The positive role of housing derivatives

Anyone trying to project the impact of the stock market sell-off on home prices should explore the CME S&P Case Shiller home price futures contracts. While I'm open to helping users hedge (long or short) the key for all viewers is just to be aware of the prices.

I have been making markets in the CME S&P Case Shiller home price futures contracts for ~10 years. Part of why I got involved was a search -post the FInancial Crises - to the (Watergate-like) question on the fall in home prices: "what did they know and when did they know it". It seemed to me that financial derivatives could have performed an even more powerful (positive) role in either bracketing forward home price expectations, or in publicly demonstrating where home price risk could be exchanged.

Now investors, homeowners, renters, and potential buyers and sellers, find themselves in the midst of another financial crises as stock prices tumble. Users looking to guidance will find no help from backward looking databases, lagged indices, or even one-month old projections for 2020 HPA (home price appreciation). Investors seem less concerned about what has happened, or what might happen from a pre-crash perspective. I expect that what they need is a metric for what the future holds, that is public, and that can be continually updated as the crises plays out. These contracts might help.

I've argued that -despite any critiques on either contract or index design-that the CME Case Shiller home price index contracts are (conceptually) one of the few publicly traded platforms where users can get a sense of either forward home price expectations, or (depending on the expiration) where users are willing to transfer home price risk. (There are a few stocks where value is based on home prices -e.g. INVH, AMH -of the prospect of building homes -e.g. ITB, but few platforms that are priced on the cumulative value of homes).

The table below shares where contracts were at closing Thursday night. (A caveat -these were all my quotes. More on that below). "Spot" values are the index levels released in February 2020 that represent activity through Dec 31, 2019. Bids and offers are on the Feb 2021 (G21) contracts that will settle on the index values from activity through Dec. 31 2020. Recall that since the Feb '21 contracts must converge to index values (as they "cash settle") it can be argued (debated) that contract prices should reflect expectations for year-end 2020 index values.

The left column in the table shows the YOY index changes for 2019. They range from just under +1% (e.g. CHI, NYM) to above 4.0% (e.g. BOS, SDG). The columns to the right convert today's bids and offers to "% vs spot" and "Mid" levels. For example, the BOSG21 contract was bid 227.4 or 1.8% lower than the spot value, while the offer of 230.4 is 0.5% below spot. The mid-market value (the average of the two) is 1.1% less than spot. Note that of the ten regional contracts (i.e. ignoring the HCI/10-city index) eight of the mid-market "% vs. spot" are negative, and for the two contracts that are positive (i.e. BOS and SDG), they are barely above zero.

Finally the far column to the right shows the change in YOY gains (i.e. the left column showing 2019 gains vs. the "projected" (air quotes) gains for 2020 under the Mid header. The declines range from ~3 to > 5% (with LAV being hit the hardest).

Net, if you believe that these contract prices represent broader views on where home price risk clears, I would argue that prices are consistent with a mild sell-off in home prices for 2020, varying across regions.

Now the big qualifier in all of the above is that these are my quotes, and that the quotes during the sell-off have tended to be 1x1 (i.e. a bid for one lot vs. an offer for one lot). Posted bid/ask spreads have widened since Jan 31st (when they were about 3.0 points/contract). I'm not saying that I have any particular insight to where prices "should" be, or where risk "should" clear. Instead what I'm trying to do is to use these quotes, and to try to somewhat continually update these quotes, to bracket discussions about the impact of the crises on home prices. I'm open to taking either side of trades in limited amounts (and was involved in all 38 lots traded in February and 20 this month) but what I'd strongly prefer is for others to weigh in on where they think contracts should clear by bidding, offering, or working with me on orders.

I'll leave to housing experts the discussions on fundamentals, but it seems that every CNBC talking head is saying that market distress creates opportunities. Is a slowdown in HPA to, in some cases, outright declines in index values, too much, or at a discount to spot, do forward home prices represent an opportunity (especially when combined with tight inventory and lower interest rates)? Where do "home prices flat in 2020" stack up vs. stocks down 20%. Are they too low/high? Is this cycle going to be similar to the path home prices took in 2007-08, or are the fundamentals different this time?

Finally, note that I've shared only the Feb '21 contract prices here. The Case Shiller contracts have ten open expirations, but it's been my long-held view that there are benefits to having users focus on a limited number of expirations. I've been quoting 5-6 expirations on each region, but many of those prices (with the exception of the front two contracts -May '20 and Aug '20) are derivatives of these Feb '21 contracts. (That is prices on the Nov '20, and May '21 and Feb '23 contracts are generated either via calendar spreads or intercity spreads). Users can trade any of those expirations, but the more users we have in the Feb '21 contract, the deeper that market will be and the more users (and I) can link to that depth, to create deeper markets in other expirations.

Net, please feel free to contact me and weigh in.