Contract

#Definition

A contract in prediction markets is a tradable financial instrument that pays a fixed amount if a specified event occurs and nothing if it doesn't. Contracts are the fundamental building blocks of prediction markets; they transform questions about the future into assets that can be bought, sold, and priced.

Each contract has clear terms: the event being predicted, the payout structure (typically $1 for winning,$0 for losing), and the resolution criteria that determine the outcome. The price at which a contract trades reflects the market's collective estimate of how likely the event is to occur.

Note: Contract vs. Share In casual conversation, these terms are often swapped. Technically, the contract is the agreement defining the rules (e.g., "The 'Will it Rain' Contract"), while a share is the unit you trade (e.g., "I bought 10 shares of the 'Yes' outcome").

#Why It Matters in Prediction Markets

Understanding contracts is essential for prediction market participation:

Price equals probability

In standard binary contracts, the price directly represents implied probability. A contract trading at $0.70 implies a 70% chance the event occurs. This makes interpretation intuitive.

Limited liability

Your maximum loss is the amount you paid for the contract. Unlike some derivatives, you can't lose more than you invest.

Standardization

Contracts standardize abstract predictions into comparable assets. Whether predicting elections, weather, or corporate earnings, the structure remains consistent.

Tradability

Contracts can be bought and sold before resolution, allowing traders to exit positions, lock in profits, or cut losses without waiting for the event.

#How It Works

#Contract Structure

#Contract Structure

Every prediction market contract includes:

Event specification

What exactly is being predicted? Clear, unambiguous language prevents disputes.

Outcome set

The possible results. For binary markets, this is Yes/No. Categorical markets have multiple exclusive outcomes.

Payout structure

Typically:

• Yes contract: Pays $1 if event occurs,$0 if not
• No contract: Pays $1 if event doesn't occur,$0 if it does

Resolution mechanism

Who decides the outcome and based on what? This includes the oracle and resolution source.

Timeline

When does the event window close? When will the market resolve?

#Contract Lifecycle

1. Creation: Market opens with defined terms
2. Trading: Buyers and sellers exchange contracts
3. Price Discovery: Prices fluctuate based on information and sentiment
4. Event: The specified event occurs (or doesn't)
5. Resolution: Oracle reports the outcome
6. Settlement: Winning contracts pay $1; losing contracts pay $0

#Numerical Example

A contract asks: "Will Company X stock close above $100 on December 31?"

Trading phase:

• Current stock price: $95
• Yes contract trades at: $0.40
• Interpretation: Market implies 40% chance stock exceeds $100

Trader's decision:

• Believes probability is actually 60%
• Buys 100 Yes contracts at $0.40 =$40 invested
• Edge: 60% - 40% = 20 percentage points

Resolution scenarios:

If stock closes at $105 (Yes wins):

Payout: 100 × $1.00 = $100
Profit: $100 - $40 = $60
Return: 150%

If stock closes at $98 (No wins):

Payout: 100 × $0.00 = $0
Loss: $40
Return: -100%

Expected value (if trader's 60% estimate is correct):

EV = (0.60 × $60) - (0.40 × $40) = $36 - $16 = $20 expected profit

#Examples

#Example 1: Binary Election Contract

A market asks "Will Candidate A win the election?"

• Yes contract: Pays $1 if A wins
• No contract: Pays $1 if A loses
• Current prices: Yes at $0.55, No at$0.45

A trader who believes A has a 65% chance buys Yes contracts. At resolution, if A wins, each contract pays $1.

#Example 2: Categorical Contract

A market asks "Which company will acquire Company X?"

• Company A contract: $0.35
• Company B contract: $0.25
• Company C contract: $0.15
• No acquisition contract: $0.25

Prices sum to $1 (approximately). If Company B acquires X, Company B contracts pay$1; all others pay $0.

#Example 3: Economic Indicator Contract

A market asks "Will inflation exceed 3% in Q4?"

• Yes contract: $0.72
• Resolution source: Bureau of Labor Statistics CPI release

The contract allows trading on a precise economic outcome that would otherwise be difficult to speculate on.

#Example 4: Time-Limited Contract

A market asks "Will Product Y launch by March 31?"

• Yes contract: $0.60
• If product launches March 15: Yes pays $1
• If product launches April 5: No pays $1 (deadline passed)

The time boundary creates a clear resolution criterion.

#Risks, Pitfalls, and Misunderstandings

Resolution ambiguity

If the contract terms don't anticipate all scenarios, disputes arise. "Will Team A win?" might be unclear if the game is cancelled. Always read resolution criteria carefully.

Counterparty risk

On some platforms, contracts are promises from the platform to pay. If the platform fails, contracts may be worthless. Prefer platforms with strong financial backing or decentralized settlement.

Liquidity risk

Owning contracts doesn't guarantee you can sell them. In illiquid markets, you might be stuck until resolution or forced to accept poor prices.

Binary thinking trap

Contracts force binary outcomes, but reality is continuous. "Will stock exceed $100?" treats$100.01 and $200 identically. Consider whether the contract captures what you actually want to predict.

Timing mismatch

Contracts specify exact resolution times. An event that happens one minute after the deadline results in No resolution, regardless of the subsequent outcome.

#Practical Tips for Traders

• Read the full contract specification: Don't assume what a contract means. Verify event definitions, resolution sources, and edge case handling

• Check the resolution source: Ensure the specified source will actually provide the needed information. Some sources change their methodology or become unavailable

• Consider contract expiration: Factor in how long your capital will be tied up until resolution

• Evaluate liquidity before buying: Can you exit if needed? Check order book depth and recent trading volume

• Understand the payout structure: Most contracts pay $1 for wins, but some platforms use different structures. Confirm before trading

• Compare equivalent contracts: Different platforms may offer similar contracts with different terms or prices. Shop for the best execution

#Related Terms

• Binary Market
• Categorical Market
• Resolution
• Resolution Criteria
• Implied Probability
• Yes/No Shares

#FAQ

#What's the difference between a contract and a share?

In prediction markets, these terms are often used interchangeably. A "contract" typically refers to the agreement (event specification, payout structure), while a "share" refers to a unit of that contract you hold. Owning 100 shares of a Yes contract means you hold 100 units of that specific contract.

#Can I sell a contract before resolution?

Yes. Contracts are tradable. If you bought Yes at $0.40 and the price rises to$0.70, you can sell for a $0.30 profit per contract without waiting for the event. This is a key advantage over traditional betting.

#What happens if the event is cancelled?

It depends on the contract terms. Well-written contracts specify how cancellations are handled; often the market is voided and positions are refunded at purchase price. Poorly written contracts may create disputes.

#Are prediction market contracts securities?

Regulatory classification varies by jurisdiction. In the US, the CFTC regulates some prediction markets as derivatives. Other jurisdictions may classify them differently. Platforms like Kalshi operate as registered exchanges; others like Polymarket operate in different regulatory contexts.

#How do contract prices stay between $0 and$1?

Arbitrage enforces this. If a Yes contract traded above $1, you could sell it and buy the underlying for guaranteed profit. If it traded below$0, it would cost nothing for a potential $1 payout. Supply and demand within these bounds determine the exact price.