Boston – HomePriceFutures.com

Should Boston over LA be 2 points?!? -Super Bowl special (IC spreads)

Yes, I’m going to pile on to social media efforts to capitalize on Super Bowl interest. Of course what I have in mind is here is getting readers to debate which side they prefer of the current pricing that has the CME Case Shiller BOS contracts outperforming the LAX contract (using the X20/ Nov 2020 expiration) by 2 (percentage) points. In addition I want to illustrate how one might look at intercity spreads, to new readers.

To recap, one can trade either side of two contracts outright, or an intercity spread between the two. Intercity spreads allow for simultaneous execution of a long and short on two different regions at a pre-negotiated point spread. There’s no risk of doing one side first, only to see the other move. In addition, IC spreads typically are quoted at tighter levels than legging two trades.

Such IC trades can be very useful if a trader has a view about one region vs. another, but who doesn’t want to take outright risk.^1

The following table illustrates the logic required to get to 2%. Contracts trade at different prices, so quotes are converted into percentages vs. spot. The BOSX20 (Nov 2020 expiration) contracts are quoted at prices that are 98.8/101.6% above spot levels. The LAXX20 quotes translate into 96.8/99.6%. The contracts are quoted at 6 and 8 point bid/ask spreads so to buy one/sell the other would mean working at reducing the total 14 point spread (from bid on one side to offer on the other).

However, an IC spread of 60.2 would allow the buyer to own BOS at 218 (+100.7%/spot) while selling LAX at 278.2 (or 98.7%) over spot, consistent with BOS outperforming LAX by 2% between today’s spot level and Nov 2020. On the flip side a 57.4 spread would allow a user to own LAX priced at 3% under BOS.

Someone who thinks that BOS and LAX will perform about the same from here through 2020 might consider buying LAXX20 at 60.2 over Boston (as the quote has out- performance for BOS price in, while someone who thinks that LAX will underperform BOS by more than 3% migth consider buying BOS at 57.4 points under LAX.^2

Note that this type of IC spread can be orchestrated on the CME for any pair of regional contracts. In addition, OTC spreads are possible for indices not covered on the CME.

Feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this blog, or any aspect of hedging home price indices.

Footnotes:

^1 Note will always be some outright risk as the contracts trad at different prices. So while an IC trade may involve the same number of contract lots, it may not involve the same notional value. That problem can be somewhat addressed by having more of one region than another, e.g. 5 vs 4.

^2 Note that CME spreads may be quoted with negative numbers. I’ve used positive numbers here as clearer for illustration.

CME reaction to post Tues Sept 25 CS#’s

Quotes on the CME Case Shiller home price index futures are mixed, and a hair lower, after this morning’s release of Case Shiller numbers. As illustrated in the table below, prices on the Nov ’19 (X19) BOS and LAX contracts are lower by one point, while the LAV and SFR contracts are higher. The HCI (10-city contract) is lower by 0.5 reflecting slight declines across the ten regions. Bid/ask spreads are almost back to pre-CS#’s.

While there have been no trades yet today, (with the turn in HPA) I continue to receive inquires from people looking to buy puts. (Most inquires are for 1-2 years for slightly out-of-the money strikes). In my Sept 21 blog I highlighted that options are now easier (for me) to trade across all ten regional contracts. I have a limited budget for put writing, so anyone looking to sell puts should have some pricing power.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on this blog, or any other aspect of hedging home price indices.

Thanks, John

Playing the Amazon HQ2 announcement

Many are waiting for Amazon to announce the location of HQ2, their new second headquarters. The thinking is that the “winning” city will see home prices soar in anticipation of the need to house thousands of new employees. While there’s been lots of buzz about what Amazon might do, there’s been little offered in ways to play this announcement. Calls on CME Case Shiller home price futures might be one tool worth exploring. (Note that there has been almost no trading in such CME options, but as market maker, I am looking to facilitate -at first by taking the other side – trading inquiries).

The two sets of tables and graphs below show information from the CME Case Shiller contracts on two of the leading candidates: 1) the Boston area, and 2) the Washington DC area. (Note that both areas are defined in the Case Shiller methodology and may/may not/ incorporate specific locations being considered by Amazon. However, each may be viewed a generally reflective of home prices for the broader areas of Boston and Washington.)

