Predictit Trading: Brexit

A few people have asked me what I think of Brexit, specifically with respect to the Predictit market: Will the UK vote to leave the EU by year-end 2016. Rather than answer all of those questions individually I decided to write a quick brief on strategy for this market.

First let me address my personal bias: I am pro Brexit. I think the EU is a terrible political organization and the UK is a terrible fit for membership in that organization even under the best conditions, which is far from what we are seeing in Europe at present. I would not have bothered to point out my bias, a good argument should stand on its own merit, except that in this case it actually provides a tangible differentiated benefit towards understanding the present conditions of the market. Openness to Brexit as a real possibility, something that actually could happen, changes how this market looks, and reveals a relationship pattern that should yield a productive return.

To start we should review the polling data. Polling has been back and forth for the last several months, with neither side able to string together more than a couple of consecutive ‘wins’. As far as polling methodology goes, different polling types have produced different results, and the inclusion or exclusion of undecided voters has favored both “Remain” or “Leave” depending on the week and poll source. Still, if you were to take the poll data at face value, the market prices should be “Leave” @ 51 cents and “Remain” @ 49 cents as of April 19th.

Obviously, we have yet to see anything near that number reflected in the trading price.

90 day market price of Brexit as of April 19th

Brexit price 1.PNG

So, now we have to consider what is being priced in. Predictit is defining the market resolution as “The Government of the United Kingdom shall hold a referendum on that country’s membership in the European Union, in which a qualifying majority expresses opposition to remaining a member.” I would interpret that as the most favorable “Leave” resolution conditions possible. Not requiring the actual execution of Brexit or the possibility of a double-referendum, minimizes the risk that might otherwise be attached to this contract by the political and legalistic chicanery of europhilic government officials.

So, again, why the low price? It is my belief that, in spite of polling data evidence, many people consider it impossible that the UK would actually leave the EU. Importantly, this belief is more strongly represented in “Remain” voters, who are demographically speaking higher income, have higher levels of post-secondary schooling, and are located more frequently in major metropolitan centers than “Leave” supporters. Considering the composition of “Remain”, is it any wonder that most British (and by extension international) media institutions, which are staffed almost entirely by this genteel demographic, would be unable to comprehend the actual likelihood of Brexit?

Is there truth to the notion that Brexit presents such a massive uncertainty that it would fail even with very strong polling suggesting the opposite? Sure. That idea seems well supported by the failed Scottish Independence Referendum. Brexit would present a real challenge to the UK in terms of realignment, and that could be reflected in some negative impacts. But, and this is the significant thing for trading on this, how close did the Scottish Referendum come to success relative to the polling data, and in what time frame?

Looking at the data, the “Remain” side was nearly always ahead in the long range forecasts, but was cut to within single digits in the month leading up to the actual vote. In fact, the risk was so under-appreciated by the government and the media that a last minute, widely mocked, campaign to encourage the Scottish not to leave the UK was clumsily rolled out of No.10 mere weeks before the referendum was scheduled to take place. “Remain” ultimately won by 10%, which represented an outperform of 5% above the average opinion polling of the week leading up to the referendum.

Now consider the time factor. Even though polling had been conducted weekly for over two years prior to the referendum, public interest in the event, as best as can be assumed from Google search trend data, was relatively small until the month before the actual referendum. The acceleration of search interest, in relative terms, during the one month period of time beginning August 18th at 4% and ending with the referendum on September 18th at 100% coincided with a narrowing of the opinion polling margin and a subsequent move towards more conservative betting lines from bookies, all of which is an excellent demonstration of the tremendous velocity at which apathy is demolished by proximity.

Good Trends for Scottish Independence Referendum, Full Year 2014

scottish interest

There are three really significant strategic takeaways from this:

  1. “Remain”, which has disproportionate control over the media and so called ‘thought leadership’ did not take “Leave” seriously until dangerously late in the game.
  2. The impact of incumbency was only worth a +5% bonus over polling for “Remain”
  3. Public interest was as much as 25 times less one month prior to the referendum as it was the day of the referendum.

