I've added a graph to the most recent version of the template for HPHF Ratio Agreements. Recall that these RA agreements can be used to add/reduce the relative risk of a region versus a more national index. However they might also be combined with an exposure to the Case Shiller 10-city index futures (traded on the CME) to convert a relative risk view into a quasi-absolute price view on that region. ^1
Recall also, that the HPHF Ratio Agreements (RAs) are bounded with caps and floors to a) make finite any out-of-pocket costs, and b) thereby eliminate the need for margin calls (as HPHF is in the business of engaging with qualified counterparties, and is not in a client-facing business.)
While my intention here is to illustrate how an RA might be converted to an outright exposure, let me start with a recap of the graphs and tables in an HPHF RA template.
The illustration below shows (in black) the historical ratio of the Case Shiller MNX Minneapolis NSA Index divided by the Case Shiller 10-city index.^2 The blue triangles are indicative levels that HPHF would bid for a RA agreement to expire at the end of either Feb 2024 or Feb 2025 ^3 while the red squares are indicative offering levels. (Note that the bids and asks are a small percent of the ratio. This is because, many cities (e.g. MNX) have prices that are highly correlated to the national market, and therefore a large part of their outright price moves can be explained by movements in national prices. However, this might not be the case for outliers such as Austin and Boise). Floors and Caps on the RAs are represented by the dashed blue and red lines.
For example, HPHF would have an implicit bid of 0.71 for a Feb 2024 RA, and an implicit offer of 0.73, versus the current ratio of 0.72. I say "implicit" as HPHF Agreements are actually structured as options to cap total exposures. As such, the implicit bid of 0.71 would actually be a bid by HPHF on a call with 0.68 floor and a 0.76 cap for 0.03 points of premium(the difference between the floor of 0.68 and the implicit bid of 0.71). Alternatively, the implied offer of 0.73 would translate into HPHF buying a put with a strike of 0.76 (so 0.03 points in the money).
In each case a user looking to be a counterparty to HPHF would trade an offsetting option. In the first case were HPHF to pay 0.03 points for a call the user would buy a put priced at 0.05 (0.78-0.73).
Let me add four key notes:
* Note #1 -The value of a point would reflect the nominal amount of exposure a user wants to take. For example, someone looking to hedge $400,000 of MNX exposure might want the value of each 0.01 to be $5,480. That is, a 1% change in the exposure (of $4,000) would mimic a 1% change in the ratio from 0.73 to 0.7373. A full 0.01 move would be $4000/ .73.
* Note #2 -The bids/ask, and caps/floors shown are indicative, and subject to negotiation.
* Note #3 -That said, HPHF will quote RAs for some price, for some retail-hedging sized levels of exposure. That is, while I'm happy to tout axes of various users, a user doesn't have to wait until HPHF has lined up a third party for the other side of a trade (as I will take the offsetting exposure, at some price).
* Note #4 -Caps and floors are shown to be wider over time as uncertainty expands. Wider caps and floors require higher "out of pocket" proceeds by each party to buy the respective calls and puts, and as such, tie up capital. Given that, I'm less inclined to write longer-dated agreements, but am happy post axes.
As I noted above, a key value proposition for HPHF RAs is that they can be used in combination with Case Shiller futures contracts (traded on the CME) to create a quasi outright exposure. (see footnote 1). That is, using MNX as an example, someone with a bearish view of MNX might buy a put on the MNX/10-city index ratio and then sell the 10-city index contracts (for the same notional amount). The long 10-city index exposure in the denominator of the RA would be offset by the short position in the CME futures, leaving just the negative exposure on the MNX index.^4
The graph below shows how this combination strategy looks versus the historical outright MNX index.
For example, if implied bid on the MNX RA is 0.73 and the 10-city index Feb 2024 (HCIG24) futures are bid 323, the RA implies a forward MNX outright bid of 229.33 (0.73 * 323, versus 235.56 spot), Using the same process, the RA ask of 0.75 and the city index futures offered at 328, the implied MNX outright offer would be 239.44. (Note that for someone interested in a combination strategy, I am open to quoting either the 10-city index futures, or the HPHF RA inside the stated bid/ask levels).
Note that the lower values for the implied MNX index for Feb 2025 are primarily (in this process) a result of lower prices on the CME 10-city index contracts for Feb 2025 (i.e. Feb 2024= 323.0/328.0 v Feb 2025 317.6/322.0). That is, someone thinking that the outright value for MNX won't fall (Feb 2024 v Feb 2025) is implicitly saying that the MNX Ratio will rise (as the 10-city index falls). As with CME futures, the implied MNX prices are not necessarily of expectations, but are levels where risk might clear.
I realize that there are multiple moving parts to the above illustrations, so feel free to DM me if you have any questions.
As noted above, while I used MNX as an example, I'm open to quoting HPHF Ratio Agreements on other cities (to include those referenced by the CME, or any of the other opt 50 cities, referencing Freddie Mac indices.
Finally, while the examples shown have been for single cities vs more national indices (i.e. Case Shiller or Freddie Mac), I'm open to quoting city pairs. Some might be highly correlated (e.g. Boston v New York) allowing for narrower floor vs caps (and therefore lower premiums) while some "snowbird swaps" (e.g. Chicago v Phoenix) might have lower correlations (and lower liquidity) and would require wider windows.
Feel free to DM me on your hedging needs and I'll try to offer a creative solution.
Thanks, John
^1 I use "quasi" as the combination differs from a hypothetical outright hedge when the Ratio exceeds the cap or floor.
^2 There are 20 sets of public Case Shiller indices, but there are only 10 regions referenced by the CME Case Shiller futures. As such, these HPHF RAs are one of the few ways of expressing a relative value view on "non-CME" cities. Further, the RA template can be expanded to any of the top 50 cities by referencing the Freddie Mac home price indices.
^3 Recall that the Case Shiller indices released in February reflect activity through the preceding December, so these contracts are designed to foster debate on year-end levels for 2023 and 2024. For HPHF Agreements referencing Freddie Mac indices earlier settlements would be used. Note that while RAs could be constructed for any month, I've learned from experience that having too many expirations limits the possibility of either netting exposures, or having users unwind open positions.
^4 Again, to emphasize, this only mirrors an outright position should the ratio remain inside the cap and floor.