I’ve added quotes on the futures, as well as indicative offering levels on a variety of call options on those futures (see lower left of each display).

So, if one thought that home prices in the WDC or BOS area might pop, one might consider buying calls. I’ve shown contracts for Nov ’18, ’19 and ’20 expirations (the X18, X19 and X20 contracts) with strikes ranging from 220 to 250. (Other strikes and expirations are possible). As with most options, the more time to expiration and/or the lower the strike, the greater the premium.

As an example (and ignoring fees), if one bought a WDC 240 (strike) November 2019 (expiration) call for 4.5 points (at $250/point = $1,125/contract), and the Nov ’19 WDC contract settled at 250, then one would have a 5.5 point profit/contract (equal to 250 settlement price minus 240 strike minus premium of 4.5 points, or $1,375). While there has been no volume in either call, there also would be nothing limiting a call holder from selling the call before expiration, or hedging with the underlying futures contracts.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on this blog, or any aspect of hedging home price indices. As noted above I’m very interested in facilitating any inquiries, matching potential buyers and sellers, or in buying calls.

Thanks,

John

Revisiting ways to play the impact of a lower “Mortgage Interest Deduction” (MID

I had previously written about possible ways for market participants to play the impact of the prospects to changes in the Mortgage Interest Deduction (MID) in a blog on Oct 21 . Since this remains a timely topic, I again want to offer two opportunities for fans of the NAR’s (National Assoc. of Realtors) views, on how they might play the pending collapse in home prices in the higher- home price areas that have historically taken advantage of MID.

The first would be to enter either an OTC spread trade, or a total rate-of-return swap (TROR) on the difference between the performance of the Case Shiller 10-city index and the Case Shiller National index over some time frame. The CS-10 index contains many of the areas with higher-priced homes (e.g. NY, San Fran, Los Angeles) while the National index covers a much wider cross-section of the country that includes many lower-priced homes, where borrowers would presumably be less impacted by a cut in the ceiling in the amount of mortgage debt subject to the MID. The graphs to the right show the index values for the Case Shiller 10-city, 20-city and National indices (on top) as well as the year-over-year percentage changes in the indices.

Note that while the 10- and 20-city indices did much better in 2013, that the National index has recently been outperforming the 10-city index (i.e. 6.07% vs 5.33% for the last year, as of the October Case Shiller numbers released in Oct.) I would be open to an OTC trade on the differences between the index levels one-year forward (currently 216.5 on the 10-city index and 195.1 on the National index), or on the difference in percent gains (currently 74 bps) on the YOY gains in the National versus 10-city index.

While the above speaks to possible OTC trades, one can also take a more targeted view (by area) on existing CME products (i.e. Intercity Spreads). That is, one can “bet” on the performance of a particular regional index versus the Case Shiller 10-city index, if one truly believes that the areas with the highest priced homes will suffer relative price declines with the lowering of the cap on mortgage interest deduction.

The table above lists six regions that have both larger than average home values (using the Zillow ZHVI) as well as having regional CME Case Shiller futures contracts. (Note that while Zillow and Case Shiller geographic regions are not a perfect overlap, the ZHVI index does a good job of comparing the average prices to their national average. By any measure these six regions have higher-priced homes.)

In addition to a trader just outright selling the NYMX18 or SFRX18 contracts (X18= Nov 2018), they could also enter into an Intercity Spread trade where they simultaneously buy one contract and sell the other (in this case the CS 10-city index contract -HCI). This might be a more conservative play than just an outright sale as the end result will be a function of the difference between the two indices referenced in a trade. These IC contracts are listed where the bid side shows the price difference between where one might buy the HCI contract while selling the regional contract. So, for example, the -29.6 bid on HCI/SFR-X18, displays the bidder’s willingness to buy the HCIX18 contract at 224.8 while selling the SFRX18 contract at 254.4.

Note that the 224.4 price on the HCIX18 contract is 3.84% above the current spot level (of 216.49) while the SFRX18 price of 254.4 is 4.47% above the SFR spot index of 243.52. In effect, were one able to execute this IC trade on the bid side, one would be selling the SFRX index (for Nov 2018 settlement) with higher priced gains over the next 13 months, than the HCI index by 63 bps.

