June 10, 2005

Bringing Hedging to the Masses

HedgeStreet allows traders to bet on everything from oil prices to interest rates

SAN MATEO, Calif. (HedgeWorld.com)--HedgeStreet's tag line is "Trade Things that Matter."

So what matters to the average American these days? Gas prices? HedgeStreet lets people trade them. Home prices? HedgeStreet has contracts for those. Interest rates? Got 'em. Employment figures? Check.

In fact, HedgeStreet has a trade for just about any corner of the economy you can think of, from crude oil prices to non-farm payroll numbers to currencies. And the really interesting part is that no qualifications are necessary to trade these derivative contracts, called Hedgelets. The only requirements are access to an Internet connection to access the site and $100 for the initial deposit.

Essentially trading Hedgelets is betting on outcomes. In that respect it's not much different from online gambling. However, instead of playing a game of chance to win extra money, Hedgelets allow everyday folks to use their knowledge to hedge against economic events in their own lives--rising gas prices or an overseas trip requiring currency conversion, for instance--or to make a straight profit.

With a minimum trade order of $10, plus minimal settlement fees for contracts held until expiration, Hedgelets could also be considered just plain fun and games for those with more disposable income.

Think of it as E*Trade or Ameritrade, but with derivatives.

"E*Trade disintermediated the brokerage from the overall trade flow," said HedgeStreet co-founder Russell Andersson. "It used to be you call your broker, the broker called their exchange rep, the rep had the trade executed and then it went to settlement and clearing. Then E*Trade linked the customer directly with the exchange and they could place their orders directly to the exchange. HedgeStreet attempts to collapse and disintermediate the entire process. We are the exchange and also handle settlement and clearing.

"The net result is this economy of savings and net reduction in cost."

Mr. Andersson said of the 25 million Americans with online brokerage accounts, fewer than 250,000 trade derivatives. HedgeStreet attempts to bring to derivatives trading the same kind of "empowerment" that online brokerages brought to stock traders. But some might argue that such empowerment should not extend to derivatives, which tend to be perceived as murkier and more risky than traditional stock and bond investments. Others would argue just as strenuously, however, that greater use of derivatives provides the best kind of understanding.

And HedgeStreet appears to be limiting the risk. With Hedgelets, traders can't lose more than they bet. So if someone buys $100 worth of Hedgelets betting that the price of crude oil will rise above a certain level by the end of the week, they can't lose more than $100 if they're wrong.

Currently HedgeStreet offers 26 different Hedgelets covering nine areas: Economic indicators, employment, inflation, commodities, currencies, interest rates, fuel, mortgage rates and most recently, housing prices.

HedgeStreet even provides a calculator so traders can figure out what happens if various scenarios play out. Take fuel, for example. If someone thinks oil prices are going to rise by the end of June and either wants to profit from it or try to make a little extra cash to cover the added expense at the gas pump--or conversely, wants to wager that the price will go down--HedgeStreet trades Hedgelets that expire on June 30, allowing bets on whether the per-barrel price of oil will be less than US$52.97, between US$52.97 and US$57.97 or above US$57.97.

A realist would probably bet on prices being somewhere between US$52.97 and US$57.97, given that July contracts for light sweet crude closed at US$53.63 on the New York Mercantile Exchange on June 2. But a pessimist might expect higher prices, and a speculator might want to take a chance. A US$500 bet on oil prices rising above US$57.97, if correct, would yield US$910 according to HedgeStreet's calculator. That's a profit of US$410, which might help cover the added cost of filling up. Or not, depending on the vehicle.

New contracts allow users in certain markets to bet on prices of the homes around them. New York City residents confident in the appreciation of real estate there can buy a Hedgelet that the New York median home price will rise above US$457,000 by Nov. 11. A US$500 bet, if correct, would return US$780, a US$280 profit. Other Hedgelets, called variable contracts, provide a payout based on how much over the expected price the actual price turns out to be. For instance, a bet that the median price will be between US$440,000 and US$470,000 would yield US$90 for every 3,000 points above US$456,590, according to HedgeStreet's calculator.

"For most Americans, their home is their single largest investment and, as such, the desire to reduce risks surrounding that asset is important," said John Nafeh, chief executive of HedgeStreet, in a statement. "Housing price Hedgelets provide a unique way for them to hedge against depreciation in the value of a home, or conversely, speculate on the degree to which housing prices will appreciate."

HedgeStreet is regulated by the Commodity Futures Trading Commission. Since it acts as its own exchange and clearing house, its size depends on the number of people willing to take offsetting positions. In an effort to get more people to do so, HedgeStreet recently lowered the minimum deposit amount to US$100 from US500, and offered free trading.

"We realized the key value in this is allowing people to experiment," Mr. Andersson said. "We wanted to reduce the cost of experimentation."

More of the latest hedge fund news from HedgeWorld can be found here.
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