With the expiration of the CME Nov ’17 Case Shiller futures on the ten regional (and one 10-city index) today, we get to see: 1) an illustration of convergence, and 2) what “the market is predicting” for tomorrow’s Case Shiller numbers. Recall that CME contracts settle on the index values released on the last Tuesday of every month. Recall also, that while there are CME contracts expiring on a quarterly cycle (i.e. Feb, May, Aug and Nov) that the November expiration is the one that has the longest time outstanding. That is, the Nov ’17 contract was opened Nov ’12, and tomorrow, the CME will open a contract for Nov 2022.
The graph below illustrates the key point of all cash-settled contracts. That is, since the contract is settled on the index value at expiration, the contract price and the index must converge to the very near the same price. Note that while the Case Shiller 10-city index has been rising the last 2+ years, that the futures contract has been range-bound between 210 and 220. That is, while the press has been reporting on the “news” that home prices have continued to rise, expectations (at least as measured by the closing prices of the Nov ’17 HCI contract) have barely changed.
Second, I mentioned that prices converge to “very near the same price” as traders don’t know precisely what the Case Shiller index numbers will be tomorrow -despite the fact that the data for the indices (to be released in November) over the period July -August -September. I acknowledge that there are huge efforts to predict tomorrow’s numbers, but, in theory, those numbers should be incorporated into CME quotes.
The table below shows bids, offers and mid-market levels on the 11 contracts (as of 10 AM) that stop trading at 3 PM (EST) today, and settle tomorrow. (Note that end of trading on front contract is before close of trading (4 PM- EST) on other contracts). Contract bid/ask spreads average just under 1.0 point, with the HCI (10-city contract) the tightest, as is often the case.
As an example, should someone “know” that the SFR index value to be released tomorrow will be 243.0, they could sell a contract at the current bid of 244.0 and collect $250 (i.e. the value of one point per contract) when the 243 index is printed tomorrow. On the other hand if someone “knows” that the index will be 246.0, they could buy a contract at 245.0 and pocket $250 when they are proven correct.
Since neither has happened (yet) today, I would posit that the SFR index tomorrow will be somewhere between 244 and 245, so there is no arbitrage opportunity.
Feel free (and I will blog tomorrow) to compare the actual results against the 3 PM quotes on these contracts. While I embrace the theory that these contract values should provide boundaries on expectations, in each quarterly expiration we see 0-6 outliers/surprises (i.e. where the index value is outside the bid/ask quote on the previous day).
If anyone has any questions on this blog, or any other aspect of hedging home price indices, please feel free to contact me (firstname.lastname@example.org).