(The analysis in blue, shows the relative differences were a buyer to pay the offered side, in this case -28.0 points on the IC spread).

Note that if one were able to buy the IC spread on the bid side, they would be entering the trade at levels where in 5 of the 6 cases, the regional contract would be sold at a level with implied gains, higher than that of the regional contract. (The NYM contract is priced for lower price gains than the 10-city index).

Even if one bought the IC spread on the offered side, they would still be selling the BOS and DEN regional contract with higher priced gains than the HCI contract.

I am open to facilitating inquiries (or trades) on small amounts of such IC spreads to prompt further reaction to the MID debate. Please feel free to contact me (johnhdolan @homepricefutures.com) if you have any questions on this blog or any aspect of hedging home price indices.

Impact of “neutering” of mortgage deduction on home prices. A trading opportunity?

The Wall Street Journal had an article Tuesday morning (see link) titled “Mortgage Break Faces Irrelevancy” which outlined possible impacts from proposed tax changes. The author (Laura Kusisto) quoted several sources each of whom suggested that, under the current proposal, fewer taxpayers would be able to take advantage of the mortgage interest deduction, as they would find defaulting to use of the standard deduction (which might double) more attractive. (See WSJ illustration below graphically depicting projected changes in use of standard deduction across selected regions.) Based on that premise (and assuming that deduction of state and local taxes were also abolished), some (not-so-disinterested) parties, such as the National Association of Realtors (NAR), arrived at a forecast that, were the tax changes to be implemented, home prices would fall ~10%. (See the report the NAR commissioned from PriceWaterhouseCoopers here. )

When people make such outlier forecasts (most housing experts are projecting 4-6% gains in 2018) I like to remind them that the CME Case Shiller futures and options platform provide the best public, pure-play to financially express their views.

To recap the opopportunities for housing bears, or just for those who worry about increased volatility as the tax legislation gets debated, recall that:

There are futures contracts on the Case Shiller 10-city index, and ten more for each of the regional components. Six of the cities highlighted in the WSJ article have CME regional contracts. (Note 1 – regional definitions may not overlap. Note 2- transactions referencing other regions could be done in over-the-counter trades.) As such one can view forward prices, or take a position on an index that spans many regions, or, alternatively, if you believe that the high-priced coastal areas (that typically have higher mortgage balances and local real estate taxes) will be hit harder, trade the BOS (Boston), NYM (New York), SFR (San Fran) contracts.
There are 11 expirations for each contract to include quarterly contracts that mature in Nov ’18, Feb ’19 and Mar ’19. Since the contracts cash-settle (much like the S&P 500), contract prices should eventually converge to the index value at settlement. As such, some argue that, forward prices may incorporate some expectations of forward index levels.
The current CUS (10-city index) is 215.50, while the Nov ’18 is quoted 224.0/225.0 (or 3.9/4.4% above spot). That is, the market is priced for ~4% gains, so if you believe that home prices will fall (conditional on some events) you might expect to see a sharp price decline. This contract might be a way to express that, or just observe market reactions as proposed tax legislation moves forward.
In addition to futures, puts (and calls) can be traded on the CME platform. Strikes are quoted at 5-point intervals so one might look at the 215, 220, or 225 strikes. These are options on the futures so while they can be traded, they can only be exercised at expiration (European style).
Finally, if a trader thinks volatility will jump higher (or stay low), one can pursue many universal volatility strategies (e.g. buying/selling straddles, strangles, across strike combinations).

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions about this blog, or on the topic of hedging home price risk, or would like to discuss a trade.

Thanks,

John

Reaction of Prices at CME post Jan release of Case Shiller #’s

Quotes on CME Case Shiller home price index futures are higher across the board after this morning’s release of the November Case Shiller #’s.

Using the Nov ’17 contract (X17) as a proxy, mid market prices are up from 0.4 (in LAV and MIA) to 1.2 (BOS) and 1.7 (NYM). The price changes seem to be consistent with the gain in seasonally adjusted values for the indices (as both BOS and NYM seasonally adjusted index values were up over 1 percent from the prior month). Gains are slightly higher in shorter expiration contracts (e.g. BOS Feb ’17 (G17) is bid 2.6 points higher.)

