How to trade on possible impact of Trump election on home prices

Much has been written elsewhere on the possible impact of a Trump Presidency on home prices.  There are macro issues (e.g. mortgage rates and the fate of the GSEs) as well as possible relative value regional issues (e.g. who will benefit from increased spending on infrastructure vs. who will be taxed to pay for it).  I leave all of those very timely, important discussions for others to host.

The angle I’d like to address here, is “how does one express a view (financially) if they feel a certain way on either category of issues?”

This is where CME Case Shiller home price futures may play a role in two different dimensions.

First, outright market levels, across the CUS 10-city index and each of the ten regional components, allows one to express an opinion on the absolute level of any particular index.  I’ve picked the Nov ’18 (X18) expiration series as: a) two years should be enough time for any changes to play out, b) it’s the longest contract (by expiration) that has regularly had two-sided markets, c) comparing Nov ’18 to today avoids much of any seasonality (but not all) and d) more germane to the second point I’ll make, there are intercity quotes for all regional pairs with the CUS 10-city index.

The chart below takes the CME quotes and converts bids, asks, and mid-market levels into percentages versus the spot index. The “cold” areas (e.g. the Northeast, Chicago and Denver) are to the left, the HCI (CUS 10-city index) is in the center, and the rest are to the right.

nov-18-outright

Note that all 11 contracts are priced at levels that are about 3-9% above spot levels.  Implied HPA has slowed but has not turned negative.  DEN and LAV are priced for the highest gains, while NYM, WDC and CHI look weaker.

One can trade any of these contracts on an outright basis, particularly if they have a view on home index changes over the two years that are different than this chart reflects.

However, and this is my second point, there may be traders who are not comfortable with an outright view but they have certain strong ideas about future levels of one region versus another.  For example, some might argue that President Trump might be positive for LAV (home to construction workers), DEN (extraction industries) and MIA (where he’ll likely spend time) and less so to WDC (smaller government) and California.

The middle bar in the candle bars below express (a version of) the differences in the above chart – shown as CUS gains minus regional gains – hence DEN is shown as negative as CUS gains are lower DEN.

The top and bottom value to the candles are the implied gains from quotes on intercity spread contracts.  That is, one can enter into a trade where one can simultaneously buy (or sell) the HCIX18 (10-city index) contract while selling (or buying) a regional contract, at an agreed upon spread.

nov-ic-markets

While those spreads are quoted in terms of points, one can convert those point differences into implied percentage differences. (See my Sept 28th blog for a more detailed explanation of IC spreads.)

With IC spreads one can express a view about relative price moves with much less outright risk.  Note though, that as with outright trades where it’s not enough to think that home prices will be higher two years from now, as that’s already priced into the X18 quotes.  The same theme applies here.  That is, it’s not enough to think that MIA, LAV and DEN will outperform (or NYM, WDC, or CHI will under-perform) as that is already priced into IC spreads.

What a trader/hedger must determine -both on outright and IC trades – is whether the level implied by current quotes is above/below their expectations.

A note, I’ve only posted quotes on CUS vs. regional pairs but any regional vs. regional pair can also be traded electronically.  Let me know if you have any interest in such.

Furthermore, in addition to outright and IC spreads, please know that one can also trade calendar spreads (e.g. Nov ’18 vs. Nov ’16, or Nov ’20) for any contract.

Finally, options (both puts and calls) can be quoted on CUS, NYM, CHI and LAX.  I’ve had a number of inquires from traders looking for options on the other regions.  The CME seems to be working to make this happen.

Net, there’s a variety of tools for traders to express views on how a Trump Presidency (or any other factor) might impact home prices both to outright levels, and on relative value.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this piece or any trading axes.