I’ve compiled an interesting set of data that I’ll use to illustrate how the CME S&P Case Shiller home price index futures have traded over the last 7+ years. It may help traders understand how to better trade the contracts, as well as quirks within the contracts. I will be blogging about over the next few weeks, to include an analysis the robustness of contract prices in forecasting, contract biases, and volatility. I’m open to ideas on what readers might want to see, and would be open to slicing and dicing the information to address any longer-term questions.
I’ll start with a presentation on bid/ask spreads for a one-year horizon. (Views using other time periods to follow).
The graph below shows the bid/ask spread on the one-year forward contract at the point nearest the quarterly expiration cycles that I could find. For example, the information for Nov. 2012 shows the difference between the bid and offer on the Nov 2013 contract. (The bids and offers come from information I’ve tallied over 7 years as market maker). Spreads have been compiled for all 11 regional contracts (the 10-city index as well as each of the ten regional components). There are 29 quarterly observations for all 11 contracts (except in May 2015 on where 7 quotes can’t be found. Note gap in graph for some regions.).
I’d draw a few observations from the graph:
- Bid/ask point spreads have generally compressed since 2013 ( with the narrowest bid/ask spreads, for all 11 regions, having occurred in Nov 2017 (for the Nov 2018/X18 contract)). I attribute this first to getting past the large rally that started in May 2012. The strength of that rally created uncertainty about how much indices might rise, after falling and wandering around lows for 3-4 years after Financial Crises. Tighter bid/ask spreads since then seem to have been: 1) a function of greater participation by third parties, 2) greater confidence in my willingness to post tighter spreads, and/or 3) lower expected volatility. All three factors, and the resulting tighter spreads, are conducive to increased trading.
- Note that bid/ask spreads are shown in points. Since some indices (and contract prices) are now double what they were in 2013 (e.g. the SFRK13 (May 2013) contract had a mid-market value of 132.3 in May 2012, vs. a spot index level today of 267.24) so bid/ask spreads on a percentage basis have narrowed even more. (See Graph in Reports section showing bid/ask spreads in both points and percent, or access here). BTW -The widest % spread across all 11 regions. in Nov. 2017 was 1.39%.
- Bid/ask spreads have for the HCI 10-city index (shown in red) have generally had the tightest bid/asks spread. LAV and DEN have recently been the tighest as prices have not sold off as much as other regions.
- All regional spreads exhibit “seasonality” in that bid/ask spreads have been tightest on November expiration cycles. (The one-year forward May contract has tended to be the widest). The relative narrowness in November contracts seems to be a function of Nov being the longest contract. As such, it has more time to attract open interest which may be important as traders have a vested interest in quotes.
- I’ve tried to be more “democratic” about bid/ask spreads over the last year (putting a personally-imposed cap of bid/ask spreads for much of early 2018), and the distortion between May and Nov quotes (as well as other quarters) has been less pronounced over that last 15 months. I’m trying to promote more trading in Feb expirations, particularly in OTC trades, as that expiration references year-end Case Shiller values. As such, Feb contracts will be better in sync (from a timing perspective) with the term that most forecasters use (i.e. year-end numbers).
- HCI bid/ask spreads seemed to bottom out at ~1 point bid/ask spreads in 2015, 16 and ’17, but then widened this past November (2018). I attribute that to the large sell-off seen across many contracts as California contract prices collapsed, and that I’ve written about in past blogs: CME Price declines since Sept 5 and Diagram to reflect changes in forward SFR markets. Bid/ask spreads have continued to widen since early Nov as these contracts prices have not found a bottom (i.e. a level where third-parties will buy). Only when we see two-sided interest would I expect bid/ask spreads to tighten back to mid-2018 ranges.
Please feel free to contact me (firstname.lastname@example.org) if you have any questions from this blog, have any ideas how to analyze this new data, or have any questions related to hedging home price indices.