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11 for 11!, limited trading post CS release

As I mentioned in a blog from last week, four times per year, as CME Case-Shiller futures contracts expire, we get a chance to contrast the accuracy of “market expectations” in predicting the actual Case-Shiller numbers. This moth (Nov) was one of those opportunities.

For the first time in recent memory, the actual results of the 11 indices traded on the CME (the national CUS index, and the ten regional indices) all came out within the bid/asked range of the futures quotes the week before the close.

Not only did the bid/ask spreads bracket the actual results, but the the contracts that were “expected” to perform worse (LAV -1.13%, SDG -1.56%, and SFR -1.26%) were two of the worst three performers. Additionally, the two contracts with (relatively) the best “expectations” (NYM -0.23%, and WDC -0.28%) were the two best performing indices (and the only two that rose Month-On-Month).

The fact that the actual Case-Shiller indices were in line with market expectations may be the reason that there has only been one trade today. In prior months when the release of 4-6 Case-Shiller indices were outside the final CME market bid/ask spread, there was more trading.

So….I’m pleased to see that market prices can be used as a very valuable tool (one of many) in analyzing forward home prices.

Predictive ability of small markets. Iowa Electronic Market

It’s not lost on me that there’s not much volume traded in the Case-Shiller contract. Some use that low volume to automatically dismiss prices suggested by forward quotes. Without getting into the merits of exactly what futures prices for 2013-2015 mean, let me introduce you to my favorite, thinly traded (at least in dollar amount) set of contracts -those on the Iowa Electronic Markets. http://tippie.uiowa.edu/iem/

The IEM has been a great academic laboratory in integrating people’s expectations about the outcome of future events (e.g. the 2012 Presidential race) by relying on a futures format. Individuals can bet on not only whether they expect say Romney to be the Republican nominee for President (see graph), but by allowing a market for that 0-1 (binary) outcome, to come up with the odds of such an event.

Trading accounts are kept small (to avoid gambling issues). The markets are two-sided and there may be many more bids and offers than actual trades. Analysts, academics and pollsters have relied on these real-time markets to note changes in expectations. (see the Perry’s surge and fall.)

I see the Case-Shiller contracts as having “the potential” for the same set of predictions on future values of the Case-Shiller indices. Similarly to IEM, the contracts’ predictive power will be more enhanced the 1) more widely known they are, and 2) the more traders choose to narrow bid/asked spreads.

Much like Perry supporters, you don’t have to like what the market is telling you about home prices, but if you disagree, there’s a place where you can put your money where your mouth is (with attractive odds).

What Housing Recession? (2013-2015)

In the midst of bearish short-term home price forecasts, it might be useful to step back and see what the market is “saying” about home prices (or at least prices on the Case Shiller index) over the next few years. The graph below shows the mid-point price (splitting the bid and ask quotes) on both the Case-Shiller 10-city index (bolded in black) and the ten regional contracts.

Note that while market quotes are in line with current pessimism, that expectations turn more bullish once we get to 2013. In fact, in certain areas (the three Northeast regions of WDC, BOS and NYM, and their 24/7 sister city on the west coast (SFR)) prices turn up sooner, and more sharply. Alas for DEN and CHI, the future doesn’t seem so bright.

So, potential good news on forward price levels, potential good news for certain regions and potential good news in that real estate markets are moving away from being so highly correlated.

There are a number of possible inter-city trade themes that one can employ. Please email me (johnhdolan@homepricefutures.com) if you care to discuss some swaps.

Hacked! -August expiration

For anyone who’s checked the site in the last week, or anyone who’s wondering what looks different with the homepage, the site was hacked. I’ve lost (for now) all of the work between March and August. Nasty!

I’m looking to repopulate old blogs and would appreciate anyone forwarding missing pages to me. In general I have the graphs, but not the text as I composed directly on the site. In the future, I’ll draft in Word and the copy over. A learning experience.

Besides that, I’ve been busy on a consulting project that has consumed much of my attention. Not that there’s been too much to write about with multiple 100-point days on the Dow, S&P downgrading US debt, and an East coast earthquake!

Back in this quiet part of the world the only big news is that the August contract is set to expire next week. We stand to lose the open interest on 13 contracts so there could be some trading going into the close.

While I was quite vocal on the predictive power of the futures contracts on the Case Shiller indices released in May, I sense that the markets are much more wary this time around. Seasonal factors have given the indices a lift over the last two months (and may do so again), while housing fundamentals remain weak. Figuring which will dominate is a balancing act. Compounding the challenges faced by these offsetting factors, revisions to the WDC and NYM indices last month, may be making traders reluctant to bid higher/offer lower (on fears of revisions to other contracts).