Bid/ask spreads are slightly wider with most spread widening occurring in Nov ’17 expirations and longer. Bid/ask spreads on the front contract (G17) average 1.9 points, which is relatively wide with one month to go.

There were 15 trades yesterday (primarily in CHI and SFR contracts, and with a large share in the K17 expiration), but as of 11:30 EST (Tuesday) there have been no trades today. With 23 trades month to date, Jan ’17 looks to be the second highest volume since May 2014.

Recall that electronic trading for options for all regions starts on Mon. Feb 5. I, unfortunately will be traveling, so I hope to get involved the next day.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions about this blog or any aspect of hedging home prices.

Contrasting Pulsenomics Expectations vs. CME Forward Markets

I’d like to take the data and work done by two of my favorite sources (Pulsenomics and Getting Real) to further illustrate two points that I’ve been making here over the past few months.

First, as part of their quarterly survey of home price expectations across 100 participants (full disclosure, I’m one), Pulsenomics asked for opinions on how the home prices of 25 regions might perform in 2017. Their results are shown to the right. Please read their report for details on how they quantified relative price moves. For purposes of this illustration, higher (and positive is better and optimistic, while lower and/or negative is not).

Be aware that details of the regions identified (e.g. “Boston”), might be different than your understanding of that region, and important for later, the BOS Case Shiller index.

I then compared this tally versus the year-on- year gains for the these “regions” versus Case Shiller indices of the some name.

Observe (in the graph below) that the regions that have been identified in the Pulsenomics survey that are likely to do well in 2017, are typically the regions that did well in the last year (and vice versa). (FYI – 18 of the 25 regions used in the Pulsenomics survey have public Case Shiller indices. There are others, e.g. San Jose, but you have to subscribe to get them).

Real estate prices tend to have momentum, and so therefore this observation doesn’t surprise me, the current market for CME futures does not necessarily reflect the same high correlation.

First, note in the scatter diagram below that the forward prices for all 10 CME regional contracts (noted on the Y axis) falls below the red 45 degree line (with the slight exception of NYM). (FYI – To calculate the forward CME “prices” (in this graph) I took the mid-market values for the Nov 2018 contract and divided by the spot index (released in Nov). That percent gain is then converted back into annual gains). That is, forward HPA (as implied by CME prices) is much lower than gains over the last 12 months (measured with the X axis).

Second, there seems to be a reversion to the mean (in forward HPA) as forward gains for all contracts are converging to a narrow range (between +1.75-3.50%).

Third, away from any such reversion the slight outliers appear to be BOS (GE move?) and LAV (NFL/ beneficiary of construction?) while the below trend regions include CHI (pensions problems?) and the three California indices.

As I’ve noted (and conceded) in prior blogs, the California contracts seem out of line. While it could be that there are fundamental issues at work in California that I’ve not focused on. My contribution to this discussion is, that there may also be a seller who is larger than my potential interest in going long. In thinly traded markets, a small change in the balance between buyer and seller weight can have a disproportionate impact.

As I look to explain the California under-performance in the last few months, I can find lots of smaller hedgers that also want to sell. If there’s nothing “wrong” with the California real estate market, what do we need to do to entice prospective longs into dipping their toe in the longer-dated California contracts?

I’m happy to post any comments, share thoughts, or facilitate any trading ideas. Feel free to contact me (johnhdolan@homepricefutures.com) to discuss this blog or any other aspect of hedging home prices.

BOS-Patriots Day Graph

I mentioned earlier on my LinkedIn Group (CME Case Shiller home price futures) that I’ll be speaking this week at Babson College about these contracts. Between that, it being Patriot’s Day (a holiday in Boston when they run the Boston Marathon, among other things), and my desire to post a graph to the BostonBubble website page, I thought that I would provide a snapshot of the Boston market.

The BOS market has been somewhat orphaned for many months. There’s only 1 open interest (and that’s in the front May ’16 contract). I don’t get a sense of others weighing in with bids and offers. Those who want to make a very-wide geographical statement tend to gravitate toward the NYM contract (over BOS and WDC).

