I had previously written about possible ways for market participants to play the impact of the prospects to changes in the Mortgage Interest Deduction (MID) in a blog on Oct 21 . Since this remains a timely topic, I again want to offer two opportunities for fans of the NAR’s (National Assoc. of Realtors) views, on how they might play the pending collapse in home prices in the higher- home price areas that have historically taken advantage of MID.
The first would be to enter either an OTC spread trade, or a total rate-of-return swap (TROR) on the difference between the performance of the Case Shiller 10-city index and the Case Shiller National index over some time frame. The CS-10 index contains many of the areas with higher-priced homes (e.g. NY, San Fran, Los Angeles) while the National index covers a much wider cross-section of the country that includes many lower-priced homes, where borrowers would presumably be less impacted by a cut in the ceiling in the amount of mortgage debt subject to the MID. The graphs to the right show the index values for the Case Shiller 10-city, 20-city and National indices (on top) as well as the year-over-year percentage changes in the indices.
Note that while the 10- and 20-city indices did much better in 2013, that the National index has recently been outperforming the 10-city index (i.e. 6.07% vs 5.33% for the last year, as of the October Case Shiller numbers released in Oct.) I would be open to an OTC trade on the differences between the index levels one-year forward (currently 216.5 on the 10-city index and 195.1 on the National index), or on the difference in percent gains (currently 74 bps) on the YOY gains in the National versus 10-city index.
While the above speaks to possible OTC trades, one can also take a more targeted view (by area) on existing CME products (i.e. Intercity Spreads). That is, one can “bet” on the performance of a particular regional index versus the Case Shiller 10-city index, if one truly believes that the areas with the highest priced homes will suffer relative price declines with the lowering of the cap on mortgage interest deduction.
The table above lists six regions that have both larger than average home values (using the Zillow ZHVI) as well as having regional CME Case Shiller futures contracts. (Note that while Zillow and Case Shiller geographic regions are not a perfect overlap, the ZHVI index does a good job of comparing the average prices to their national average. By any measure these six regions have higher-priced homes.)
In addition to a trader just outright selling the NYMX18 or SFRX18 contracts (X18= Nov 2018), they could also enter into an Intercity Spread trade where they simultaneously buy one contract and sell the other (in this case the CS 10-city index contract -HCI). This might be a more conservative play than just an outright sale as the end result will be a function of the difference between the two indices referenced in a trade. These IC contracts are listed where the bid side shows the price difference between where one might buy the HCI contract while selling the regional contract. So, for example, the -29.6 bid on HCI/SFR-X18, displays the bidder’s willingness to buy the HCIX18 contract at 224.8 while selling the SFRX18 contract at 254.4.
Note that the 224.4 price on the HCIX18 contract is 3.84% above the current spot level (of 216.49) while the SFRX18 price of 254.4 is 4.47% above the SFR spot index of 243.52. In effect, were one able to execute this IC trade on the bid side, one would be selling the SFRX index (for Nov 2018 settlement) with higher priced gains over the next 13 months, than the HCI index by 63 bps.
(The analysis in blue, shows the relative differences were a buyer to pay the offered side, in this case -28.0 points on the IC spread).
Note that if one were able to buy the IC spread on the bid side, they would be entering the trade at levels where in 5 of the 6 cases, the regional contract would be sold at a level with implied gains, higher than that of the regional contract. (The NYM contract is priced for lower price gains than the 10-city index).
Even if one bought the IC spread on the offered side, they would still be selling the BOS and DEN regional contract with higher priced gains than the HCI contract.
I am open to facilitating inquiries (or trades) on small amounts of such IC spreads to prompt further reaction to the MID debate. Please feel free to contact me (johnhdolan @homepricefutures.com) if you have any questions on this blog or any aspect of hedging home price indices.