It seems that a growing numbers of commentators are becoming ever-louder in their bearish views. Yet few give their readers any practical advice as to how to put this “knowledge” to work. Are they suggesting that people sell their houses and rent? I’m not suggesting that the pundits are wrong (or right) but I would observe that the absence of any action plan undermines the value of such advice. (Being told it’s going to rain for 40 days and 40 nights is an outlook. Being told to build an ark is an action plan that proved to be worth quite a bit more.)
To those not familiar with the Case Shiller (home price index) futures that are traded on the CME, let me share that there may be a more family-friendly alternative to implied “sell and rent” suggestions. The CME futures allows a homeowner (or bear/bull of any kind) to financially back up their view of forward home price levels (or at least of home price index levels) with a trade.
The CME has contracts on 11 S&P Case Shiller home price indices (ten regions and the CUS 10-city index). There are 11 expirations on each contract that range (today) from May 2014 out to Nov 2018. Since each contract settles on the Case Shiller index value released in the expiration month, it can be argued that the futures prices capture the views of forward Case Shiller index values.
A benefit of trading on an exchange is that one can publicly see both the best bid and the best offer, so you don’t have to find the most bullish or bearish person. The CME is your counterparty to any trade, and since positions are fungible, one can reverse a trade at a later date in the market.
Each contract has a notional value of $250* the index level/100 so, for example, an index level of 20000 would be contract priced at 200 and would be “worth” $50,000. Each one point move in the contract value is worth $250.
The graph to the right shows recent values of the CUS 10-city index contract (mid-market in green) vs. prior levels (Dec ’11- red dashes, Dec ’12 black dashes) and vs. the historical Case Shiller index (solid black).
Forward prices are upward sloping (albeit with seasonal dips)-consistent with ~6% HPA for 2014 slowing to 3-4% in subsequent years.
Because forward prices are higher than spot levels, a trader selling at the higher futures price doesn’t need the index level to fall to profit. Instead a trader selling CUSX16 at 209.0 (so ~16% above 180.08 spot level) profits (at expiration) if the final index value is less than 209.0 (but loses money if the index settles above their 209.0 trade price.)
While one has to post margin on either a buy or sale, the CME required margin is <5% of the notional value of a contract. (That said, your individual futures broker may require higher margin).
The futures prices trade and settle on index levels so a hedger needs to appreciate that the price performance of any one house may vary from an index. Given that basis risk, I would still submit that for those looking to back up statements about declines (or rises) in the general level of future home prices, or for those with views that are different that suggested by CME futures prices, there is no better pure play on home prices available to retail traders than the CME Case Shiller home price futures.
While there has been some legitimate push-back on the volume of CME contracts traded, I would be willing to buy or sell 5 contracts (so ~$250,000 notional) to the first traders looking to hedge. Ideally this conversation might start greater two-way flow and larger-sized hedges will occur.
Please feel free to review my website www.homepricefutures.com to review blogs on trading and for links to key sites (including CME margin). I’d be happy to walk any reader through the trading process, and in particular, to talk to any futures brokers who need to get up to speed on the product. Feel free to contact me at firstname.lastname@example.org with any questions.