Now that most commentators have accepted that home prices are falling, is it too early to ask the question -how will the decline in home prices play out over the next few years? I ask this as the calendar spreads for Feb '23/'24 and Feb '24/'25 paint a picture of a continued strong selloff in 2023, with prices rebounding in 2024.^1 This might be one possible scenario, but perhaps users see another, or milder or more severe versions of HPA for 2023 and 2024 for the 10-city index.^2
The table below shows quotes and implied annualized percent changes for the permutations of Feb '23, Feb '24 and Feb '25 10-city index calendar spread contracts. The Feb '23/'24 are quoted positive (i.e. Feb '23 quoted at a premium to Feb '24). That is consistent with Feb '23 index values being higher than Feb '24. The bid of +17.0 (i.e. where someone would simultaneously buying Feb 2023 while selling Feb 2024) is consistent with an index value in Feb 2023 being 5.8% higher than in Feb 2024, (( 292.5-275.5)/292.5). On the other hand the offer of +21, is where someone would sell Feb 2023 over Feb 2024, and is consistent with Feb 2023 being about a 7.2% premium (hence prices falling in 2023 and the negative sign on the percentage values).
A selloff of 5-7% in 2023 would be in addition to any selloff that is tallied before year-end 2022 (reflected in spot or peak index vs Feb 2023 contract prices)^3 and so might total 15-17%. People looking for more or less of a selloff in 2023 (or none at all!?!) might consider a directionally appropriate position in the G23/G24 calendar spread. (I'd note that since the G23 and G24 contracts are my key benchmark contracts (i.e. feeding intercity spreads), I'd open to quoting either tighter spreads and/or larger than 1x1 markets. Note that the G23/G24 calendar spread is not dependent on whether home price sell off during 2022 at a faster rate (or not at all).
By contrast, the Feb 2024/Feb 2025 calendar spread is quoted at a discount. That is, the bidder wants to buy Feb 2024 10 points below where she'd simultaneously sell the Feb 2025 contract. A higher Feb 2025 price is consistent with rising prices and positive HPA. (Note that the -10.0/ -3.0 quotes translate into HPA of 3.7 vs 1.1 %). BTW -This is the shape of longer-term calendar spreads (e.g. Feb 2024-'26, '27) which are not shown.
Note that the longer-term Feb 2023/Feb 2025 calendar spread is quoted with positive numbers (i.e. Feb 2023 priced higher than Feb 2025) consistent with either a slower, but longer-term selloff, a rapid selloff in 2023 followed by a smaller rebound in 2024, or just hedging (selling) interest in Feb 2025.
Net the calendar spreads provide a template for debating the timing and magnitude of forward price declines reflected in contract prices, and at the moment they portray periods of both rising and falling home prices during different years going forward.
Feel free to contact me if you have any questions about this blog, have any trading ideas you'd like to explore, or just want to learn more about how people use housing derivatives in home price hedging decisions.
Thanks,
John
^1 Recall that the Case Shiller indices issued in February reflect activity from the prior October through December. That is, the Feb 2023 release will be for year-end numbers for 2022, and the Feb 2024 release will reflect activity through Dec 2023.
^2 Calendar spreads can also be traded on each of the ten regional index contracts (and I have already posted quotes on several). However, I'd like to start the conversation referencing a more national index, to try and develop better liquidity in the one contract, before trying to post tighter levels on all ten contracts. I'll respond to inquiries, but I'd like to center the debate around the 10-city index first.
^3 The Case Shiller 10-city index peak was 330.31, and the Feb 2023 contract is offered at 295 (-35.31 points) consistent with a ~10.7% selloff through the Feb 2023 contract.