Recap of Jan activity in CME Case Shiller Futures has been posted

I posted my recap of activity in the CME Case Shiller home price index futures for Jan.  You can find the recap in the Reports section, or link here.

The comments from the summary page include:

–Activity picked up with 25 trades in January.

–There were trades in 5 regions and 7 expirations across 5 dates.  Beyond the HCI contract, trading was concentrated in CHI (8) and SFR (7) contracts and in the G17 (6), K17 (7) and X18 (6) contracts.

–There was both buying and selling in SFR (beyond my role) while CHI saw interest from buyers.  G17/K17 curves have flattened as a result.

–Open interest rose to 53 from 41.

–Bids and offers were flat during the month, but then rose after CS#’s.

–Forward curves stopped flattening.

–Bid/ask spreads ended up unchanged, after tightening all month, and then widening after CS #’s.

–InterCity  and calendar spread orders were both executed.

–See new section on individual graphs for each region. (End of report).

–The CME announced that they would open electronic trading for all 10 regions starting Mon Feb 5th. (See options page for details.)

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions, or trading ideas.

Reaction of Prices at CME post Jan release of Case Shiller #’s

Quotes on CME Case Shiller home price index futures are higher across the board after this morning’s release of the November Case Shiller #’s.

Using the Nov ’17 contract (X17) as a proxy, mid market prices are up from 0.4 (in LAV and MIA) to 1.2 (BOS) and 1.7 (NYM).  The price changes seem to be consistent with the gain in seasonally adjusted values for the indices (as both BOS and NYM seasonally adjusted index values were up over 1 percent from the prior month).  Gains are slightly higher in shorter expiration contracts (e.g. BOS Feb ’17 (G17) is bid 2.6 points higher.)

Bid/ask spreads are slightly wider with most spread widening occurring in Nov ’17 expirations and longer.  Bid/ask spreads on the front contract (G17) average 1.9 points, which is relatively wide with one month to go.

There were 15 trades yesterday (primarily in CHI and SFR contracts, and with a large share in the K17 expiration), but as of 11:30 EST (Tuesday) there have been no trades today.  With 23 trades month to date, Jan ’17 looks to be the second highest volume since May 2014.

Recall that electronic trading for options for all regions starts on Mon. Feb 5.  I, unfortunately will be traveling, so I hope to get involved the next day.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions about this blog or any aspect of hedging home prices.

CME Case Shiller Futures Product Introduction updated

In anticipation of the roll-out of electronic option quotes on all 11 regional CME Case Shiller home price index contracts in early February, I updated my “Introduction to CME Case Shiller Futures” piece.  You can find it in the Reports section or link here.

Readers who have followed my monthly recap will recognize many of the pages.  I’ve combined pages from recent recaps with some of the (timeless) pages from the earlier report into primarily statistical reports, graphs and tables,  that highlight the CME contracts at this point in time.  I’ll leave discussion as to why there’s been so little volume, or how to break the chicken-and-egg cycle to future blogs.

My intention is to have the “Introduction” piece evolve over time, either as readers find errors, or as I find new ways to illustrate activity.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on either this report, or any aspect of ideas on how to hedge home prices.

Thanks,

John

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

 

 

Review of CME Case Shiller activity for Dec 2016

I’ve attached this month’s recap of activity in the CME Case Shiller home price index futures to the Reports section.  (Access here).   This 26-page summary has graphs, tables and observations on many aspects of trading in the CS futures.

The key observations include:

–Activity slowed with only 7 trades in December.  Still 2016 volume was 57% higher than during 2015.

–There were trades in 4 regions and 4 expirations.

–Open interest rose to 41 and the Avg. time-to-expiration slipped.

–Bids were higher across all regions (except the CUS-10 where declines in longer-expiration contracts fell resulting in net lower bids).

–Forward curves continued to flatten noticeably (particularly in Calif).

–I continue to receive inquiries from parties looking to hedge California exposure, as well as Seattle, Portland and Vancouver.

–Bid/ask spreads tightened slightly, across most expirations, primarily reversing last month’s spread widening.

–Option trading was quiet, with no inquiries.  (I understand that the CME may be making progress on opening up electronic trades of options to more than  4 current regions).  There are traders who would like to buy protection on regions that are currently not listed.

–IC (intercity) spread quotes exist for all X18 regional pairs vs. the CUS-10 index contract.  Possibly as a result, bid/ask spreads on X18 contracts are almost as tight as they are on X17!  (That’s the first time I can recall a longer-dated Nov cycle expiration having as tight a bid/ask as an earlier Nov. expiration.

My sense is that interest picks up in the contracts, and that volume tends to increase, when markets turn, or there are events that give readers an additional incentive to act.  Recent trading is consistent with the notions that either a) there is a new mindset about the value of longer-dated expirations in the California contracts, or b) there are sellers looking to hedge at clearing prices that may be depressed as volume is so low.

