The two blogs from last week refer to Ratio Agreements (RAs) where the denominator is the Case Shiller 10-city index. This allows RAs on any of the 20 sets of public Case Shiller indices.^1
A key feature of such RAs is that while they can used as a stand-alone hedge for view on relative performance, the RAs can be combined with a position (long or short) in the CME contracts on that index (e.g. HCIG24) to create a quasi- outright long/short position in any of the 20 CS indices. This might be particularly helpful for readers who'd like to add/reduce exposure to the "second" ten components of the Case Shiller 20-city index (e.g. Atlanta, Phoenix, Seattle) that are not referenced by CME futures.
However, while Case Shiller has public sets of indices referencing 20 metros, there have been readers who have expressed interest in many more cities not referenced by Case Shiller (e.g. Houston, Austin, Nashville, Pittsburgh). (To date) I've used the publicly available Freddie Mac indices to reference price histories on such other cities. ^2
While it's possible (and I have marketed) RA's referencing two different index providers (e.g. Freddie Mac divided by Case Shiller) there are many logistical issues to include that the release dates don't coincide. ( Note, that I am open to offering Freddie/Case Shiller indices, as those might be useful to users trying to back into an ~outright position, but my focus here is on Freddie/Freddie RAs.)
Circling back, last week's enhancement was to illustrate that one could generate implied outright forward values, where risk might clear, on Case Shiller regional indices that are not traded as futures contracts. However, key to that is that is the existence of a forward value of a market-clearing price for the denominator of the RA. In the case of RAs referencing Case Shiller indices, such values can be observed in the prices of the CME futures on the 10-city index. However, there is no quoted 1-2 year forward market-clearing value for the Freddie Mac National index.
So, I've created an estimate here, and a way to back into such a value.
(Note that while there are other sources (e.g. pulsenomics.com) for forward values on other indices, a) those represent expectations, not clearing levels, and b) the levels are not "Actionable" ). The key to having any derivative linked to the clearing levels on the CME - either through a CS/CS ratio, or a Freddie/CS ratio, or a Freddie/implied Freddie forward national ratio -is that hedging discussions are then grounded in clearing levels, not expectations.
The illustrations below show that the ratios for the Freddie Mac index divided by the Case Shiller 10-city index, and the Case Shiller National index divided by the Case Shiller 10-city have both been very stable, but with the two more national indices outperforming the 10-city index almost every year in the last ten. This is no surprise has the Case Shiller 10-city index has no exposure to Texas (a booming real estate area for the last many years), the Case Shiller index has a heavy exposure to California (with Los Angeles, San Diego and San Francisco comprising ~35% of the Case Shiller 10-city index), and the Case Shiller 10-city index has limited exposure to the second- and third-tier metros have seem population inflows since Covid.
Despite these differences (and the timing measurements and index methodologies), the correlations across the three indices have been very high.
As with the regional Ratio Agreements, I'm open to posting RAs on the Freddie Mac Ratio divided by the Case Shiller 10-city index (Freddie index released at the beginning of the month divided by the Case Shiller index released on the last Tuesday.
Below are indicative levels on such RAs for Feb '24 and Feb '25 expiration.
Note that in both cases the mid-point of the RA is higher than spot or the prior year, consistent with the Freddie Mac index outperforming. Further, the indicative bid/ask quotes on these RAs are quite tight, as I'd like to facilitate these being used in conjunction with a Freddie regional index (to be discussed in a next blog).
Finally, the suggested floors and caps on these RAs are tight, which again speaks both to tight correlation and intent to use them in combination with regional RAs.
This tool -i.e. the Freddie/Case Shiller "converter" - is important to understand, either as a) users propose Freddie regional vs Freddie national ratios but look to take offsetting national exposure in the CME 10-city index contract, or b) as users proposed Freddie vs Case Shiller 10-city index RAs.
Given that this is a key linchpin to getting comfort on dozens of regional derivatives, I'd very much appreciate feedback on your reactions to this "converter". Please feel free to contact me here.
Thanks, John
^1 Core Logic produces more than 20 Case Shiller indices, but only the components of the CS 20-city index are made public.
^2 Some index providers either sell their indices, or even if they have public indices (e.g. Zillow), will not allow third parties to reference their indices in derivative trades.