While the ten regional CME contracts reference some of the larger cities ^1, some large cities with Case Shiller indices (e.g. Phoenix, Charlotte, Detroit, and Minneapolis) are not referenced by CME contracts, and other large cities (e.g. Houston, Pittsburgh, and Philadelphia) as well as "hot" markets (e.g. Boise, Salt Lake, Austin) do not have a public Case Shiller index, much less tradable contracts.
Readers desiring to to add (or reduce) exposure to index price moves in these "other" 40 cities, might consider OTC Home Price Hedging Fund ("HPHF") agreements.
These agreements have many of the same benefits of the CME contracts in that users can a regional home price index, thus avoiding the 100% Rent v Buy v Sell decisions that go along with these large anxiety-inducing life decisions. (See prior blog for a more detailed discussion on the benefits of partial hedging). Users can add/reduce exposure to home price index movements in larger areas without the need to buy an entire house (at one point in time), qualify for a mortgage, (and if buying as an investment) finding tenants. Renters who would like to have some exposure to home prices, or buyers who might be looing for a house in a few years (moving or transitioning from rentals) might consider adding longs, while those looking to hedge gains, or who anticipate downsizing in a few years, might consider hedging.
Since these agreements on done OTC (over the counter), agreements are structured to be fully collateralized (for the stated range of outcomes), and I need to review counterparties in advance.^2 That is, there is no customer relationship in our dealings. I am not offering financial advice and I will not be holding client funds. (See The HPHF page for examples of documentation).
The agreements may work particularly well for those concerned about price moves over the next 1-2 years, and/or those who do not expect to sell their homes in the next few years. (Shared appreciation strategies might work well for those with a longer timeframe but many programs don't pay out on losses in the first two years, and/or require the sale of the house. In addition, HPHF agreements can be used to add exposure to a home price index, something that is difficult for retail investors to customize with a shared appreciation strategy. Of course index hedges have basis risk versus a hedge on an individual house -which a shared appreciation hedge can provide- so one will need to have a view on the correlation of the price of an individual house and that of a region.)
Finally, I'm open to show actionable prices on small amounts, as price discovery is important to my efforts. For larger amounts, I'm happy to tout axes that you may have, and then try to broker exposures.
As I've written in past blogs these OTC agreements can take at least four forms (forwards, relative performance agreements, ratio swaps and options). The diagram to the right illustrates versions of all four using Austin as an example. Feel free to contact me if you have an interest in quotes on other cities.
1) Forward Agreements: Forward contracts are most similar to futures in that one takes an exposure at a price for a particular expiration, and then is exposed to both increases and decreases in prices. That is, gains and losses move point for point with changes in the index at expiration. For example, the Jan '22 Austin HPHF forward settles on value of the Freddie Mac NSA index for Austin-Round Rock, released in late January/early February, that references the Dec (year-end) index.^3 Unlike futures, the payout on price moves is typically banded at +/- 8%. In addition, the agreements are structured as at-the-money options. That is, the "purchase" of a Jan '22 Austin forward at 312.0 might be converted into a purchase of a call struck at 285 with a 340 cap at a price of 27 (312-285). (see HPHF page for more details on the structure of these agreements). The maximum payout of 55 (330-285) would occur at an expiration of >= 330, while at index values < 285, the buyer would lose the entire premium. (Note that Austin Jan 2022 was offered in January 2022 at 265.6, so prices can be volatile.
2) Relative Performance ("RP") Agreements pay on the performance of the stated index relative to moves in a benchmark index at the expiration of the agreement. These RP agreements might be considered by users who'd like to add/reduce the relative performance of a region, but without taking an explicit outright view on home prices. The RP levels shown at the top of the diagram to the right, are such where HPHF would buy the performance of Austin (for the whole year of 2021) vs. the performance of the Freddie Mac National index, with Austin outperforming the National index by 3.5% as breakeven. I'd offer the reverse at 5.5% breakeven. Note that both quotes have imbedded in the pricing that Austin will outperform for 2021. The debate is by how much.
RP agreements have an advantage of being structured on any notional value. The difference in percent gains (or losses) during the year is compared to the starting break-evens (here 3.5 or 5.5%) and is multiplied by the notional amount to determine payouts. Again, as above, the range on RP out-/under-performance is capped/floored to determine collateral levels and maximum payouts. Ranges of +/- 10% points above/below the initial strike would be considered.
3) Ratio swaps are a form of RP agreement that may be simpler to understand, easier to calculate and more fungible. The graph at the bottom of the diagram shows the ratio of the Freddie Mac NSA Austin/National indices, and highlights the values for December in red. Forward ratio values are rising, consistent with Austin outperforming the National average (regardless of which direction prices move). As above, ratio moves are capped, and agreements are structured as options. For example, one might buy the Austin/National ratio at 1.35 (for Jan 2022) in the form of a 1.25 call with a 1.45 cap.
Note that both RP and ratio agreements can be converted into a form of an outright agreement with a long/short position in the national index. I'd encourage those interest in forward contracts to explore these notions as markets on the national index will be much tighter (bid-ask spread) and the ability to unwind an agreement (should someone want to) will be much easier if the outright long/short is a national index, instead of a regional index. Users might further consider taking their outright long/short exposure in CME Case Shiller 10-city index futures, as margins are low, price moves can be uncapped, reversing a position doesn't depend on me as the back counterparty. Here's an example of RP and ratio agreements referencing Portland and Seattle from last year.
4) Finally, I'm open to structuring trading options where a user buys a put for an upfront cost (premium) and therefore can lose no more than the initial premium. For example, a put struck at 295 (again with a floor of 270 to cap payouts) can be purchased for 6.3 points ^4. Against that upfront premium, the maximum payout would be 25 points (295-270). Here's an example of options on the Phoenix Case Shiller index.
Feel free to contact me if you'd like to discuss any hedging ideas, or if you have questions about this blog.
Thanks, John
^1 - BOS, CHI, DEN, LAV, LAX, MIA, NYM, SDG, SFR and WDC
^2 - e.g. KYC- "know your customer", and AML- "anti-money laundering" practices
^3- The agreements are listed as Jan 2022 as the index for December (that is used to settle agreements) could be released in the last week of January or the first week of February.
^4- Points would need to be converted into dollars based on negotiations over the notional amount to be referenced.