Inter-city quote spreads may be a great way to express a view on the relative performance of two contracts for a given expiration. The outright level of home price moves may be reduced with a simulaneous buy and sell, execution risk is reduced as the buy and sell are done at the same time at a pre-determined spread, and the inter-city spread quote is sometimes tighter than outright buy and sale.
Here’s a sample of recent inter-city quotes.
Recall that IC spreads are quoted just as calendar spreads with the front contract being bid (in the case of an IC bid) and the back contract being offered. So in the first quote, the bidder is offering to buy the HCIK13 (aka CUS) contract at 4.2 points above where he would simultaneously sell the MIAK13 contract. The reverse of that trade (a sale of the HCIK13 contract and purchase of the MIAK13 contract) is offered at 5.8 points. In effect someone wanting to express a view on the relative performance of the Miami contract versus the 10-city index (for May ’13) can do so in a relatively tight bid/ask spread. This view could later be reversed, or since both sides of an inter-city spread expire on the same day, run to expiration.
As both the HCI and MIA contract prices imply different price appreciation (or depreciation) relative to their respective spot indices, the HCI/MIA IC market is a way to express a view on how MIA will perform relative to the 10-city index. (I leave it to the reader to work out the math, but I would conclude that the 4.2/5.8 market brackets the MIA outperformance (vs HCI) to 0.21% to 1.26%.)
(Note: the 4.2 bid, and all other quotes in red are what I refer to as “arb” quotes. Those are automatically generated by the CME from outright bids and offers. Please contact me if interested to discuss possible inside quotes.)
In theory, IC bid/ask spreads should be tigher on a) shorter contracts, and b) contracts between highly correlated contracts. The later is especially useful as IC spreads can be used to take what might be a large risk (e.g. the outright level on the LAX contract in Nov. 2015) and reduce the risk by narrowing the question to the relative performance of LAX vs. SDG for the same expiration. As above, anyone wanting to express an opinion on the relative performance of LAX vs. SDG can express that via the IC spreads.
Inter-city spreads can be quoted between any two contracts with the same expiration. As such there are a ton (actually 2,420) of possible inter-city markets, and while some may not be meaningful, there are still too many to continually quote. Please contact me (email@example.com) if you have a particular quote that you’d like to see (at inside arb levels) or if you have any questions on after reading this blog.