As such, bid-asked spreads are wider (about 2-4 points) that on previous expirations. Stay tuned.

Bloomberg Seminar:Home Price Projections, Mar 24th

I will be moderating a panel at Bloomberg on March 24 on the topic: Issues in Projecting Forward Home Prices. While there are often many comments about the direction of home prices over the next 12 months, this panel will discuss the tools that can be used for, and the potential issues involved with, projecting home prices over a 2-5 year horizon.

Terry Loebs, from MacroMarkets, will speak on the work his firm has done in systematically surveying home price expectations.
I will speak in my capacity as CME market maker on how CME Home Price futures may be used to narrow the range of home price expectations
John Sim, JPMorgan, will review his firm’s work in modelling forward home prices to a variety of scenarios, and
Laurie Goodman, Amherst Securities will give her perspective on how the many non-modelable parts of the housing finance industry (e.g. GSE reform, modification programs, revival of an RMBS new-issue market) might influence such views.

The seminar will start at 5:30 with short presentations and then Q&A from the moderator and the audience. If there are aspects of this topic that you think the panel should incorporate into their presentations, or questions that you like to have asked, please feel free to share them with me at johnhdolan@homepricefutures.com.

There will be a reception following the presentations that will start at 7 PM.

Bloomberg is located at 731 Lexington Ave in NYC. Please contact your Bloomberg representative, or sign up on Bloomberg to save a spot.

Basics – Spread trading (using CUS)

One way to trade Home Price contracts is on spread trades. This allows one to trade on the eventual price difference between two contracts. While trading spreads results in no net position (a spread trade results in a long in one contract and a short in another) that is not to say that they are less risky. I’ve tallied the live spread trades for the Nov cycle maturities as an example.

Note (1st VERY IMPORTANT) that the spreads are quoted as the first contract against the second contract. As such, the -500 quote along the CUSX11 line, and under the X12 column, translates into someone willing to buy the CUSX11 contract 5points below where they will simultaneously sell the CUSX12 contract. (Note, I am jumping back and forth between how the indices are quoted (e.g. 150.00) and how the contracts are traded (e.g. 15000)). So, for example if someone hit that bid, there would be two trades: one where the “-500” bidder would buy a CUSX11 contract at 150 while at the same time selling the CUSX12 contract at 155, while the seller sold a CUSX11 at 150 while buying the CUSX12 at 155.

The -160 spread offer represents someone who is willing to sell the CUSX11 contract “only” 160 points below the CUSX12 price.

Spread quotes may also be the basis for an outright bid. For example, the -1100 offer between CUSX11 and CUSX15 means that someone will sell the CUSX11 11 points under the CUSX15 contract. This is the same as someone being willing to buy the CUSX15 contract 11 points above where they can sell the CUSX11 contract. As such, if there’s a 150 bid in the CUSX11 contract (as shown) the -11 spread (CUSX11/CUSX15) will result in the CME computers generating a 161 bid for CUSX15. This bid will exist as long as both the 150 bid exists in CUSX11 and the -1100 spread offer is working. If the 161 bid is hit, the spread order will simultaneously hit the 150 bid in CUSX11.

Net one trader will be short a CUSX15 at 161 (as he wanted). One trader will be long a CUSX11 as they wanted, and (possibly) another trader will be short the CUSX11 and long the CUSX15 at an 11 point price difference.

Finally, even-year spread differences can be easily translated into forward HPAs (Annualized Home Price Appreciation). Using the above example, if someone is willing to buy the CUSX11 at 150 while selling the CUSX12 at 155, it may be inferred that they expect CUSX12 prices to be no more than 5 points (or looking to the right side of the table~7.3%) higher by the time the CUSX11 contract expires. It may be interpreted that the buyer of the spread at -160 thinks that prices will rise by more than 1.3%.

Any spread order can be translated into a forward HPA assumption, and (importantly for trading) any HPA can be translated back into a spread order.

2nd Important Note- A spread trade is a buy/sell of a front contract combined with a sell/buy of a back contract. When the front contract expires one is left with an outright position in the back contract. That is why I’ve taken pains here to say “one may interpret/infer”… There are other reasons one might buy or sell a spread.

Basics -Home Price quote systems (Bloomberg, etc.)

“They” say that you can’t tell the players without a scorecard. I’ve had the question asked -where do I get a “scorecard”? That is, how do I follow the prices on these contracts.

While this should probably fall under the FAQs category, I’ve tended to use the Basics category for anyone looking for information on the contracts so I’ll post this there also.

Combining these symbols with real-time links (the old BLP functions) will allow a trader to follow contracts at his/her desktop.

For those who have commodity systems E-Quotes from the CME is another great link for real-time access. (I use E-Quotes).

