I just had an inquiry for an option on a home price index, and thought it made sense to share my updated thinking with this wider audience.
While I might have a preference for writing puts or calls on metros referenced by CME home price index futures: a) to facilitate price discovery a market-clearing forward price, and b) to allow trading in the underwriting for either side to hedge/lock in gains, it seems that I'm getting as many inquiries for metros ranked 11-50 (Sorry Houston, I didn't chose Case Shiller 20-index cities). As such, this example will be on a Freddie Mac index, but options could be written on any eligible, public, monthly index. (As an added benefit, Freddie uses appraisals in their index calculation so with a multiple of data points vs Case Shiller (based on repeat sales) their monthly indices would likely be more stable that if Case Shiller calculated indices on a one-month's activity. Will review.)
My template below shows an example for a Call and Put on the Pittsburgh NSA Freddie Mac index. Note that I've included a graph for the reference index to both illustrate trends and to remind readers that (in this instance) a 220 floor was < 2 years ago. ( I've also attached a schematic of payouts).
A reminder that these are European-style options, i.e. that can only be exercised (and will be automatically exercised) at expiration.
As with futures, I want to steer expirations to the index that references year-end values. (In addition, focusing on 2-3 expirations increases the possibility of netting exposures.) Freddie Mac updates their indices the first of the month, refencing activity through the month before last. That is, the Feb 1 release covers activity through Dec 31.
I write option trades via HPHF (Home Price Hedging Fund -see link for further details). I'm open to suggesting levels on any Top-50 metro.
That said, I try to limit expirations that I principal vs HPHF to the 1-2 year-end cycles, so today Feb '25 and Feb '26. I'm open to exploring longer-dated options, but a) they may be subject to where I can broker activity, or b) where there's been a high correlation with national prices. (A related topic is that shared equity mortgage/HEL/ programs have some element of imbedded calls/ reducing index exposure. In my mind, those programs have high costs (if not also structural impediments) for, 1-2 year horizons, so homeowners looking for longer-term puts might want to get familiar with Unison and Point, two industry leaders. (Happy to tout others that DM me.)
As noted in the HPHF website, I limit exposures with caps and floors. This both lets the buyer see the total upside/downside of any position, and caps my risk. I say that as I have no interest in writing exposure to "home prices down 30%" as that seems to be social policy best left to governments (e.g. flood, earthquake insurance)
All illustrations of quotes are quoted in points, which can be translated into dollar value/point. In the attached example, the user wanted $500,000 of notional value. At a spot index of 245.88 that translates into $2034 per point. The value of each point can then be used to translate price points to dollars.
As with all options, counterparties can reduce the purchase price of a put or call, by moving the strike away from an indicative or suggested (by my own analysis) forward price. (That is they can, in effect, self-insure some move). In this example, each side is quoted to offer 25 points or about ~10% price protection. The premiums here are 2.5-3.0% of spot or 25-30% of the protected amount (e.g. 7.5 points on put vs 245 strike). Option premiums looked at in this manner will vary depending on: tenure, degree out-of-the-money, size, and volatility of the refence metro index price. That is, expect to pay more for Boise than Louisville.
The best way to approach this effort (given # of cities, strikes and expirations) is to suggest an exposure (within the above parameters) that you're looking to address. I'm more keen on dealing with homeowners, financial advisors, realtors on specific properties, rather than JP Morgan asking where they might hedge $25mm.
Hopefully this is enough prompt interest/get you started.
Feel free to DM me with any questions/inquiries.
Thanks, John
#homeprices #realestate #options #hedging #houston