Basics – Spread trading (using CUS)

One way to trade Home Price contracts is on spread trades.  This allows one to trade on the eventual price difference between two contracts.   While trading spreads results in no net position (a spread trade results in a long in one contract and a short in another) that is not to say that they are less risky.  I’ve tallied the live spread trades for the Nov cycle maturities as an example.

Note (1st VERY IMPORTANT) that the spreads are quoted as the first contract against the second contract.  As such, the -500 quote along the CUSX11 line, and under the X12 column, translates into someone willing to buy the CUSX11 contract 5points below where they will simultaneously sell the CUSX12 contract.  (Note, I am jumping back and forth between how the indices are quoted (e.g. 150.00) and how the contracts are traded (e.g. 15000)).  So, for example if someone hit that bid, there would be two trades: one where the “-500” bidder would buy a CUSX11 contract at 150 while at the same time selling the CUSX12 contract at 155, while the seller sold a CUSX11 at 150 while buying the CUSX12 at 155.

The -160 spread offer represents someone who is willing to sell the CUSX11 contract  “only” 160 points below the CUSX12 price.

Spread quotes may also be the basis for an outright bid.  For example, the -1100 offer between CUSX11 and CUSX15 means that someone will sell the CUSX11 11 points under the CUSX15 contract.  This is the same as someone being willing to buy the CUSX15 contract 11 points above where they can sell the CUSX11 contract.  As such, if there’s a 150 bid in the CUSX11 contract (as shown) the -11 spread (CUSX11/CUSX15) will result in the CME computers generating a 161 bid for CUSX15.  This bid will exist as long as both the 150 bid exists in CUSX11 and the -1100 spread offer is working.  If the 161 bid is hit, the spread order will simultaneously hit the 150 bid in CUSX11.

Net one trader will be short a CUSX15 at 161 (as he wanted).  One trader will be long a CUSX11 as they wanted, and (possibly) another trader will be short the CUSX11 and long the CUSX15 at an 11 point price difference.

Finally, even-year spread differences can be easily translated into forward HPAs (Annualized Home Price Appreciation).  Using the above example, if someone is willing to buy the CUSX11 at 150 while selling the CUSX12 at 155, it may be inferred that they expect CUSX12 prices to be no more than 5 points (or looking to the right side of the table~7.3%)  higher by the time the CUSX11 contract expires.  It may be interpreted that the buyer of the spread at -160 thinks that prices will rise by more than 1.3%.

Any spread order can be translated into a forward HPA assumption, and (importantly  for trading) any HPA can be translated back into a spread order.

2nd Important Note- A spread trade is a buy/sell of a front contract combined with a sell/buy of a back contract.  When the front contract expires one is left with an outright position in the back contract.  That is why I’ve taken pains here to say “one may interpret/infer”…  There are other reasons one might buy or sell a spread.