Subjectively, I would say that Brexit represents a less significant a change in the status quo than does the prospect of an independent Scotland, and my conclusion seems consistent with the strong polling for Brexit “Leave” relative to Scotland “Leave” over the same periods of time when measured against their respective referendums.

Now, with all that in mind, we can finally talk about the strategic case for investing in this market.

My high level take on this is Brexit “Leave” shares are structurally undervalued until they reach 45 cents, and should then be priced according to a -3% on weekly polling averages. The market should be considered in terms of time left before June 23rd, (hereafter: T). If my logic holds, share prices for “Leave” should be generally inversely correlated with T until we hit the 45 cent structural price. After that, we should see “Leave” under priced by more than 3% of polling data. Once we hit T=1 week, assuming the same relative polling, we will hit the lowest discount rate, which should get us to the -3% discount. The only way that trading discount will be diminished is if “Leave” polling starts showing a consistent gap over “Remain” that credits 75% of undecided voters to “Remain”.

In application, my advice for a conservative strategy, assuming you are buying “Leave” (invert these numbers if you want to run the other side of this market), selling shares for a profit with a greater than 99% chance of success, would be to buy anything below 38 while T=30+ days, then setting sale price for 45 cents immediately. Moderate risk would involve purchasing below 40 and holding until the market gets within T=2 weeks and pricing according to conditions. Higher risk would be buying anything under 42 cents and holding for T=below 2 days when the conditions will be volatile, assuming the polling hasn’t shifted the dynamic. If you want to buy and hold for resolution, considering all of the other data, I would price according to the previous week average polling data -5% at the absolute minimum.


Can you hedge this market? Actually, yes, there is a likely prospect for hedging in the Boris Johnson Prime Minister in 2016 market. If Brexit does happen, David Cameron’s leadership of the conservative party might be at an end. There is little doubt that his most probable replacement would be Boris, who has already declared he is in favor of Brexit, and polls well with conservative voters, besides being one of the few UK politicians that qualifies as a household name. Obviously there are a lot of “if” cascades involved in this hedge, but the market is trading at 19 cents for “Yes” as of April 19th, which seems a reasonable price considering the market should be pricing in Brexit “Leave” and the evacuation of Cameron’s leadership for any other reason including a scandal driven non-confidence vote (IE a worsening of the panama papers scandal “Dodgy Dave”), his removal to prevent a fracture of the conservative party even if the referendum fails, or even a health issue that might render him unable to preform the job. I would suggest buying this at anything below 22 cent until Brexit “Leave” hits 45 cents and anything under 50% of the current market price after that if you are interested in pursing this strategy. Following the Brexit referendum resolution I might take another look at this market considering how the circumstances have changed (a close loss for Brexit “Leave” may threaten to destroy the conservative party).





The Battle of Waterloo, Indiana

The Indiana primary, scheduled to take place May 3rd, will ultimately prove to be the decisive contest of the campaign for the Republican Party presidential nomination, as Donald Trump, compelled by circumstance, must gamble everything on a decisive victory in the state in order to cement his candidacy, lest he face an ignominious defeat by the procedural machinations of his foes in a brokered convention. Trump, a charismatic and cantankerous upstart who declared war on the entrenched establishment that has long dominated the Republican Party, succeeding despite long odds utilizing bold and unorthodox tactics, now faces a do-or-die contest with these opponents who have been driven to desperate action, mobilizing a last effort to defeat him to avoid their destruction. With only a small number of states remaining before the convention, and considering the current delegate totals, for both Trump and his establishment opponents, the path to victory appears, as it did in 1815, to advance through a town called Waterloo. The contest for Waterloo’s possession, and for the possession of all the other towns like it in the Hoosier state, has transformed what is typically a low-stakes primary in an inauspicious part of the country into a referendum on the political and cultural civil war that has rocked the Republican Party, a schismatic conflict that has frayed the bonds that have, for decades, united the various political constituencies of the American conservative coalition. A Trump victory in Indiana would signalize the success of the anti-establishment, America-first, revolutionaries in subverting the establishment Republican ideology of domestic neo-liberalism and foreign neo-conservatism as the dominant framework for representative American conservatism.