Finally, I’ve had discussions with CQG and they also tell me that they can provide a real-time feed for CME Home Price futures.

I hope that this helps. If anyone has other suggestions, please circle back to me and I’ll share with the world.

Basic -Year End Prices

Here’s a table of year-end bids and offers for the CUS Home Price futures.

Trades on Dec 31st helped tighten up Boston quotes.

Four contracts (BOS, CUS, NYM and SFR) now have quotes for all expirations.

The average bid/asked spread for all Nov ’11 contracts is 5.4 points. There are six contracts for Nov 2012 with bid/asked spreads <7.5.

Basics -Implied HPA using prices

Many housing economists and traders prefer to quote home price changes in terms of HPA (annualized Home Price Appreciation). For a one-year holding period this is simply the (End Price/Begin Price)-1 expressed in percentage terms.

For longer periods one must discount the End Price/Begin Price fraction by time, so a three year holding period HPA would be:

((EndPrice/BeginPrice )^.3333) – 1

With that math, with quotes in all the Nov 2011-2015 expirations, and with the Nov 2010 as the most recent Case-Shiller release, one can easily compute implied HPA for both long-term holding periods (say spot vs. 2015), or for interim periods (say Nov 2013 vs Nov 2014). The results for mid-price quotes are shown here.

Reading the table one can see that the implied annualized HPA over the five years from Nov 2010 to Nov 2015 is 1.7% (lower right). This is a result of a total price increase of 1425 points or 8.8% over five years.

The path to higher prices is not a straight-line. Prices dip in 2011, and then rebound at ever slightly higher annualized rates (e.g. 2.4% between Nov ’11 and Nov ’12 to 3.9% between Nov ’14 and Nov ’15).

Note that prices shown here are mid-market prices. Since bids will be lower, the price gains, and therefore annualized HPA will be lower. Offered prices result in higher implied HPA. (next blog).

A final point (to help trading) is that while one might have a weak view on the level of home prices for a particular year, one might have a strong view on the HPA for any given year. Spread trading, allows a trader to express such views on particular years.

So, for example, while the difference between Nov ’12 and Nov ’13 mid points is 440 points or 2.8%, someone thinking that home prices will rise more than 2.8% during that period might think the spread should be wider and could enter such a spread trade order.

(A warning -spreads are quoted backwards from what a layperson might think. Since the earlier contract is quoted first both in terms of action and price, someone looking for the spread to widen would put in a spread order to sell the front contract at a discount to the back contract. The more negative the number, the more the person thinks that back contract prices are going to rise -relative to the front contract. More later, but this is an important qualifier.)

Basics -Mid v Close

A number of first time visitors to trading in home price futures may be curious as to why quotes reference the “Mid” rather than the “Close” price. After all if they are MBS traders they are used to seeing the “Close” on all the other contracts they follow: T-Notes, Euro$, S&P indices. Alas with less frequently traded contracts the bid-asked spread is sometimes wide, and unless there’s been a recent trade (or lower offer or higher bid since the last trade) the close may be dated.

The attached graph shows the situation in the CUS contract which has the benefit of at least having quotes for every contract. Note how the Close curve bounces from the offered side to the bid side of the market and back again.

Using the Nov ’11 contract as an example, the close and offer are both 15800 as the current offer is lower than the last trade. The closing curve bounces down to 15200 in Feb ’12 as the last trade was below that level, and the 15200 bid is higher. Finally, the close curve bounces back up to 16040 as that was the last trade and both the current offer is higher and the current bid is lower than that level.

There is not much to learn from the CUS close curve. The situation is worse for other contracts that do not have bids and offers for each expiration. A trade done several months ago might be the foundation for calculating today’s close, unless a lower offer or higher bid has been posted.

By contrast the Mid curve better reflects recent action in the market – even if those are only bids and offers. In the case of the CUS contract, the Mid curve reflects a view that prices will be lower through 2011 then start to climb (albeit slowly) during 2012-2015.

Any subsequent “better” quote (a higher bid or lower offer) will impact this curve and reflect a change of sentiment.

The downside of Mid pricing is that one doesn’t know whether a 170 Mid price represents a 168 bid and a 172 offer or a 150 bid and a 190 offer. That’s why it’s important to also show bids and offers to give viewers a sense of the spread. Traders cannot necessarily expect to act on Mid prices. Markets, particularly OTC markets, that show just Mid without also showing the bid and ask sides, may mislead traders into what prices they can expect to act on. Traders who typically download only one number for their historical records may then not see that bid-ask spreads have tightened if they only download close or mid.

That said, while Mid prices have their issues, they are a much better reference point than Close prices for illustrating market sentiment.