Feel free to contribute to this discussion, or ask me any questions at johnhdolan@homepricefutures.com.

Happy New Year, and thanks, John

 

CME reaction to Dec CS #’s

CME Case Shiller home price index futures contracts did not have much of a reaction to today’s release of the October CS #’s.  As shown in the table below, CHI and DEN Nov ’17 contracts are quoted slightly lower (using mid-market levels), while the SDG and SFR contracts (where most of the trading action took place in Oct-Nov) are quoted slightly higher.

Bid/ask spreads are a tad wider (mostly in the longer-dated contracts, and in the SDG/SFR regions).

Quotes for the front contract (Feb ’17 expiration) have not tightened much (as typically happens when the time to expiration falls from 3 months to 2, or 2 to 1).

There have been no trades yet today.

I could use some help in tightening spreads, filling out missing prices, for the year-end summary report.  Any help would be appreciated.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions or trading ideas.

 

 

Contrasting Pulsenomics Expectations vs. CME Forward Markets

I’d like to take the data and work done by two of my favorite sources (Pulsenomics and Getting Real) to further illustrate two points that I’ve been making here over the past few months.

First, as part of their quarterly survey of home price expectations across 100 pulse-surveyparticipants (full disclosure, I’m one), Pulsenomics asked for opinions on how the home prices of 25 regions might perform in 2017.  Their results are shown to the right.   Please read their report for details on how they quantified relative price moves.  For purposes of this illustration, higher (and positive is better and optimistic, while lower and/or negative is not).

Be aware that details of the regions identified (e.g. “Boston”), might be different than your understanding of that region, and important for later, the BOS Case Shiller index.

I then compared this tally versus the year-on- year gains for the these “regions” versus Case Shiller indices of the some name.

Observe (in the graph below) that the regions that have been identified in the Pulsenomics survey that are likely to do well in 2017, are typically the regions that did well in the last year (and vice versa).  (FYI – 18 of the 25 regions used in the Pulsenomics survey have public Case Shiller indices.  There are others, e.g. San Jose, but you have to subscribe to get them).

pulse-survey-vs-fwd-prices

Real estate prices tend to have momentum, and so therefore this observation doesn’t surprise me, the current market for CME futures does not necessarily reflect the same high correlation.

First, note in the scatter diagram below that the forward prices for all 10 CME regional contracts  (noted on the Y axis) falls below the red 45 degree line (with the slight exception of NYM).  (FYI – To calculate the forward CME “prices” (in this graph) I took the mid-market values for the Nov 2018 contract and divided by the spot index (released in Nov).  That percent gain is then converted back into annual gains).  That is, forward HPA (as implied by CME prices) is much lower than gains over the last 12 months (measured with the X axis).

last-year-vs-next-two

Second, there seems to be a reversion to the mean (in forward HPA) as forward gains for all contracts are converging to  a narrow range (between +1.75-3.50%).

Third, away from any such reversion the slight outliers appear to be BOS (GE move?) and LAV (NFL/ beneficiary of construction?) while the below trend regions include CHI (pensions problems?) and the three California indices.

As I’ve noted (and conceded) in prior blogs, the California contracts seem out of line.  While it could be that there are fundamental issues at work in California that I’ve not focused on.  My contribution to this discussion is, that there may also be a seller who is larger than my potential interest in going long.  In thinly traded markets, a small change in the balance between buyer and seller weight can have a disproportionate impact.

As I look to explain the California under-performance in the last few months, I can find lots of smaller hedgers that also want to sell.  If there’s nothing “wrong” with the California real estate market, what do we need to do to entice prospective longs into dipping their toe in the longer-dated California contracts?

I’m happy to post any comments, share thoughts, or facilitate any trading ideas.  Feel free to contact me (johnhdolan@homepricefutures.com) to discuss this blog or any other aspect of hedging home prices.

Where are the LAV bettors? A link to a good resource

Given the local economy, it somewhat surprises me that no one in LAV has chosen to use the CME platform to place a “bet” on where the LAV index might be in the future.  (i.e. open interest = zero).

I crossed paths with John McCelland (an LAV blogger/ researcher/ real estate person)  who has put together a very comprehensive 17-page  report on the rental dynamics in the LAV market that he has allowed me to post.  The report cites the CME LAV futures in a graph on page 3 (so I’m already a fan) but then also has tons of detail on multiple home price metrics.  I’d encourage anyone looking to trade the LAV contracts to review this report and to follow John’s blog.

I promised John that if he let me post his report that I’d tighten up the LAV quotes.  I’ve not focused on LAV (as I noted, there’s been little interest) so any help would be appreciated.  LAV appears to already be priced with gains above the CUS10 market.  How much better might LAV perform than other regions?

If you’d like to start a discussion of relative value in the LAV markets, or discuss any aspect of hedging home prices, please feel free to contact me (johnhdolan@homepricefutures.com).

