My sense is that the best conditions for a home price index hedging market exist when you have:
- Pronounced different views on the future
- Recent history to color participants interest (or need?) in hedging
- A mindset that trading (or hedging, betting) is an acceptable activity.
No regional market satisfies these three conditions better than Las Vegas (and therefore the LAV contracts traded on the CME).
First, opinions as to where LAV home prices are headed range, on the one hand, from the National Association of Realtors designating Las Vegas as one of its Top 10 Housing Markets for 2019 (with projected price gains of 7.9%), and Zillow also forecasting 7.74%), while on the other, the Greater Las Vegas Association of Realtors notes that inventory for sale has nearly doubled from the lows, and Fitch has designated Las Vegas as the most overvalued Top 20 city (at 20-24% overvalued).
Las Vegas home prices have the tailwinds of population growth and the headwinds of accessing sustainable water supply, adding to the debate over future home price forecasts.
Second, while current LAV index value (189.97) has more than doubled since the low in 2012 (of 89.88), the index is still only ~80% of the 2006 peak value (234.78). The LAV index suffered the greatest percentage decline of the Case Shiller 10-city components (~-62%), and the second largest increase from the bottom of 211% (trailing only SFR at +225%). Such volatility validates the benefits of hedging.
Third, other than possibly the Wall Street derivative community, where else in America is there a more open mindset to hedging one’s bets? LAV residents seem to have the biggest need for hedging (given both the uncertainty and history).
However, volume and open interest (OI) in the CME LAV contracts remains low. I tallied six LAV contracts trading in 2018, and current OI is three.
Recent LAV contract prices are consistent with MUCH lower home price growth for 2019, but well above levels (measured as percent of current price to spot) of the three California CME contracts (LAX, SDG and SFR). For example, LAV hedgers should note that the LAVG20 (Feb 2020 expiration contract) settles on the value of the LAV index through Dec. 2019, and is offered at 1.2% above spot levels. As I’ve noted before I don’t know whether this is due to market imbalance (w/ bias that contracts have typically traded lower than expectations), change in fundamental outlook, an opportunity, and/or reflects lack of depth in this market.
On the depth of market issue, recall that each contract has a notional value of $250* price, or just under $50,000.^1 Most quotes are 1×1, e.g. one lot bid vs. one lot offered. While posted quotes are actionable – and in bite-sized pieces that lend themselves to partial hedging^2 -my goal is not to be the market for LAV but to post initial suggestions on the market (or “line” in LAV parlance) while then bringing in as many participants on each side, to narrow the bid/ask spread and make more exposures available -on both sides. While there are some efforts that offer home price hedging products at the individual home level, I think that the CME represents the best public, trade-able, play on forward home price indices.)
In any case, I’m not suggesting that the G20 contract prices represent what I or other traders think the index will be a year from now (as traders have multiple reasons for trading) but it does reflect a level where some traders are willing to buy/sell LAV home price index risk.
In addition to futures, the CME also allows for option trading on the futures (both puts and calls). Since a change in futures prices might result in a margin call, options have a benefit of limiting the total outlay for a hedge. The table to the right has offering levels where I’d offer either puts or calls on LAV futures.
Net, the LAV market seems to have the biggest need for hedging of the larger US cities. Those who might like to have more/less exposure to regional-wide LAV home price risk, might consider the CME futures and options.
Feel free to contact me (firstname.lastname@example.org) if you have any questions on this blog, or any aspect of hedging home price index risk.
^1 Note that initial margin is often less than 10% (or $5,000 in this case). The CME sets minimum margins, but clearing brokers may charge more.
^2 See Feb 2nd blog for more details on bite-sized hedging. https://www.homepricefutures.com/reduce-the-stress-of-100-rent-vs-100-buy-decision-with-bite-sized-pieces/