I’m surprised that there’s not more activity in BOS as: 1) there’s large young crowd that might want to buy a house a few years from now (who might consider buying futures against a pop in forward prices), 2) the move by GE to Boston should be impacting forward expectations, and 3) one of the rating agencies has observed that Boston seems more immune to economic downturns that other regions, yet forward BOS contracts closed (on a percent versus spot indices) lower than NYM and WDC (not shown here but can be viewed in monthly recap).

As with other contracts, I’m happy to facilitate trades (outright, calendar spreads, or intercity spreads vs. NYM or CUS). Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions or trading ideas.

CME activity post June release of CS #’s

CME markets have been mostly quiet this morning as Case Shiller numbers came out generally in line toward CME quotes for the Aug ’15 contract. The two exceptions seem to have been in the BOS and SDG contracts where Nov ’15 contract prices have dropped sharply (as shown in the table below). There was one trade in SDGQ15 -the only one at the time of this report.

On the other hand, LAX and DEN prices moved higher as upward price momentum (at least in the non-seasonally adjusted numbers) continued.

Bid/ask spreads have recovered to yesterday’s levels after wider quotes before and after the 9:15 release. While spreads are about the same across all regions and all expirations today, on the month bid/ask spreads are much tighter -particularly in the CUS and CHI contracts, as well as the Q15 and X17 expirations. (I am traveling the next few days so I may not get the June recap out until during the July 4th weekend. Please contact me if you’d like to see a specific table earlier.)

As today is month-end expect some filling in of prices on less-frequently quoted contracts and a sharp pencil being taken to some calendar spreads. Any help would be appreciated as the tighter the month-end quotes, the better the contracts look when I go to market them.

If you have any questions please contact me @ johnhdolan@homepricefutures.com . I’m hoping that my tech and email problems are behind me as I’ve transitioned to a new server.

Recap of CME contracts post June release of Case Shiller #’s

The complacency of prices in the CME contracts got a mild shock yesterday with the June release of the April Case Shiller indices. Prior to Tuesday there had been no trades in June (that I was aware of) and very few meaningful price changes. That changed when the S&P announcement of the Case Shiller numbers revealed weaker than expected (by the market) results.

(While use of the contracts in longer-term hedging is a goal, the reality is that the bulk of trades currently take place in the front contracts. As such, I’m going to focus my comments there.)

The table below shows historical CS indices (available prior to Tuesday morning, so without any revisions), bids, offers and mid-market levels for the Aug (Q14) contract from Monday’s close, and then mid-market levels for about 3:30 on Tuesday afternoon. With the exception of the BOS and CHI contracts, most Q14 contract prices ended up lower on the day.

A comparison of the June (release) CS #’s versus the May release and August contracts may shed some light on the degree of the “surprise” to the market.

The red horizontal bars in the candle graph to the right show how much (on a percentage basis) of the difference between the May (release) index levels and the (higher) August mid-market contract prices was eaten away by the June (release) CS #’s.

Now I’m not arguing that a linear interpolation between May and August is what the market should expect. Between seasonal factors, momentum, and the impact of moving averages, getting from May index levels to Aug mid-markets is not a straight line.

In addition, there’s nothing that says that the Aug contract prices are correct. That said, if the market believes in Aug prices, CS indices somehow have to get to Aug levels from May.

As the graph indicates the impact of the June numbers ranged from near zero (NYM) to ~50% (BOS) of the difference between May and August mid-markets. Checking back to the first table, BOS contract prices jumped, while NYM (and LAV, LAX and SDG) sagged. Net – new information (the June CS #’s) resulted in a shift in market prices.

Looking forward the August (Q14) contract levels are consistent with further upside in the Case Shiller index levels across all regions over the next two months.

Again, these are just observations and I will leave it to others to opine on importance of seasonal factors, momentum, etc.

I would highlight that not only do the BOS and CHI contracts have the highest % gains priced in, but those were the two contracts that traded yesterday.

Net, Aug ’14 prices are consistent with an expectation that journalists will be reporting that “Case Shiller index levels increased this month” for the next few months.

I’d be happy to discuss my interpretation of these 3 illustrations in more detail, or to hear from those that have views that are outside the price forecasts implied by the August contract prices. Feel free to contact me (johnhdolan@homepricefutures.com).