Two Dimensions of Trading CME Case Shiller Futures: Absolute Level and Path of Home Price Recovery

There are two key dimensions that someone can either trade or use to interpret CME Case Shiller home prices- the depth of the decline, and the possible paths that prices might rebound. Users can focus on either approach, but each approach has a different tool that works best.

The first dimension is the most obvious:  how far have CME prices fallen, is that enough, or have they overshot?

The graph below shows that closing prices for the Feb '21 contract are ~10% below spot levels and about ~12% below where there were priced in mid February. ^1 Key to embracing this graph, and from moving away from a focus on rolling HPA, is that the CME Contracts are forward looking, while any analysis done on historical Case Shiller index information, today uses data gathered though January. As such I think that users might be able to better observe changes in sentiment as to how far home prices will fall, with the CME contracts. ^2

Today (Wednesday April 15) the HCIG21 (Feb 2021) contract traded at 205.6 or 88.8% of the year-end spot index. One can debate whether that should be higher or lower, but users might consider including such trading data points (of a decline of >11%) when reading that HPA is still positive, or in making their own forecasts of future prices.

Further, while there are many markets that one can express outright views, many of they are derivatives of this HCI Feb '21 market. (I'll explain how this contract impacts longer expiration HCI contracts below,and regional contracts in a subsequent blog). Please consider focusing on this contract to debate outright price views.

The second dimension to debate (or just observe) is the timing and shape of any rebound. The two red lines in the graph below represent two arguments that have been made on home price recovery. ^3 The upper one is consistent with a V-shaped recovery that will quickly recover to the "old normal". The lower red line is consistent with the notion that home prices (and possibly the entire economy) will be slower to bounce back, that prices might stay low for a few years, that there might be more permanent changes to how people view home values, and that home prices wont' get back to 2019 levels (at least for a long time).

I've drawn the two lines to bracket the most recent closes on the Case Shiller 10-city index contracts (in purple)^4

While reader can express a view on the type of rebound using outright markets, there are few outright bids and offers in longer-expiration contracts. A better alternative is to consider Calendar Spread markets.

The table below shows calendar spreads on selected HCI markets.^5 Recall that these are contracts that allow users to submit prices that they would enter two opposite facing positions (i.e. a long in one, and a short in another) at a pre-negotiated price difference. The contracts reference the front contract versus the second, so pricing may be a bit misleading. Using HCI G21/G25 as an example, the bid shows that the user will buy the G21 contract 14 points below where they would sell the G25 contract, while the seller would sell the G21 contract 5 points below where he would buy the G25 contract.

Net, both side of the G21/G25 calendar spreads quotes higher than the Feb 2025 contract, than the Feb 2021 contract. Further, while it might appear that this is consistent with the outright prices (to the left side of the table), it is more the case that calendar spreads are framing outright quotes. For example, the 222.0 offer on the G25 contract is generated by the 14 point calendar spread. That is, the seller is willing to offer at 222.0 as long as they can buy the G21 contract 14 points lower, at 208. Thus a reduction in the G21 offer, will lower the offer on G24. (This is way I continue to have traders looking to express outright views to focus on the HCIG21 contract.)

Net, one might impact the G25 market in three ways: 1) an outright quote, 2) a change in the front leg of a calendar spread (here G21, or 3) a change in the calendar spread.

Note that calendar spreads can be traded regardless of market levels. That is one could buy/sell G21/G25 at 10 points, whether G21 was trading at 190 or 210. This means that those looking to express a view on how a recovery in home prices might play out, without having to pick the level that a rebound will start from.

I'd encourage users to consider splitting the two decisions: 1) the outright level of HCI contracts) and, 2) the recovery path of home prices, using whichever approach is more appropriate (or in combination).

Please feel free to contact me if you have any questions, or trading ideas.

Thanks, John

^1 This graph is a repeat of April 8th blog "A day of reckoning for home price futures".  It shows the historical Case Shiller 10-city index in black, the closing prices of the 10-city contract on Feb 21 in green, and the most recent closing prices on the Feb '21-'25 contracts in purple. The left hand vertical axis has the percentage of prices versus 2019 year-end index values (i.e. the numbers released in Feb '2020).

^2 While I embrace the notion that Case Shiller futures clear at lower levels than expectations (see my April 13th blog for a detailed explanation), expectations of a some level of price decline are priced into the contracts. The contract prices will combine some combination of expectations and a discount where risk clears, but my point is that expectations are better captured here than in Case Shiller numbers.

^3 This is for illustration only, it ignores what level price bottom, and doesn't include other possibilities (e.g. that home prices don't recover).

^4 Note that I'm referring to closes, not mid-market or bid levels. Again this is just done to illustrate the concept of calendar spread trading.

^5 Regional markets can also be quoted this way.