Trump is likely to win in New York, his home turf, on April 19th, and should likewise do well in Connecticut, Delaware, Maryland, Pennsylvania, and Rhode Island, which all vote the following week on April 26th. While he can be proud of his probable successes in these primaries, winning a slate of states that are unlikely to vote for the Republican party in the national election does little to silence his critics within the Republican establishment who contend that his selection as nominee would doom the party to a landslide defeat in the general election. Thus, while Trump does need to win those aforementioned states to avoid a brokered convention, they are, in a sense, less important than Indiana, where his success or failure will be a measure of his ability to appeal to a Republican leaning state that is noteworthy for its exceptionally average character. Likewise, if his opponents are able to engineer his defeat in Hoosier country, the event of a brokered convention is made both more likely, as Trump is deprived of vital delegates, and the case for dispossessing him of the nomination by a brokered convention is strengthened: his establishment critics can argue he has failed to win a mandate from the most loyal conservative constituencies.

Can Trump win Indiana? As the defeat of Napoleon at Waterloo was “the nearest-run thing you ever saw in your life“, so, too, does the upcoming primary battle for Indiana promise to be a tightly fought contest. As of April 10th, prediction markets suggest Trump’s chances are a little under 40%, but it is likely that this number will rise as the primary draws nearer. The primary is an open ballot affair, which has favored Trump in the past, but with the narrowing of the field that advantage has noticeably diminished. Due to a law circumscribing the use of automated phone solicitation, opinion polling in the state is both more difficult, and expensive, than it is in most other parts of the country. Certainly polling will be conducted, but the volume and timeliness of data available is unlikely to satisfy those of a statistical disposition. Thus, the best, and for the moment only, way to speculate on the state of the state is by considering the composition of the strategic elements in play, which, in this case, can be narrowed down to three significant characteristics. Those being (1) the effect of outsourcing on the state economy, (2) the impact of the Cruz campaign’s new establishment support, and (3) the predilections of moderate conservatives as swing voters. There is an obvious connection between points (2) and (3), but as they both have at least one unique strategic characteristic it is prudent to consider them separately on their own merits.

Indiana has faced a high rate of job loss from outsourcing activities in the manufacturing sector, of which, Mexico has been a significant foreign beneficiary. The recent announcement by Carrier that it would be moving its Indiana manufacturing facilities to Mexico, costing the state 2,100 jobs, is a damning, and timely, affirmation of the truth behind Trump’s declamations on the negative impact of the neo-liberal trade policies his establishment opponents support. Trump has successfully capitalized on the marginalization of disposed working-class voters in previous contests, and Indiana is inundated with a general resentment for big business that is less pronounced in Republican states outside of the Rust Belt. That sentiment extends beyond blue-collar workers, permeating small town Hoosier communities that have seen their economic prospects diminished, atomized, to appease predatory special interests, only to have their struggles ridiculed by pusillanimous establishment eunuchs who jeer at their misfortunes. At his best Trump speaks to this anger, and if he remains on message he will be competitive in the state: what cannot be achieved by well conducted righteous fury must be outside the capacity of mankind to realize. With the support of his “high energy” base, broadening the scope of his message to connect the betterment of the state economy with his America-first trade policies could help him to expand his support with evangelical and very conservative voters, groups he has had inconsistent success with in previous contests.

