From 15¢ spreads to 3¢ — the missing hedge for event-contract market makers.
D8 probability options, call-spread/butterfly ladders, and variance swaps on binary and scalar event contracts. All bilateral ECP OTC.
Open the MM Desk →The Market Maker's Problem
Quoting binary and bracket event contracts creates naked inventory risk. Each contract resolves to 0 or 1 — as the event approaches, gamma spikes toward infinity. A market maker holding inventory near a contested outcome faces potentially unlimited loss on a binary jump. Today, a 15¢ bid-ask spread exists because that risk has no hedge: no instrument lets a market maker offset the terminal jump without taking on a new unrelated position. The spread is pure risk premium — and it prices out retail participants and compresses volume.
The Hedge That Closes the Gap
Three instruments combine to hedge the full risk profile of a binary/bracket book:
Call-spread from adjacent ladder rungs
Finite gamma: buy the call at rung k, sell at rung k+1. The spread caps your binary gamma exposure to the width of one rung. Calibrated from the live bracket density.
D8 probability option for vega
A probability option whose payoff depends on the implied probability at resolution. Hedges the vega of your ladder position — when the market re-prices the outcome probability, you receive (or pay) the implied move.
Perpetual leg for delta (where available)
Where the underlying event has a continuous signal (polling average, scoring probability), a perpetual funding-rate swap hedges the directional delta continuously. No roll, no expiry gap.
Together these three instruments reduce the required bid-ask spread from ~15¢ to ~3¢ — a 5x improvement in market quality.
Arb-Free Density
Before proposing any hedge, the engine reconstructs the full risk-neutral probability density from the live bracket quotes. It enforces three no-arbitrage conditions:
- Monotone CDF: higher rungs must have weakly lower probability. Quotes violating this imply a free rung-to-rung arbitrage.
- Non-negative butterflies: every adjacent triple must have a non-negative butterfly spread. A negative butterfly means a rung is overpriced relative to its neighbors.
- Rungs sum to 1: the full ladder must integrate to 1. The engine normalizes gracefully rather than hard-failing on near-miss quotes.
Hedges are priced at the fair value implied by the enforced no-arbitrage density — not at the raw bracket mid.
Resolution-Zone Governance
As a contract approaches its resolution event, the engine enters the resolution zone — a configurable window before the terminal jump. In this zone: new option writing is frozen (no new D8 probability options or call-spreads); margin on existing positions is escalated toward 100% of max loss; the perpetual delta leg continues to mark but its funding rate is capped to prevent rate-spike exploitation. Existing hedges are held through resolution. The freeze is asymmetric: closing/reducing positions is always permitted; only new risk-taking is blocked.
Residual Risk to the Fabric
Any residual counterparty risk, basis risk, or tail exposure remaining after the IOI hedge is placed routes automatically into the PTRRS fabric for multilateral fractionalization. The fabric identifies other participants with offsetting exposures — for example, another market maker with the opposite ladder inventory — and compresses the bilateral book. Capital freed by compression reduces the required margin on future hedges, compounding the spread-compression benefit over time.
FAQ
Are these regulated as swaps?
Yes. Probability options, call-spreads, and variance swaps on event contracts are structured as binary payment swaps under CEA §1a(47). As bilateral OTC swaps between ECPs, they are exempt from mandatory clearing under §2(h)(7). The ECP gate runs on every counterparty before any instrument is confirmed.
What is the resolution zone?
The period near a contract's resolution event, configured per contract type. The engine escalates margin and blocks new option writing to protect against the terminal jump. The window is typically 1–4 hours before resolution for binary contracts, shorter for fast-resolving intraday events. Existing hedges are held.
How does the ladder connect to the hedge?
The engine reconstructs the full risk-neutral probability density from the live bracket quotes on the event contract, enforces no-arbitrage (monotone CDF, non-negative butterflies, sum to 1), then prices the call-spread and D8 option at the fair value implied by that density. The hedge is always calibrated to the actual live market — not to a model assumption.