Yes, I’m going to pile on to social media efforts to capitalize on Super Bowl interest. Of course what I have in mind is here is getting readers to debate which side they prefer of the current pricing that has the CME Case Shiller BOS contracts outperforming the LAX contract (using the X20/ Nov 2020 expiration) by 2 (percentage) points. In addition I want to illustrate how one might look at intercity spreads, to new readers.
To recap, one can trade either side of two contracts outright, or an intercity spread between the two. Intercity spreads allow for simultaneous execution of a long and short on two different regions at a pre-negotiated point spread. There’s no risk of doing one side first, only to see the other move. In addition, IC spreads typically are quoted at tighter levels than legging two trades.
Such IC trades can be very useful if a trader has a view about one region vs. another, but who doesn’t want to take outright risk.^1
The following table illustrates the logic required to get to 2%. Contracts trade at different prices, so quotes are converted into percentages vs. spot. The BOSX20 (Nov 2020 expiration) contracts are quoted at prices that are 98.8/101.6% above spot levels. The LAXX20 quotes translate into 96.8/99.6%. The contracts are quoted at 6 and 8 point bid/ask spreads so to buy one/sell the other would mean working at reducing the total 14 point spread (from bid on one side to offer on the other).
However, an IC spread of 60.2 would allow the buyer to own BOS at 218 (+100.7%/spot) while selling LAX at 278.2 (or 98.7%) over spot, consistent with BOS outperforming LAX by 2% between today’s spot level and Nov 2020. On the flip side a 57.4 spread would allow a user to own LAX priced at 3% under BOS.
Someone who thinks that BOS and LAX will perform about the same from here through 2020 might consider buying LAXX20 at 60.2 over Boston (as the quote has out- performance for BOS price in, while someone who thinks that LAX will underperform BOS by more than 3% migth consider buying BOS at 57.4 points under LAX.^2
Note that this type of IC spread can be orchestrated on the CME for any pair of regional contracts. In addition, OTC spreads are possible for indices not covered on the CME.
Feel free to contact me (firstname.lastname@example.org) if you’d like to discuss this blog, or any aspect of hedging home price indices.
^1 Note will always be some outright risk as the contracts trad at different prices. So while an IC trade may involve the same number of contract lots, it may not involve the same notional value. That problem can be somewhat addressed by having more of one region than another, e.g. 5 vs 4.
^2 Note that CME spreads may be quoted with negative numbers. I’ve used positive numbers here as clearer for illustration.