Hedging for Small Investors

Trading is often compared to gambling, but can "water cooler" wagers such as "I bet the Dow ends up 100 points today" be considered trading? What if you are long stock -- would taking the other side of your co-worker's proposition be considered a hedge against your existing positions? Can this be considered a derivative?

The founders of HedgeStreet.com certainly would answer a resounding yes to all of the above.

The site, which launched in early October, bills itself as "the nation's first mass-market online derivatives exchange" and created a unique way for "individual investors to manage the risks in their everyday lives" according to Russell Anderson, co-founder and vice president of instrument orientation at HedgeStreeet.

A Bet Is a Bet Is a Hedge?

Almost all wagers in which there is a win/lose proposition -- that is, in which a set of criteria are either met or not met within a specified period of time -- can be considered binary options and therefore a derivatives contract.

What distinguishes HedgeStreet from sports books, online casinos and even the local bookie? Like these gambling outlets, HedgeStreet, which operates as both an exchange and clearinghouse, is a licensed operator, in this case by the Commodity Futures Trading Commission. But there are two main differences.

The first is that HedgeStreet allows for trading of the contract right up to the expiration or completion of the event. (There are not many racetracks that allow for betting after the race begins.) And the second difference is really a matter of focus rather than the pure product difference. Unlike other sites, you won't be able to wager on the expected snowfall in Central Park , "HedgeStreet only offers contracts with economic or financial significance," says Anderson.

Currently, HedgeStreet offers contracts on economic data -- such as employment numbers, CPI numbers, the Fed's next move, the direction of mortgage rates and energy prices.

HedgeStreet hopes that by concentrating on events with a direct economic or financial impact, it will be the leading player in that sector. This is crucial, because as with any marketplace, its success is dependent on being the market leader, as liquidity breeds liquidity, whether it be an options exchange, an auction market such as eBay(EBAY Quote) or an online dating service.