More options are coming! (or at least being electronically listed)

The CME announced on Thursday (Jan 12) that it was expanding electronic trading of Case Shiller options to all 11 regional contracts (the one CUS-10 city index, and each of its 10 regional components).   Electronic trading in the complete list of options can begin on Feb 5.  See this link for the announcement and details.

I had requested such a change in the fall as I’d received inquiries over the past year on option trading for MIA, SFR and DEN and, until now, only the CUS, CHI, LAX and NYM contracts could be electronically traded. (Recall that one could trade the other seven regions “ex-pit” for a minimum of 20 lots and clear the contracts on the CME.  This may still be useful over the next few weeks but after Feb 5 one won’t need a broker (or two) to agree to post the trades, and the minimum size requirement will disappear).  The CME has graciously expanded the list to cover the full set of contracts despite the limited trading in the underlying futures.  My hearty thanks to all at the CME who made this happen!

Opening up electronic trading in the other seven regional contracts will hopefully foster debate on some of the trickier contracts to trade (e.g. DEN, which has been so bullish, and SFR/SDG which have dropped).  Maybe options trading will prompt some trading (via hedges) in BOS and WDC futures. Discussion of implied volatility across the contracts, and versus other financial instruments of interest (e.g. S&P 500 index, US 10-year notes, and maybe even Apple stock for SFR investors ?!?) are encouraged.  Debates as to correlations across the indices can now move from the futures contracts to all options.

A potential challenge to this move is the exponentially larger number of possible contracts to quote.  Any expiration, on any region, for any (“round”) strike, in both puts and calls is possible.  Opening up electronic trading of options has to potential to fragment possible inquiries, bedevil a market maker trying to link a trading algorithm across 100’s of non-linear trading relationships, and all while requiring much larger capital.  As such, my focus, at least to start will be in the following four areas:

  • Responding to specific inquiries.  I don’t know what traders might want to trade, so I’ll go with the flow and post inquiries where at least one other party has an interest.
  • Slightly out-of-the money, shorter-dated puts.  Many of the inquiries that I’ve received, and all three of the trades I’ve done have been prompted by real estate investors looking to hedge against sharp downturns over the next 6-18 months (which matches their construction, or re-selling, holding periods).  Put buyers have tended to prefer paying lower fees (so shorter term and out-of-the-money) as a form of disaster insurance.  I’d expect to see more of that put buying interest.  A benefit to CME volume is that the deltas on such trades are low, so the risk of writing larger trades should be smaller (to a writer) than buying futures outright.  (BTW- Maybe due to this feature options volume and open interest rivaled that of futures in 2006-07 when these contracts first started trading.  In addition, futures and options volume would seem to feed on each other, as one platform can be used to hedge exposure in the other.)
  • Longer-dated calls with strikes near spot value.  There have been some OTC loan programs where investors offer to home owners an upfront premium where the investor then participates in the price rise (if any) of the regional index on that home buyer’s house.  In one hypothetical example, a new home-buyer might still get an 80% LTV loan, but only put down 10%, as the investor fee (call premium) would cover the remaining 10%.   This is a version of the logic embedded in SAMs (Shared Appreciation Mortgages).  A more transparent longer-dated call market might help homeowners see the true cost of sharing the upside.  A call market across ten regions might illustrate variations in call premiums based on quoted forward, prices and implied volatility.  Trading in such longer-dated calls would be deep-in-the-money (at least versus the futures) and might foster trading in longer-dated futures.  While Case Shiller indices might have large geographic basis risk versus an individual house, the separation of a CME call from a loan might better allow a homeowner to unwind the option portion of a SAM without selling the house, or paying any penalty fees with a refinance of the SAM loan.
  • Front contract options.  OK this is a nit but it allows me to make a point. There have been front contracts that get down to a 0.2 bid/ask spread quote near expiration.  Recall that options can be traded to 0.1 minimum spread.  Additionally, call and put premiums near expiration are the only funds a buyer has to post.  A willingness to buy (via calls) or sell (via puts) expiring contracts, may require less margin/capital (albeit only to the buyer) than a futures contract.

As I’ve noted before, every option strategy you can think of (e.g. delta neutral trades, bull- and bear- spreads, calendar spreads) should be theoretically possible (although two-legged trades will require some coordination and trust).  In addition, one “guideline” from futures holds especially true when it comes to options -never enter a “market” order.  (I’d suggest only limit orders).  Finally, as when trading in futures, if you contact me first, I can try to facilitate the other side of an inquiry, whether with a higher number of contracts than quoted, or at a different price.

Now, of course to trade options, you’ll need a broker that allows a trader to post option quotes.   This may be trickier than some of your just starting this process might think.  Probably in response to the lack of volume (the “chicken and egg” problem that is at the root of most home price hedging activities) many futures brokers currently won’t allow their traders to post quotes in home price index futures, and fewer still allow trading in such options.  I know that Insignia Futures (that clears through Iron Beam) allows quotes on options (on the Case Shiller home price index futures).  Please feel free to contact me for details.  In either case, allow a few weeks (maybe from now to Feb 5?!?) to set up, and fund,  your account so that if/when there is a trading opportunity that you’d like to pursue, at least your account will be ready.  If anyone else has another broker willing to post allow the posting of option quotes, please let me know and I’ll tout their name here.  My hope is that with the CME demonstrating their willingness to support trading in home price derivatives, that other brokers will see this as an opportunity to serve this very large (underlying) market.

If anyone has ideas for a trade using the new contracts, please get in touch (johnhdolan@homepricefutures.com) , and I’ll either try to facilitate a small trade, or post your inquiry to focus interest.

Thanks,

John