HedgeStreet, Hedgelets, and the Hedging
of Everyday Risks

The previous article in this series, Derivatives and the Common Investor, introduced HedgeStreet™ (www.hedgestreet.com), a new CFTC-designated contract market for non-intermediated retail derivative contracts. This article describes the instruments traded on HedgeStreet.

An Online Exchange for Trading Derivatives at the Retail Level

HedgeStreet exists solely to enable the common investor to trade what economist Robert Shiller calls “the next generation of instruments that address economic risks faced by people every day.” Essentially, these instruments allow traders to hedge or speculate based on future economic outcomes.

HedgeStreet has carefully designed its financial instruments, called Hedgelets™, to make trading simple. Key features of Hedgelets include:

• Variety – Hedgelets are defined for a broad range of financially significant events, from interest and mortgage rates to commodity and real estate prices to manufacturing and employment statistics, so you can precisely hedge your particular risks—or speculate exactly where you feel you have the greatest edge.
• Simplicity – Each Hedgelet takes a YES or NO position on a single, explicitly-defined future event, such as whether the FOMC will raise interest rates at its next meeting, so your investment is always easy to understand.
• Low Price – A single Hedgelet never costs more than $10, so you can invest precisely the amount you choose.
• Limited Risk – There is no margin trading, so you can never lose more than you paid for the Hedgelets.

Hedgelets are the only instruments traded on HedgeStreet —and they can’t be traded anywhere else.

Trading Hedgelets

HedgeStreet defines all of the Hedgelets traded on the exchange, but it does not take a position in any Hedgelet. Market makers set a bid/offer, and members can buy and sell Hedgelets on the open Exchange until the Hedgelets’ specified expiration dates. Prices are determined by the market’s view of the likelihood that a Hedgelet’s underlying event will occur.

Soon after a Hedgelet expires, the underlying event’s outcome is determined, and whichever Hedgelet (YES or NO) is “in-the-money” is redeemed for $10, while the other “out-of-the-money” Hedgelet expires worthless.

For example, assume that HedgeStreet defines a Hedgelet based on whether the price of regular gasoline at the pump, as reported by the Energy Information Administration, is greater than $2.00 on Dec. 31, 2004. Also assume that during the Hedgelet’s life cycle, 100 of the YES Hedgelets are offered for sale for $5.65. Trader A, expecting that the price of gasoline will be above $2.00 on the specified date, purchases the 100 YES Hedgelets for $565. He may then do any of the following: offer them for a higher price, sell them later to another trader bidding a higher price, or hold them until expiration. If he holds the Hedgelets and the price of regular gasoline is greater than $2.00 as of Dec. 31, 2004, he will receive $1,000 ($10 for each Hedgelet held). His profit will be $435, minus the small fees for his transactions. On the other hand, if Trader A turns out to be wrong and on Dec. 31, 2004, the price of regular gasoline is less than or equal to $2.00, his 100 YES Hedgelets will be worthless, and his loss will be $565, plus the small fees for his transactions.

Because its Hedgelets are based on simple, explicitly-stated future events, and the potential gains and losses from a particular position are always readily apparent, HedgeStreet makes trading this new class of financial instruments simple and straightforward.

All Hedgestreet Articles:

• Hedgestreet article number 1.
• Hedgestreet article number 2.
• Hedgestreet article number 3.
• Hedgestreet article number 4.
• Hedgestreet article number 5.
• Hedgestreet article number 6.
• Hedgestreet article number 7.
• Hedgestreet article number 8.
• Hedgestreet article number 9.
• Hedgestreet article number 10.
• Hedgestreet article number 11.

The HedgeStreet marketplace is open now at www.hedgestreet.com.