Chapter 4: Key Takeaways

Contract Types

Binary contracts are the fundamental building block of prediction markets. They pay $1 if the event occurs, $0 otherwise. The price equals the market's implied probability.
Multi-outcome contracts extend the binary model to questions with multiple mutually exclusive answers. Each outcome has its own contract. The completeness constraint says prices should sum to approximately $1 (plus any overround).
Scalar (range) contracts handle continuous numeric outcomes. They come in two flavors: bracket contracts (a set of binary contracts covering ranges) and linear scalar contracts (payoff scales proportionally with the outcome).

No-arbitrage pricing: In a binary market, P(Yes) + P(No) = 1. If the sum is less than 1, buy all sides for a guaranteed profit. If greater than 1, sell all sides. Arbitrageurs enforce this constraint.
Overround is the amount by which prices exceed the theoretical sum of 1. It represents the market's implicit margin and is a cost to traders. Normalize prices by dividing each by the sum to extract true implied probabilities.
Arrow-Debreu securities: Multi-outcome prediction market contracts are the practical embodiment of Arrow-Debreu securities. A complete set allows replication of any desired payoff.

Every trade follows the same lifecycle: Research (form a view, identify edge) -> Order Placement (specify contract, side, quantity, price) -> Matching (exchange pairs buy and sell orders) -> Position Held (monitor unrealized P&L) -> Resolution (authoritative source determines outcome) -> Settlement (payouts distributed).
Exit before resolution is always an option. You can sell your position in the secondary market at any time, realizing a gain or loss based on price movement since your entry.

Market orders guarantee execution but not price. Limit orders guarantee price but not execution. Choose based on whether speed or price control matters more.
Time-in-force modifiers (GTC, FOK, IOC, Day) control how long your order remains active if not immediately filled.
The order book shows all outstanding buy and sell orders. The bid-ask spread is the gap between the best bid and best ask — it is the implicit cost of immediate trading.

Average cost basis is the weighted average price of your accumulated position. Track it carefully, especially when building positions across multiple trades.
Unrealized P&L = (current price - avg cost) x quantity. Realized P&L = (sell price - avg cost) x quantity sold. Both matter, but only realized P&L is locked in.
Prediction markets are typically fully collateralized: the buyer's cost plus the seller's margin always equals $1 per contract. This eliminates counterparty credit risk.

Resolution criteria are the single most important thing to read before trading. Ambiguous criteria lead to disputes. Good criteria specify what is measured, when, by whom, and how edge cases are handled.
Special resolutions include early resolution (outcome becomes certain before the date), voided/N/A resolution (event becomes meaningless), and disputed resolution (outcome is contested).
Settlement is typically automatic and near-instantaneous on centralized platforms. On blockchain-based platforms, it requires an on-chain transaction.

Total trading cost = explicit fees (trade fee + winner fee) + implicit costs (half the bid-ask spread + slippage). Always calculate the fee-adjusted break-even probability before trading.
The break-even formula with fees: $q_{\text{break-even}} = \frac{p \times (1 + f_{\text{trade}})}{1 - f_{\text{win}}}$. Even small fees can consume a significant percentage of your edge.
Slippage increases with order size relative to available liquidity. Always check the order book depth before placing large orders.

Liquidity matters more than price: A contract at a slightly worse price with deep liquidity is often better than a theoretically perfect price that you cannot trade in size.
Contract specification pitfalls are a real source of losses. Ambiguous timing, unclear metrics, revision risk, and subjective criteria have all caused painful resolutions.
Platform risk (regulatory shutdown, insolvency, hacking) is a non-trivial concern. Diversify across platforms and do not keep more on any single platform than you can afford to lose.
Position sizing should be conservative, especially for beginners. Never risk more than 5% of your bankroll on a single contract. We will revisit this with the Kelly Criterion in a later chapter.

Think of a binary contract as a bet on a coin flip where you get to choose the odds. The price IS the probability. If you think the true probability differs from the price, you have found a potential trade.
Think of a multi-outcome market as a horse race. Each horse has odds (prices). The overround is the track's take. Your edge comes from knowing something the other bettors do not.
Think of a scalar market as a thermometer for expectations. The price tells you where the market thinks the temperature will be. Brackets give you the full forecast; the linear scalar gives you just the average.