Thanks,  John

Home Prices in the Pacific Northwest – a review of OTC trading

I noticed at least three articles in the last few days on the value of home prices in the Northeast.  Fitch issued their Q2 Sustainable Home Price report and referred to prices in Seattle and Portland as “overvalued”.    Vancouver’s Globe and Mail noted that recent taxes imposed on new foreign home buyers in Vancouver were causing investors to shift their focus to Seattle and Toronto.  Finally, Core Logic threw a monkey wrench into valuation issues with their new blog post highlighting the risk of earthquake in the Pacific Northwest.  ( I encourage readers to review all three).

What is someone exposed to such forces supposed to van-graphsdo to either figure out where home prices are headed, or how might they hedge?  What can someone do if they want to hedge exposure to either Seattle or Vancouver (or take on additional exposure synthetically) without selling the house, uprooting the family, and moving into a rental unit?

Unfortunately, there are no exchange-traded contracts for the Seattle home prices, nor are there Canadian contracts which might provide color on price expectations.  One could observe a strong correlation between Seattle and other markets (most notably Boston, since 2010) but correlations often work well right up until they don’t, and I imagine that the twin wildcards of Chinese buying and earthquake risk are not as big a part of BOS valuation.

One can trade regional bank stocks and building companies, but those don’t represent a pure play on home prices.

However, it should be possible to put together an OTC (over-the-counter) trade between interested parties (in either US$ or CAD$). I’d like to discuss the challenges in doing so here, somewhat based on my experience in putting together a similar OTC trade.

There are many differences between an OTC trade and an exchange-traded futures contract.  In an OTC trade, pricing of forward contracts may not exist (or be transparent), contracts need documentation (that may vary from trade to trade), the exposures may not be fungible and therefore may not be assignable, and most importantly, counterparty risk (i.e. the ability and willingness of your trading partner to perform) becomes a big problem.  (BTW – These are all advantages to exchange-traded, and/or exchange-cleared, products).

However, under the right circumstances, many of these issues might be addressed.  What seems to work best is a put/option trade (so one side -the put buyer -knows their maximum out-of-pocket), with coverage for a short term (which both reduces the premium and the risk to the put writer), for an uncomfortable (but not disastrous) market move.  On this last point, in my experience, short-term put writers don’t want to back into taking exposure to 9.0+ earthquake risk (particularly all along the West Coast).   In addition, the capital charges that might be assumed for such tail risk are probably high, but an out-of-the money, short-expiration put, will not generate much premium.  In addition, the occurrence of such an outlier event  will probably undermine the put writer’s ability to perform.

As such an LAX put combination could be struck (and traded electronically) but having the put buyer buy a 230 strike, while simultaneously selling a 200 strike.  This puts 30 “points” (using Case Shiller index values) at risk for the maximum payout by the put writer. (Payouts for events such as LAX dropping below 200 are best left to the Government).

The key challenge (for a buy and hold put buyer who is comfortable on price levels) is how to ensure that the put writer performs should the index value fall below the strike. (BTW -recall that all CME options are European style so the option can only be exercised at maturity.  This is a feature that I embrace when talking about puts that can be structured as forward price can theoretically be hedged, but not a spot, non-seasonally adjusted index).  In addition, a single expiration option addresses much of any seasonality issues that are relevant to home price analysis.

I’ve talked with a number of escrow companies that are happy to hold and eventually distribute collateral (should the put writer be willing to post the amount in advance) but none have wanted the liability they associate with calculating the put pay-out.  (Ideas?)  I’ve also reviewed a number of bitcoin-style platforms, but most of the ones I’ve seen pay all or nothing to one party.  For example, one could propose a market where traders could bet on whether a Seattle index (and I’m using the Case Shiller version in my graphs) was above or below some value for some specific date next year.  However, such a 0/1 payout doesn’t seem to hedge risk.

One arrangement from the blockchain mindset (that might supplement some initial collateral) is to publish the trade to a community of peers to put the put writer’s credibility at risk.  That is, if the writer promises to perform, and make payments, conditional on something happening, and he then doesn’t, then a) the put buyer has a distributed record of that failure to perform, and b) those peers will have a different impression of the put writer (and may be called to testify against the writer if litigation ensues).  This assumes that the put writer has the capacity to perform (so know your counterparty and don’t do personal trades for billions of dollars), but maybe not the willingness (AND that their reputation is important to them).

So, I think that we can get to a point where traders should be able to hedge with many issues of an OTC trade addressed.

If you’re still with me, here’s levels that I think might work for one-year puts on the Case Shiller Seattle and Canadian Teranet Vancourver indices.  Note that I show these prices to illustrate how I think a set of contracts could be written.  Net, I think that it is possible to construct a derivative for home price protection for those in Seattle and Vancouver.  If anyone is interested in fleshing this out further please get in touch.

van-puts

As always, if you’d like to discuss the themes in this blog, or any other aspect of hedging home prices, feel free to contact me (johnhdolan@homepricefutures.com)

John

 

 

 

 

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.