Basics -Convergence: Feb 2016

One of key features of using CME Case Shiller housing futures to infer home price expectations, is that in the long run the settlement price of the contract, that is, at expiration, is the index value released that month.  For example, the current front Feb 2016 contract will stop trading on Mon. Feb 22, and the settlement value for open trades will be the index value announced on Tues. Feb. 23.  (Note that while economic indices to include the Case Shiller index can later be revised, it’s the value announced in the expiration month that is used to calculate settlement value).  Thus, if a trader has a strong opinion as to what values will be announced on Tuesday (for any of the 11 contracts: ten regional and one 10-city index) she/he might bid below or offer above that level.  In theory, since there may be multiple people bidding and offering, and since being “wrong” (air quotes) costs $250/point/contract, a consensus view will emerge.  As such, contract prices on Monday should reflect trader’s views of the index values to be released on Tuesday.

This graph reflects the convergence of index and contract values.

Convergence Feb 2016

Note that there can be periods (e.g. Sept -Nov 2014) when the contract price is falling while the index value is rising.  This is due to two key features: 1) the contract price “in the long run” reflects views on what the index value will be at some point in the future, and doesn’t measure what’s happened in the past (as an index would), and 2) the contract is for a value at a certain point in time, while the index value exhibits seasonality.  (Note 1: the NSA – non seasonally adjusted CS index values are referenced by these contracts.  Note 2:  forward prices can wander away from expectations for a  variety of reasons, but “in the long run” the contract settles on the index value.  For the CUSG16 contract the long run ends on Tuesday.)

CME Case Shiller futures settle four times per year (i.e. Feb, May, Aug, and Nov).  Given this convergence of contract prices to index levels, during those four expirations we can observe what “the market” thinks (in theory, so more air quotes) index values will be on Tuesday.   (There are market quotes for bids and offers, so I use the mid-market value to infer neutral “expectations”.  I compare mid-market levels versus index values released in Jan 2016 to show month-on-month (MOM) percent gains, and versus the index values released in Feb 2015 to show year-on-year (YOY) percent gains.  The two biggest numbers, in the last two rows, are highlighted in green.  The lowest two are highlighted in red.  Note that all percent changes can be impacted by revisions to earlier index values.)

Feb 2016 expiring

If mid-market values are correct (and I’d note that there have been many times where an index value has printed below the bid, or above the offer) then here might be some headlines for Tuesday:

  • CUS 10-index prices showed YOY gains of 5.2%
  • DEN and SFR showed the greatest gains of ~10%, while CHI and WDC were the laggards at ~2%
  • Non-seasonally adjusted prices fell for many regions reflecting the combination of seasonal factors (most notably CHI) and the overall slower pace of gains
  • SFR joined BOS and DEN as 3 of the 10 regional components in the CUS 10-city index where index values are above pre-crises levels.

What I’d like to have reported is not just the historical index levels, and whether there were any surprises (e.g. index values below bids, or above offer level where someone knowing the index values in advance would have been able to profitably trade on one or the other) but whether the index values released changed forward sentiment.

To measure that, I’ll report on Tuesday the change between Monday’s prices for the X16 X17 contracts (November 2016, 2017 expirations) the prices mid-day on Tuesday.  In my opinion, any surprises in the index values released on Tuesday morning (absent more 30-point swings in the S&P 500 index) is best likely to show up in prices on those contracts.

So, use the table above to check expectations and to see if there are regional surprises.  Also stay tuned (or just observe market prices) for any significant changes between CME Case Shiller market levels on forward contracts between Monday and Tuesday afternoon.

As always, if you’d like to discuss this blog, how contracts expire, the theory behind convergence or any other aspect of hedging home prices, please feel free to contact me (johnhdolan@homepricefutures.com)