35 LAX Nov ’14 puts trade

The CME housing markets saw the first sizeable options trade in years on Wednesday as 35 LAXX14/ 200 strike puts crossed at 1.5 points (w/ a followup market of 1.0-2.0).  (FYI – my sense is that LAXX14 was 225.6/228.6 at the time.)  It has been about two years since options were electronically listed for four regions (CUS, CHI, LAX and NYM).   While I’m told that options trading volume mirrored futures activity when the housing contracts were introduced 2006-07, the 2012 re-launch didn’t result in any trades.  This trade – for a relatively short expiration, and a fairly far-out-of-the money strike – may not be indicative of further option trades, but the features are worth reviewing, if only to prompt other potential trades, and/or to have potential future options buyers and sellers appreciate how sharing their axes might result in a trade.

To recap, options allow traders one-sided price protection for an upfront fee.   Buyers may prefer, and highly value,  options as their downside is limited to the upfront fee.  As such, the risk of a market melt-up (e.g. inflation raising nominal prices) is avoided.

The CME has (electronically) listed strikes for 5-point intervals on four regions for all expirations.  To avoid fragmenting interest, I’ve tried to steer inquiries to 20-point interval strikes on Nov cycle expirations.  (One exception is that I’ve posted options on front-month contracts in the past).  Even still the number of combinations of strikes, expirations and directions (both puts and calls are listed) is daunting.  For most of the last two years, I am not aware of regularly posted quotes.  I’m happy to help in negotiations or have axes touted here (and other social media) for anyone looking to get something started in a particular option strategy.  (This trade was negotiated in such a fashion).

(Note that while options are listed electronically for the four regions listed, orders for options for other regions are feasible, but the order would have to be pit-traded, making execution potentially more difficult.)

While outright options may help traders hedge, bid/ask spreads tend to be very wide (at least on a percentage basis) as tail risk (of a price collapse) and illiquidity are risks (to a put-writer) that the CME has to incorporate into margin.

One way to reduce spreads (and possibly risks) is to pair trades in strategies familiar to most option specialists. Options with delta-equivalent hedges, straddles, bull/bear and calendar spreads are but a few of the tools an options hedgers can use to limit market or tail risk.  While such two-legged spreads are available in the futures markets (e.g. intercity spreads), I am not aware of exchange-eligible orders for such option orders in the housing markets.  Again,  I’m happy to help or tout any such option strategy that someone may want to share.

Some last notes:

  1. While many option pricing models, and some discussion of option strategies, are often based on the notion of volatility, my sense is that housing indices are too highly auto-correlated to rely on standard Black-Scholes models.   Be careful.
  2. Options can be traded in 0.1 increments (note the 1.5 price) which comes in handy for l0w premium and very short expirations (e.g. May ’14 contracts).
  3. Put writers need to pay attention to margin requirements as profits from very low premium trades may lock up capital that could otherwise be used on other trades.  As such, two traders who share the same theoretical value of a trade, but with different access to margin, or different margining arrangements, may assign different values to the same trade.

As always, please feel free to contact me johnhdolan@homepricefutures.com to discuss this blog or any aspect of hedging home price indices.