Trump making headway with evangelical and very conservative voters previously would have been a death sentence for his redoubtable opponent, Ted Cruz. However, following Cruz’s April 5th triumph in Wisconsin, the importance of those voter groups to the ultimate fulfillment of Cruz’s ambition has been somewhat diminished. Thus, the game plan for Cruz in Indiana will almost certainly be a redux of his Wisconsin strategy, predicated on winning moderate voters and leveraging establishment support to undercut Trump’s prospects. Cruz, who has frequently described himself as an anti-establishment candidate reviled by party insiders, a position that seemed well supported by a wealth of evidence, has, with his embrace of establishment support in Wisconsin, revealed that his public persona, the waggish rogue, is a facade, camouflage to obfuscate his mastery of the Machiavellian arts. His heel-turn from crusader flying the flag of rebellion to gentle protector of orthodoxy is an act of convenient pragmatism and dubious virtue. The states that yet remain to be contested skew heavily Western and South-Western. If Cruz successfully re-brands himself as a unifying moderate at the expense of some of the religious and very conservative voters who form his original base, he greatly improves his odds of preventing Trump from gaining enough delegates to avoid a brokered convention. Should he succeed, Cruz would be advantageously positioned to make a claim for the nomination, arguing he would be the only man capable of uniting the fractious party factions, which may well be true if you consider the extinguishment of the rebel faction as unity. The Republican establishment, having now thrown their support behind him, will have little leverage to prevent Cruz from achieving his design. That said, winning in Indiana, the last Republican state where there will be a serious contest, is the key to the success or failure of this plan. If Trump can make the case that Cruz has been compromised by his establishment allies, forcing him to either double down on his transformation into a moderate or backtrack to defend his original supporter base, he can co-opt Cruz’s metamorphosis, re-branding him as either a mendacious charlatan or a lupine firebrand assuming the countenance of a sheep. Neither outcome would be conducive to Cruz’s prospects for victory.

As the aforementioned conflict illustrates, the outcome of the Indiana primary will be heavily dependent on the perception of undecided, moderately conservative voters. Kasich, a non-entity in almost every respect, will win some of these moderate voters, mostly in the eastern parts of the state under the yoke of the Buckeye broadcast market. If Trump is successful in forestalling Cruz’s metamorphosis into a moderate, any votes that go to Kasich will probably benefit Trump. If Kasich drops out of the race prior to Indiana, the situation is not appreciably changed. If the existence of one of the three candidates can be said to have a negligible impact on the event, what are the key issues that will impact moderate voters? The economic situation will be a major factor here. Trump, as previously described, is better positioned than Cruz is to use this to his advantage. Social issues, while important, are less tractable as campaign fodder in Indiana than they are in more socially conservative Republican states. That said, Cruz could position himself advantageously in the state if he can quickly steer the public conversation to Trump’s alleged misogyny. By taking the moral high ground Cruz would be provided an elevated defensive position, from which it would be easier to avoid taking divisive policy positions that could upset the delicate balance required to maintain his current base while appealing to moderates. Finally, the impact of public perception on security and terrorism must be addressed. Defense issues play a significant role in determining the allegiance of primary voters. With respect to this subject there is one story of local significance that could be leveraged to great success. The settlement of refugees from Syria in America, a program pursued by the Obama administration, has unilaterally determined that Indiana should be one of the primary colonies for those Mohammedan masses. Unsurprisingly, this has not been well received by Indiana’s conservative leaning residents, and prompted Republican governor Mike Pence to launch an unsuccessful legal challenge to exempt the state from the resettlement efforts. If Trump can capitalize on this issue, it would likely pay big dividends to him in the support of moderate voters. As a bonus, it may also neuter the Indiana Republican establishment, many of whom have been quite vocal in their dislike of his candidacy, as they would be forced to oppose him while he loudly champions the ‘right’ side of an issue that is almost universally supported by the state’s conservative voters.

It took the united effort of the European establishment to restrain Napoleon, and, such was the brilliance of his leadership, they very nearly failed to defeat him despite their unprecedented unified exertions. By what slim margins are divided the most disparate outcomes, for it is now beyond our capacity to imagine how the world might have looked today had the outcome been reversed, with one exception: the town of Waterloo, the humble ground upon which was fought the battle for the possession of the future, would retain its exulted status, proof that while history does frequently rhyme, it also can echo. On May 3rd, whether we witness the defeat of a rebellion or the success of a revolution, a town named Waterloo will once again host a struggle between opposing forces, engaged in a conflict for supremacy, where one must be destroyed for the other to attain, or maintain, power. That the final act, determining the outcome of this endeavor, will take place amongst the small towns of Indiana, the crossroads of America, seems appropriate, even, poetic. The blustering rebel will do battle with the grand old prefects of the Grand Old Party in Hoosier fields. Whatever the outcome, it is assured that Trump, like Napoleon before him, will ever after be defined by the success or failure of his efforts to gain the demesne of Waterloo, and with it, the world.