Having retraced sell-off, what can be done with Case Shiller 10-city and other home price indices?

Quotes on the CME contracts are almost back to February levels (and above spot for the August - Q20 - contract). It's been a wild U-turn driven primarily by a small number of users looking first to hedge (when stock were falling) and then buying contracts (particularly May and August) as sentiment seemed to switch that there would be no distressed sales by June (the end of the reference period for the August index). The graph below  (from CME Equotes - a very useful platform) gives a sense of how far the benchmark Feb '21 closing prices fell, and have rebounded.

Given that prices have rebounded it seems that hedging options have re-presented themselves for those looking to reduce exposure to home prices. Further, since early May, some prominent home price forecasters have revised their calls to lower prices by spring 2021. (See Zillow announcement from May 4th.)

The table below shows quotes on the components of the Case Shiller 10-city index (to the left) for the G21 (Feb 2021 and G23 (Feb 2023) contracts. The middle columns (in blue) compare those bids and offers to the spot level for each of the ten regional contracts. A couple of Feb '21 contracts (e.g. BOS, DEN, and WDC) are within inches of even to spot, while most of the Feb '23 contracts (except CHI, LAV and LAX) straddle spot levels. Net, if someone wants to hedge prices 2+ years from now, they can do so in many of the Case Shiller 10-city index regions at near today's prices.

To the right, in green, I've added values to where the remaining components of the Case Shiller 20-city index might clear. Recall from my April 20th blog that users can add/ reduce exposure to these ten "other" cities via a combination of HCI contracts and HPHF Relative Performance ("RP") Agreements. That is, users combine a long or short position in the HCI 10-city index contract and a swap on the performance of any of these ten regional indices (or others) versus the performance of the 10-city index. Net, in many scenarios, the combination is similar to having an outright long/short position in these "other ten" indices.

Further, note that most of the proposals on the "other ten" swaps (with the exception of DAX/Dallas) are consistent with those regions outperforming the Case Shiller 10-city index. I would argue that this is an example of the debate that homeowners might prefer smaller cities to New York and LA (which together make up 50% of the 10-city index). (Think issues related to quarantine, fear of looting, and the absence of many things -e.g. theater, dining elbow to elbow, sports, shorter commute to work offices) that have historically made cities attractive. For example, one could hedge Phoenix (PHX), and Seattle (SEX) to the Feb '21 expiration, at levels above spot. Net, IMHO, the debate isn't whether home prices in these other areas will out-perform NY and LA, but by how much. The relative value spread quotes are my way to prompt that debate. (BTW - Users can enter a RP Agreements on a stand-alone basis if they just want to express a view of relative forward prices. That way they don't have to necessarily have a view on the level to which prices are headed, just a view on the rate of change of two indices.)

Finally, as I hinted above, this exercise can be applied to other cities that don't have public Case Shiller indices. I've proposed swaps referencing Freddie Mach indices vs. the Case Shiller 10-city index where correlations have run >50%. in some cities (e.g. Salt Lake, Reno, Boise) the swap levels might be even higher than those shown for the Cse Shiller "other ten" indices.

Net, the markets are back above levels that users had wanted to hedge in April and May, uncertainty about the future remains, and there is a platform here to hedge home price index levels on 20+ cities.

Please feel free to contact me if you have any questions on this blog, if you have ideas on a region you'd like to hedge (outright or via Relative Performance swap), or any questions related to using home price index derivatives to hedge home price risk exposure.

Thanks, John