California falling, or an opportunity?

Since home prices turned up in 2012 the California markets (i.e. LAX, SDG and SFR indices) have consistently outperformed the CUS-10 index.

The graph (to the right) cali-hpa-graphshows year-on-year percent changes in the CUS-index (in black) along with those for LAX, SDG and SFR.  It has been a near truism for the last 4+ years that the rebound in California home prices has outperformed the CUS-10 index.

However, recently, pressure on longer-dated California CME futures prices has resulted in levels that are consistent with the California markets under-performing the CUS-10 index.

The chart below shows contract values for CUS-10 and the 3 California regions for the Nov ’17, ’18, ’19 and ’20 expirations translated into percent changes versus spot levels.  (The height of each bar is the bid/ask levels and the mid-market value is shown with a green bar).

Note that the CUS bars are all higher than the California markets (barely so for LAX, but with obvious premiums over SDG and SFR).  Net, the CUS-10 index is priced at levels that would reflect California index values under-performing over the next four years.

dec-6-calif-mkts

Now, as I noted in my monthly recap, this could be due to a variety of fundamental factors but I have two thoughts:  1) Given the lack of trading the contract prices have been weighed down by someone looking to sell, and 2) There is an opportunity to either buy the California markets at relatively (to the CUS 10 contract) cheap levels.  In fact, if one doesn’t want to take outright risk the IC spread market (where one enters an order to simultaneously buy one contract (e.g. SDGX20) while selling another (e.g. HCIX20) at a predetermined spread, might be an attractive alternative.

Markets vary from fundamental values for a variety of reasons and order imbalance is often one (particularly in such a thinly traded market.)

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this theme, or any aspect of home price derivatives.

 

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