***** I updated this blog on Monday Nov 29 as I had said that the final trading day was Monday Nov. 30. It's today, Monday Nov 29. Thanks to an alert reader **********
This cycle's review of the quarterly expiring contract highlights a few issues unique to the Nov '21 contract.
First, the Nov '21 CME Case Shiller contracts stop trading at 3 PM (Eastern) on Monday (Nov. 29) ^1 and settle on the index values published the next morning.
The contract offers an interesting example of the challenges in using historical data for research/ analysis. This is because the Nov '21 contracts began trading in 2016, but were closed from Jan 2020 until Sept 2020. That's because the CME switched from a focus on a November expiration cycle, to a February cycle^2, and had closed any November expirations with zero open interest.^3
As such, a review of the historical closes of the Nov '21 contract will show unchanged prices for the ~ first nine months of 2020. ^4 Someone looking at a graph of the Nov '21 historical contract closes (in red below) might conclude that nothing happened during that timeframe. However we had a little thing called COVID during this window that created some of the biggest volatility I've seen in these contracts since the Financial Crises. By contrast, a look at the Feb '22 contract closes (in blue below) shows that contract closes dropped > 13% (from 237 to 205.8) before strongly rebounding. Same index, one expiration removed, two completely different interpretations of what happened and volatility.
Another observation I'd offer as Nov '21 expires includes that for much of late 2020, the two HCI (10-city index) contracts (Nov '21 and Feb '22) closed below then-current index values (in black). One can see that this is a rare phenomenon by looking to the left and right sides of the graph for the "normal" premium of contacts to index values. ( I use "normal" as when prices are rising, the forward contract prices, are higher than the backward-looking index values). Much of this discount was my personal trepidation at pushing up contract closes (e.g. with better bids) as I was long and worried about users looking to sell.
By later winter 2020/early spring 2021 (when vaccinations started) sentiment had improved and I was pushing contract prices higher to find levels that people would sell.^5
The premium of closes to index values expanded (to even include the premium of Feb '22 over Nov '21) until the end of summer 2021 when more noise of home price bubbles began to appear, and I started to receive more selling inquiries.
Finally, I'd highlight the strength in the underlying index over the last year. The ratcheting up of the index during 2021, regardless of seasonal factors, stands in contrast to the slow upward grind from late 2018 to mid-2020. The recent surge in home prices has been exceptionally strong and seemed to start just as the economy began to settle after the first wave of COIVD news. Recall also, that the graph shows the 10-city index which is dominated by the largest cities. Other large cities, and second and third-tier cities (e.g. Phoenix, Austin, Tampa) saw even larger gains, as people looked for more space, and better affordability, as they adapted to their post-COVID work lives.
******
Shifting to the contracts, the table below shows quotes on the 11 expiring regional contracts using closes from Friday Nov 26. Bid/ask spreads have tightened to average 2.60 points (<1% of the average index). In several cases (e.g. BOS, CHI, SDG, SFR, and WDC) the mid-market quotes are about equal to the spot index levels. These quotes are consistent with either increasing negative seasonal factors, and/or a dramatic slowdown in HPA.
Note that the implied YOY gains are still near record highs, and that Tuesday's press headlines will tout 20+% YOY gains in several of these cities. However, if Tuesday's index numbers are near mid-market levels, it will only further highlight the problems in relying on YOY gains to signal turns in the housing markets.
While some Nov '21 contracts are priced for no MOM gains, I'd note the inconsistency that the Feb '22 contracts are all priced at premiums to the Nov '21 contracts, so the market has not given up the ghost on further gains (despite the even more negative seasonal factors in the Nov-Feb cycle).
Feel free to contact me if you have any questions about this blog, have ideas for trades in the Nov '21 and Feb '22 expirations, or if you'd just like to learn more about how home price index derivatives migth be used in hedging strategies.
Thanks, John
^1 - Note that other expirations continue to trade until 4 PM.
^2 -I was a big advocate for the change as a February cycle of expirations would allign with year-end index values. (Recall February contracts settle on the index released that month, that covers activity through the month-end, two months prior, or in this case, December.)
^3 In Jan 2020 the CME also eliminated exchange-traded options and took steps to reduce the number of expirations per region from 11 to 9.
^4 -Recall that the CME protocol for closes in these contracts is the last trade, a higher bid, or a lower offer. However, without any activity the close never changed.
^5 - One of my legacy trading rules is that price discovery involves pushing prices (up or down) until you get a reaction. Until you run into someone willing to take an opposing view, you really don't know where contracts will clear.