Thesis
Underwriting Tail Risk in Illiquid Markets
I. Unwanted Exposures
Consider a fund that has owned a smid-cap industrials company for two years, with strong conviction behind its position in a consolidating market and a management team it trusts. Six months ago, a larger competitor agreed to acquire it at a premium, and in a few weeks the competition authority’s statutory review deadline arrives, essentially the approval before the deal can close. At this point, say 2 weeks out, the fund expects a clearance. Selling equity / shorting into the decision would mean giving up the spread it has carried for six months; holding it through means a large ‘jump-risk’ that hinges on the ruling.
In reality, the fund has a more nuanced view than “expected clearance / expected block”. It forms expectations on whether clearance will be unconditional or come with divestitures that cut the buyer’s rationale, whether remedy negotiations will push the close past the outside date and reopen the price, or, if the deal is blocked, where the target settles once the break fee is paid and the standalone case is re-underwritten. These ‘sub-outcome’ expectations all contain material re-rating potential for the underlying equity, and no traditional instrument isolates that additional ‘jump-risk’ with functional liquidity. Swap the deal for a rate case, a court ruling, or a permitting decision and the exposure looks the same: scheduled binary, resolvable decision inside a position whose other exposures the holder wants to keep.
II. Liquidity in Exchange-Executed Event Contracts
Exchange-listed event contracts on designated contract markets (DCMs) could facilitate a hedge. These exchanges, regulated by the Commodity Futures Trading Commission (CFTC), list contracts on a widening range of standardized outcomes. In July 2026 one of them opened a pilot of markets on Phase 3 primary endpoints and full FDA approvals. The pilot is limited to larger-cap sponsors, and each trial is listed only after enrollment closes. Listings are written for every trader at once; they reference the headline outcome (clearance or block, approval or refusal) and settle on standard terms.
A fund’s view sits inside those outcomes: in the conditions attached, in the timing, and in the value left on a block. No standard listing isolates those expectations, and none can size a payout to a single holder’s exposure.
Even on headline outcomes, liquidity is thin where hedgers need it most. An exchange book clears by crossing parties who disagree on price, including informed traders, hedgers and liquidity providers, each trading on different objectives or expectations. Around tail outcomes that mix is largely missing, because most participants want protection. The long tail of events with real business consequences and narrow, homogeneous audiences draws too little two-sided interest to hedge size.
Interest concentrates on the hedger’s side because the other side of a tail contract is a poor trade on a fully collateralized book. The buyer pays a small premium for a large contingent payout. The seller, which the rest of this paper calls the warehouse, must post the full payout and lock it until resolution to earn that thin premium, and at fair value it earns nothing in expectation. Worse, market makers on an exchange can’t tell informed participants from hedgers, so they quote wide spreads to cover the expected loss to informed flow.
III. N-of-1 Contracts and Position Building
Bespoke, bilateral event contracts isolate the fund’s view via private agreements, which pay fixed amounts upon resolution. The hedging party negotiates the terms of the event, direction, notional, and expiry details with various counterparties. This is derisked slightly by having both parties fully collateralize at inception.
If we compare this to an options position, an event “swap” moves only with the probability of the underlying outcome, not price, meaning it carries no daily variance and doesn’t decay with time unlike the natural drift of a spot price. Instead, all variance arrives as a jump-risk at resolution.
Unlike exchange-listed contracts, these can be written on the sub-outcome the fund actually cares about, such as a divestiture condition, a close past the outside date, or a narrower drug label, and its payout is capped at the exposure the hedger can meaningfully demonstrate. Most importantly, it’s private. A listed contract is fungible with retail positions on the book, signaling market movement. Bilateral contracts maintain privacy of short positions in particularly illiquid markets.
Most institutions fear one-sided demand, especially market-makers protecting against adverse selection. But in reality, one-sided demand doesn’t stop necessary markets from clearing. Insurance, catastrophe bonds, and merger arbitrage all clear one-sided risk the same way: an underwriter holds a diversified book and is paid a premium above its expected loss. Reinsurers don’t hedge hurricanes, they diversify the risk and price the premium. A “warehouse” writing event contract across many maximally uncorrelated decisions can avoid large per-risk exposure as a function of correlation factor.
