. For this trader, therefore, X={5, 3, -4, -6,-5}. Now let y equal the minimum value in X. Here y=-6. The amount set aside in Trader 3’s margin account will equal Max(0, -y)*face value of the contract. (Here the face value of the contract is $1.) So Trader 3’s margin account will have Max (0,6)*$1=$6 in it.

If you make an order to buy a contract, your margin account will increase by the value of the purchases you have made orders for. So if you make an order to buy 10 Contract 3’s at $0.25, your margin account will increase by 10*$0.25, or $2.50.

If you make an order to sell a contract, your margin account may increase if selling such contracts would change the value of y in your market position. Assume, for example, that Trader 3 makes an orders to sell 5 Contract 5’s for $0.30. This would change the value of “y” for Trader 3 to -10, and therefore increase his margin account by $4. However, this would be offset by the (5*$0.30) $1.50 he would receive should his order be accepted. So Trader 3’s margin account would be increased by ($4-$1.50) $2.50, and his available funds account decreased by the same amount.

How to place a limit order to buy

1. Log into the market website at the address provided using the user id and password provided.

2. Select the market you wish to place a limit order in from the LIST MARKETS page.

3. Go to the box at the bottom of the screen. You will enter the order to buy on the left-hand side of the box where it says “Place/Modify Limit Orders to Buy”.

4. Make sure the top box reads, “Make a New Offer.”

5. Type in the amount you want to pay per contract in the next box down.

6. Type the number of contracts you want to buy at that price (or lower) in the next box down.

7. Decide on an expiration time by selecting the radio button next to either “Does not expire” or radio button next to “Expires” and picking a time in the drop down box.

8. If you are satisfied with your offer, click on “Add Order to BuyOffer.”

9. A confirmation window should then appear. This window might also provide you feedback if there is a problem with your order or if it will result in a trade.

10. Once the order has been placed, it should appear in the order book and the table with your current offers above.

How to place a market order to sell

1. Log into the market website at the address provided using the user id and password provided.

2. Select the market you wish to place a limit order in from the LIST MARKETS page.

3. Go to the order book located near the middle of the screen. The list of offer prices should be on the right-hand side of the book. A market order will complete a trade at the highest current offer price.

4. Use the drop down menu to select the number of contracts you want to sell at that price. (Maximum number is the number of contracts specified in the highest offer).

5. Click on “Accept Best Market Order to BuyOffer Price.”

6. A confirmation window should then appear. This window might also provide you feedback if there is a problem with your order.

7. Once the order has been completed, a message should appear in the right-hand box on the screen. Also, the information at the top of the screen should have changed. “Total Cash” should have increased by the price times the number of contracts, and “You Have” should have decreased by the number of contracts you sold. It also possible that the “Cash Withheld for Margins” will change but that depends upon a number of other factors.

How to remove a limit order

1. Log into the market website at the address provided using the user id and password provided.

2. Select the market you wish to place a limit order in from the LIST MARKETS page.

3. Go to the box at the bottom of the screen. Depending upon whether you want to remove a limit order to buy or sell go to the left (buy) or right (sell) side of the box.

4. Use the drop down box to select the order you wish to remove.

5. Click on the “Remove OrderOffer” or “Remove Asking Price” button next to the box.

6. You should receive a confirmation message in a new window.

How to modify a limit order

1. Log into the market website at the address provided using the user id and password provided.

2. Select the market you wish to place a limit order in from the LIST MARKETS page.

3. Go to the box at the bottom of the screen. Depending upon whether you want to modify a limit order to buy or sell go to the left (buy) or right (sell) side of the box.

4. Use the drop down box to select the order you wish to modify.

5. The current price and quantity of the selected offer should appear in the two boxes below. You can now change them to as you wish.

6. Click on the “Change Order to BuyAdd Offer” or “Change Order to SellAdd Asking Price” button at the bottom of the box.

7. A confirmation window should then appear. This window might also provide you feedback if there is a problem with your order or if it will result in a trade.

8. Once the order has been modified, it should appear in the order book and the table with your current asking prices above.