Basics -Mid v Close

A number of first time visitors to trading in home price futures may be curious as to why quotes reference the “Mid” rather than the “Close” price.  After all if they are MBS traders they are used to seeing the “Close” on all the other contracts they follow: T-Notes, Euro$, S&P indices.  Alas with less frequently traded contracts the bid-asked spread is sometimes wide, and unless there’s been a recent trade (or lower offer or higher bid since the last trade) the close may be dated.

The attached graph shows the situation in the CUS contract which has the benefit of at least having quotes for every contract.  Note how the Close curve bounces from the offered side to the bid side of the market and back again. 

Using the Nov ’11 contract as an example, the close and offer are both 15800 as the current offer is lower than the last trade. The closing curve bounces down to 15200 in Feb ’12 as the last trade was below that level, and the 15200 bid is higher.  Finally, the close curve bounces back up to 16040 as that was the last trade and both the current offer is higher and the current bid is lower than that level.

There is not much to learn from the CUS close curve.  The situation is worse for other contracts that do not have bids and offers for each expiration.  A trade done several months ago might be the foundation for calculating today’s close, unless a lower offer or higher bid has been posted.

By contrast the Mid curve better reflects recent action in the market – even if those are only bids and offers.  In the case of the CUS contract, the Mid curve reflects a view that prices will be lower through 2011 then start to climb (albeit slowly) during 2012-2015. 

Any subsequent “better” quote (a higher bid or lower offer) will impact this curve and reflect a change of sentiment.

The downside of Mid pricing is that one doesn’t know whether a 170 Mid price represents a 168 bid and a 172 offer or a 150 bid and a 190 offer.  That’s why it’s important to also show bids and offers to give viewers a sense of the spread.  Traders cannot necessarily expect to act on Mid prices.  Markets, particularly OTC markets, that show just Mid without also showing the bid and ask sides, may mislead traders into what prices they can expect to act on.  Traders who typically download only one number for their historical records may then not see that bid-ask spreads have tightened if they only download close or mid. 

That said, while Mid prices have their issues, they are a much better reference point than Close prices for illustrating market sentiment.