Calendar spreads may be a useful tool for trading or interpreting the boundaries of HPA (Home Price Appreciation) expectations.
Using the 10-city CUS contract as an example I’ve put together an illustration (some are not real prices) of a series of calendar spreads. The graph at the top show bids and offers in the CUS set of contracts,the middle table shows spread quotes, and the bottom table shows the implied HPA from each quote.
The first (and most important disclosure for trading in spreads) is that I’ve used numbers that represent the pay-up from one contract to the month. So for example the Nov ’11/Nov ’12 offer is shown as 680. In reality one would propose this trade by offering to sell Nov ’11 while buying Nov ’12 at MINUS 680. That is since the first contract is the one that drives the spread, and you want to sell the front contract (Nov ’11) lower than the back (or buy the back higher than the front) the spread would be quoted at a discount. Note that I’ve shown the quotes as how much one would pay up (bid) for the forward contract (e.g. +100 in Nov ’11//Nov ’12) versus how much one would sell (Ask) the forward contract over the nearer one (e.g. 680 on the Nov ’11/Nov ’12 spread). BE CAREFUL.
With that caveat, one can note that the implied bids reflect HPAs of less than 1% while the implied HPAs on offers range from 3.6 to 5.2%. Longer term (e.g. Nov ’11/ Nov ’14) offers tend to trade at lower HPAs (reflecting some element of potential for up and down price movements over longer periods) while back contract single year offered spreads tend to trade at higher HPAs (reflecting uncertainty and the possibility of the return of a more robust housing market).
It may be possible to use spread trades to take a more conservative view on the timing and magnitude of future home price moves. Note that the Nov ’11/ Nov ’14 spread quote is 1260 (1700-440) while the riskier outright Nov ’14 market (not shown) has a bid/asked spread of 2740 (18000-15360).
Finally, one last set of caveats. The contracts are not trades where one can hold the spread trade through to the maturity of the longer contract – like a TROR swap. (Total Rate of Return). It may be obvious to some, but once the front side of the trade expires, one would be left with an outright position in the longer contract. Therefore it’s important to consider not where home prices will go over the life of the back contract, but where expectations for home prices on the back contract will be, as the front contract moves toward expiration.