Using DEN G18 puts to illustrate options

I recently did a trade in DEN.G18.P2000 (that is, puts on the Feb ’18 DEN contract with a strike of 200.  Here’s a graph that shows the P&L of the trade, were one to sell (write) those options at a price of 4.0.

I think that this is a useful exercise to review as while there may be many more natural hedgers (i.e. buyers of puts), this market would benefit from better two-way flow.  As such, I’m illustrating a way that a put writer might look at this trade with the hope of building some put-writing interest.

To recap, the DENG18 market this morning is 201.0-203.8, so the mid-market is 202.4 (as noted in the blue horizontal line).   The numbers along the primary horizontal axis are the index values at settlement.  The brown line shows that, if one wrote puts at 4.0, and if the settlement in Feb ’18 was higher than 200.0, there would be a profit of 4.0 points (ignoring as fees your broker might charge), but that profit would decline 1:1 for every point below 200.

The second horizontal axis (on top) lays out what each of the individual prices on the primary horizontal axis would translate into on a percentage changes versus the Case Shiller DEN index released in Aug 2016.  (I’m using the most recent Aug 2016 value, which may have been updated from the one originally released in Aug 20016).  Note also that I’m using YOY differences to reduce seasonality issues.

While the most recent YOY gain in the DEN index was ~7.6%, that gain, and HPA for all indices has been falling, and, futures market prices across many contracts are consistent with even further declines.

While a put buyer may have many reasons for buying a put (e.g. hedging real estate development, or a property that they are looking to flip, or to give their lender comfort that tail risks have been addressed, or a more bearish outlook) a put writer needs to form their own opinion of the risk-reward of this pay-off, and how such a new position might fit into their own outlook, all in the context of whether they expect to trade the position or hold until expiration.  (Note that this graph only shows price ranges of ~189 to ~208.  The risks increase should prices fall below 189, but the reward doesn’t increase above 208. Note also that this put is relatively short.)

I’m currently open to buying 5 lots at a price of 4.0 (or sell 5 lots at 5.0) should anyone want to sell.

Recall that while some CME option contracts can be electronically quoted and traded (e.g. all the CUS, CHI, LAX and NYM options), trades in some other regions first need to be agreed to off-exchange and then cleared on the CME.  That is, if someone wanted to trade a MIA option, the two sides would need to arrange the trade.  (That’s where I can help any party looking to take an exposure in another option, whether put or call).   However, since there any already been a trade in this particular region, strike and expiration, the DEN.G18.P2000 contract can be traded electronically. (There may be few futures brokers that will accommodate such a trade.  Please contact me if you need the name of one that will.)

Please feel free to contact me on this trade (johnhdolan@homepricefutures.com), or any other aspect of hedging home prices.

Thanks,  John

 

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