Basics: Using Calendar Spreads/ Implied HPA

I thought that the long holiday weekend might be a good opportunity to revisit a powerful tool -the use of calendar spreads.  (The table and graph of hypothetical numbers will be used for illustration.)

Calendar spreads allow a traders to do two things:

  1. Read the market expectations as to implied HPA, and
  2. Allow traders to express a view on the pace of future price changes.

The graph shows the market-implied HPA (Home Price Appreciation) derived from differences between the mid-point of one contract to a contract a year later.  (Note that I use the same month expiration, in this case from November to November, to avoid seasonality issues).  So, for example, the mid-point of the Nov 2014 contract (162.4) is 4.0% higher than the mid-point of the November 2013 (156.1).

If “the market” became more bullish on the strength of the housing recovery, say to a 5% HPA, then one possibility would be for the Nov. 2014 mid-point to rise to 164.0 (assuming that the mid-point of Nov 2013 didn’t change).  The calendar spread would then more from minus 6.3 (156.1-162.4) to minus 7.9 (156.1-164.0).  (Note that calendar spreads are quoted with the earlier contract first, so being bullish on HPA actually means that the calendar spread becomes more negative.) If that were to happen (as had occurred over the last four months) the price curve graph (above) will steepen.   Importantly this steepening will occur whether the Nov 2013 contract falls to 150 or rises to 165 (although a 5% increase over 150 is slightly less than a 5% premium over 165).

So if a trader thinks that that the “right” implied HPA between the Nov 2013 and Nov 2014 contract is more than 4.0%,  he might want to try and sell the X13/X14 calendar spread at a level <= 6.1 points.  Unfortunately it is impossible to trade on mid-market prices and by hitting the outright Nov 2013 bid and lifting the outright Nov 2014 ask at the same time, the spread would be -9.4 points.  (The wider number is a function of introducing two bid/ask spreads.)

A step in the right direction would be to enter a spread order, for example offering (i.e. on the ask side)  the spread at -6.0 points.  That is, in entering this order the trader commits to a simultaneous sale of CUSX13 and purchase of CUSX14 at a dollar spread of 6.0 points.  (Like outright contracts, spread orders are quoted in 0.2 point increments).  Since spread orders have less outright market risk traders can usually afford to leave tighter GTC quotes in for longer periods – and for larger amounts.  In the case of our hypothetical X13/X14 calendar spread, the spread market is quoted -8.2/ -4.0 both of which are better levels that executing both outright legs at the quoted levels.    As with stated outright GTC markets, traders may have some flexibility inside of stated calendar spreads (so contact me).

Note that a calendar spread results in one long and one short position.  Before the first contract expires, traders are free to unwind either leg, or two positions simultaneously.  Over time, the front contract will expire (at the then spot index level) leaving open the back leg.   Once the front contract expires the trader will then only own one position and will be more exposed to shifts in the level of index moves.   On a one-year spread, the second leg will expire at the  spot level 12 months later.  Allowing the first contract to expire and then holding the second position to maturity is very similar to a TROR (total rate-of-return swap) of “owning” the index for one year.

The number of calendar spread permutations exceeds 600 (for the 11 contracts across 11 expirations) so maintaining calendar spreads on both the bid and ask side for all (>1000) quotes is unwieldy.  I tend to focus on November/November spreads as the underlying contracts tend to have the tightest quotes, but will be responsive to particular inquiries.   Calender spreads to express a view on expected changes in seasonal factors could also be employed, but the seasonal factors in the Case Shiller index are not too dramatic.

Again, as with all posts, please feel free to contact me (  with any questions on this post, calendar spreads or any other question on housing derivatives.