As I mentioned in Tuesday’s blog, with the expiration of the Aug ’13 contract, the CME introduced a new contract for Feb ’15 – the G15 contract. While the Feb cycle has always had the lowest open interest of the four quarterly expirations (the longest maturing Nov cycle gets most of the attention), it has the potential to play a very important role in conveying views on year-end vs. year-end comparisons. Recall that the Feb ’14 contract references the Dec ’13 Case Shiller indices, and the Feb ’15 contract references the Dec ’14 indices. As such, the Feb ’14/Feb ’15 calendar spread may convey some information on traders’ expectations of HPA for calendar year 2014.
I say may as while all CME prices eventually converge to the corresponding index, prices on any contract may vary away from market expectations. Traders may have outright positions that they want to put on/ take off/ square up/ and may be motivated to trade at levels away from “fair value” (if a) there is such a thing, and b) it is even known to the market). Calendar spreads – which involve taking two positions simultaneously – may have additional reasons to trade away from fair value.
That said, for those with patience, I think that calendar spreads represent one of the best options for freely viewing continuous HPA expectations and for expressing a (financial) opinion.
To start the discussion on the G14/G15 calendar spread, I posted a -11.8/-8.2 bid/ask spread. Recall that a -11.8 bid means that the bidder will buy the front contract (G14 here) 11.8 points below the level that they will simultaneously sell the back contract (Feb ’15 here). The -8.2 offer is willing to do the opposite (i.e. sell the front contract 8.2 points under the level that they will buy the back contract).
These bids and offers may be more meaningful when converted into percentage terms consistent w/ HPA. A -11.8 bid versus a 180.5 midmarket on the Feb ’14 contract is 6.5% (after reversing the sign), while the -8.2 offer equates to a 4.5% difference. Thus in framing the discussion over the G14/G15 calendar spread, I’m suggesting that the debate on 2014 HPA (on the CUS 10-city index) should take place between 4.5% and 6.5% HPA assumptions.
The beauty, strength and value of publicly traded markets is that the numbers are free for all to see, and that anyone can choose to disagree without having to find the person with whom they disagree. Anyone with a strong view that 2014 HPA (on CS 10-city index) will be outside the 4.5-6.5% range may want to consider a trade. Anyone looking to (financially) express a view on some number inside the 4.5-6.5% range is invited to submit a better bid or offer.
The same exercise can be taken on each of the underlying ten regional contracts. I hope to get to some of them, but I would expect that all will be positive HPA (as of today) and those that have been strongest recently will have prices that reflect continued out-performance.
I’ve mentioned above, and want to highlight here, that this exercise applies to the Case Shiller 10-city index. Different indices, calculated under different methods, reflecting a different universe of home prices, may have different HPA for 2014, and one shouldn’t use calendar spreads on Case Shiller indices to infer HPA expectations for other indices.
Feel free to get in touch (firstname.lastname@example.org) if you have any questions on this blog, if you want some regional calendar spread discussed, or if you care to discuss any aspect of hedging home prices.