IV. Counterparties
Similar to the industrials investor in Section 1, other sector-specific funds are equally sensitive to respective event outcomes. A biotech fund may want an approval and fear the narrowness of a label. Here’s a concrete example. When the FDA granted Sarepta’s Elevidys accelerated approval in June 2023, it covered ambulatory patients aged 4–5, a narrower label than the company had sought, the shares fell 11% the next day. Given a bilateral event swap with adequate liquidity, the funds holding a substantial percentage of ADV could have kept the approval risk on book and transferred an isolated derivative of the label “sub-outcome”.
Royalty and milestone holders own payments that hinge on binary approvals, often with no public equity to short against. Large pharmaceutical balance sheets absorb most of that exposure across a diversified pipeline. The natural hedgers are standalone royalty aggregators, licensors and lenders, for whom one approval is a balance-sheet event, and they come after the equity books.
A liquidity provider (also referred to here as the “syndicate” or “warehouse”) faced a cost of writing a contract, composed of two parts: the expected loss to adversely-selected counterparties, and a premium for carrying a jump it cannot hedge. Its results therefore scale with the share of hedging demand on its book; directional flow usually carries a view the hedger can’t isolate and transfers exposure rather than trading on informational edge.
V. Addressing Adverse Selection Burden with Subscription Markets
Listed DCM venues are starting to route size off their central orderbooks. In August 2026, a large bank began arranging privately negotiated block trades on Kalshi’s event contracts for institutional clients, with a designated market maker supplying pricing and liquidity.
We’re starting to see the burdens that pure bilateral trading carries. Bespoke contracts are requested by parties that have the greatest information edge on the risk being targeted. A single dealer underwriting each such contract must build a systematically selected book, which when diversified experiences low variance but high bias. With no spread to cover expected loss, the quoted premium must be sufficiently priced. For as long as efficient markets have existed, adverse selection and illiquidity have prevented truly bespoke insurance.
Certain insurance marketplaces found solutions we can take inspiration from. The hedger’s identity and exposure are disclosed to the underwriting side under confidentiality. Each bilateral trade confirms that material facts pertaining to an event were disclosed, that nothing undisclosed bears on the outcome, and that the payout is capped at demonstrated exposure. The initial retained loss keeps the hedging party exposed to its own information and per-name caps help limit the notional value of future contracts. What remains is handled in pricing. Of course, an underwriter would quote a premium above the implied fair value, which is itself a composite of the options-implied value. That margin is what’s known as a “loading”: an informed hedger profits only if its information moves the true probability further from the reference / fair price than the loading. Timing of the event is also a factor. The closer to the event a hedge is requested, the more likely it is to carry information, so request windows must be well defined.
Capacity, or underwriting interest, is the remaining concern. Subscription markets have solved interest in bespoke operating risk already. In these systems, brokers bring an n-of-1 risk to a lead underwriter, who runs full diligence, sets the price, writes the largest position, and earns a “lead” fee. Follow-on syndicates subscribe capacity at that price, each on separate bilateral confirmations with the hedger. Lloyd’s of London, the largest insurance and reinsurance marketplace for bespoke business risk in the U.K., has operated this model at scale for centuries. Ki, its first algorithmic syndication model, wrote over $1B of gross written premium through the platform in 2024. The market’s trade body reports fast follow automating the tail of the slip, and lead costs rising steadily.
Of course, broadcasting risk to several desks weakens the privacy factor of a true bilateral swap, and invites what’s known as the winner’s curse: selling cover on a unique risk is a common-value auction whose lowest bidder has likely underestimated the loss.
VI. Settlement
Each contract’s full payout is posted at inception into an escrow, on a public ledger, which neither counterparty can move unilaterally during the life of the contract. At resolution, redemption against the written outcome settles the positions instantaneously with no custodian or central counterparty to interpose the trade. We target full collateral given the constraints of margin models on binary events, which converge to maximum loss since any close-out window containing the event carries an adverse jump equal to the entire payout.
Martingale is building the rails for the above marketplace to exist, brokering n-of-1 event swaps. We operate as a fee-only arranger and are never party to any trade.