Diagram to reflect changes in forward SFR markets

The graph below may be the best way of illustrating several  points that are key to understanding home price futures, as well as the current debate over home price expectations:

  1. All home price indices (including Case Shiller) measure events that have taken place a couple of months ago.  Since traders often incorporate changing expectations, futures prices may go down (or up) while index values are rising (or falling).   As the graph shows, the SFR (San Fran) index slowly increased in all but one month since Nov 2017, while the SFR X20 (Nov 2020 expiration) and X22 (Nov 2022) contracts rallied until about Sept 1, and then collapsed.  As such, there may be useful, more-timely information in such forward-looking markets, that is not captured in published indices.
  2. Futures prices are public, are updated in real-time, and are posted by traders willing to financially back their views.  As such, they differ from periodic forecasts.  Both may be useful (and more so, if markets are deep and liquid).  The press and analysts, should pay more attention to futures prices.
  3. Futures prices have to converge to index levels as the contracts settle on some future (albeit unknown) index value.  The graph of the SFRX18 contract and the CS SFR illustrate this convergence.  Recall that the data for the Nov ’18 settlement includes home price activity from July, August and September.  As such, (particularly on such shorter-expiration contracts) expectations of future index values should dominate pricing of futures contracts, as subsequent events (e.g. stock market falling 200 points in October, can’t impact past index calculations).
  4. At times, longer-expiration contracts may be more volatile than suggested by standard risk metrics.  (See August-Sept 2018 section in graph.)   This has implications for pricing longer-dated options.
  5. The difference between curves may be consistent with views on forward HPI.   The ~20 point difference between the X18 and X22 contracts in mid-year may have been consistent with ~3% HPA assumptions over the next four years.  By contrast, today’s X20/X22 prices have fallen due to changes in views that may be more consistent with <1% HPA.  A key debate in these markets is whether the forward premium collapse is due to more negative forward sentiment, or just the old “more sellers than buyers” adage.   (BTW -The curves may go inverted -i.e. with longer-dated contracts trading at a discount to either spot or front contracts – as was the case in 2008.  Such pricing would be consistent with negative HPA.)
  6. Hedging works.  Note that someone in May -July, looking to lock in market-implied HPA of ~3%, could have hedged spot SFR exposure with longer-dated SFR contracts, and made money on both sides as longs rose in value, while shorts fell, as HPA expectations collapsed.

Now I can’t make the above statements without adding some qualifiers and observations, that also speak to understanding trading these futures, and how one might interpret prices.

  1. These markets are thinly traded.  In the three contracts shown there may be have been weeks without a trade.  “Closes” can change without a trade as they are (at CME) a function of last trade, a lower offer, or a better bid.
  2. Traders may buy or sell (or post bids and offers) for a variety of reason beyond their expectations of future index values.  For example, traders may be looking to hedge real estate (or other) exposures, or sense that sentiment will grow more negative.  Given the lack of depth, the arrival of larger new contract buyers or sellers, may put upward/downward pressure on prices, unrelated to expectations.
  3. I tend to show 1×1 “actionable” quotes (one bid versus one ask) to form graphs, narrow bid/ask debate.  I may be aware of more interest, at, or inside bid and offer, but may not show (or keep live all day/week).  As such: 1) please refrain from market orders that are bigger than amount shown, and 2) feel free to contact me if you’d like to share ideas.
  4. The CME Case Shiller futures contracts seem to react most notably to infrequent events -e.g. monthly updates to index values, announcements on home sales, S&P 500 index changes of 50+ points.  More trading tends to take place on such days, but otherwise prices tend to be quiet and trend/drift in-between with limited trades.
  5. Most trading seems to take place in the first 30 minutes and last hour of the trading day (the former often coinciding with economic updates).   A trader looking to get something done should appreciate (IMHO) that there will be more eyeballs on the contracts at those hours.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on this blog, or would care to discuss any aspect of hedging home prices.

Thanks,  John

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