CHI – HomePriceFutures.com

Moving? A potential application of Inter-city (IC) spreads

Redfin recently published a great piece that detailed how some residents look beyond their local area for their next house. They noted that many many people in a region look at the same next cities (sorted both by in-state and out-of-state searches) with certain marked preferences. For example, many LA residents eye San Diego, New Yorkers frequently consider Boston, and Denver homeowners seem to covet Seattle’s low taxes.

The graph below (from Redfin) show the net flow of users searching for other regions. (Net flow is the number looking to leave versus the number looking to take up residence). Seattle has recently re-taken the award for most people looking to move there, while Denver residents are looking elsewhere in larger numbers. This is interesting data to those who believe that population flows are a key component to changes in home prices.

Residents moving from one region another may face the risk that home prices will fall where they live, while rising where they want to move. Fortunately, my analysis suggests, and other research confirms, that home prices on many of the common pairs that Redfin identified are highly correlated, using region-wide measurements. ^1 For example, using YOY changes in Case Shiller indicies, the LAX, SDG and SFR regions have all been >90% correlated since 2013.^2,3 Surprisingly (to this former Connecticut resident now living in DC) the correlation across the three Northeast regions is not as strong, ranging from as low as 43% between NYM and WDC, to >75% between BOS and NYM and WDC.

For those in the later categories, intercity spread trades may be a useful tool for going simultaneously short futures on the region they’re leaving, while going long on the region to which they hope to move.^4 In effect, users might be able to hedge some of the risks of their move.

The table below lists (on the left side) the top 6 interstate 2018 transitions highlighted in the Redfin highlighted report. (I’ve added the intrastate move from LA to San Diego, as there are CME contracts on both). While the Redfin article has much more detail on the net number of people moving, my contribution to this discussion is to share how the CME markets (using the Feb ’20 contract to capture 2019 year-end values) might be used to possibly hedge these moves.

First, here’s a few explanations and observations:

For both the “From” and “To” cities, I’ve listed the current spot index, the bid, ask, and mid-market for the Feb ’20 (G20) contract on each city, or levels that I’d consider OTC trades (i.e. for Seattle, and Phoenix -highlighted in yellow)^5. The “Mid/ Spot -1” columns show the difference (in percentage terms) between the spot index for each city (both “From” and “To”) versus the spot index for each city.
Note that between the pairs of “From” and “To” cities, there are a total of 10 cities, and that for all but 3 (Seattle, Denver, and Phoenix) the “Mid/Spot -1” is a negative percent. Recall that the CME figures (at least for one-year forward contracts) don’t necessarily represent expectations of lower prices. The bids and offers are just levels that traders are willing to buy or sell contracts.
Note that in 6 of the 7 moves that Redfin highlighted, the “Mid/ Spot -1” value is higher in the destination city. (The difference between the two is shown in the “Diff” column.) Thus, it seems that either people may be moving to the more booming cities, or the act of people moving to those areas is correlated with better performing home contracts (as measured by the “Mid/Spot -1” metric.
Note that, the San Fran to Seattle move looks to have the biggest “payup” (i.e. going from a region where these quotes would be consistent with the SEX (Seattle) index outperforming the SFR index. By contrast, the move from Washington DC to New York, seems like the best bargain, as these quotes are consistent with WDC (Washington DC) index prices falling slower than NYM.

Finally, I’ve added levels where I’d be open to an intercity spread trade. For example in the NY to Boston move, the difference between the NYM and BOS “Mid/ Spot -1” numbers is 1.85%. Since both regions have a CME contract, I’d buy a NY contract while selling a BOS contract (a pair someone moving might be interested in ) where Boston outperforms NY by 3%, or go the reverse (buying Boston/ selling New York) where Boston outperforms by 1%. (See example below).
I’ve not posted this particular IC trade (or any of the others) as best orchestrated off-exchange, or users will need access to a broker who can execute IC trades.
While I’ve focused on the pairs Redfin highlighted, and for the Feb ’20 contract, in concept it’s possible to construct any other pairs of indices, for any other expiration.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss any aspect of this blog, want to move forward with any of the IC proposals discussed, or have questions on any aspect of hedging home price indices.

Thanks,

John

Footnotes:

^1 This might be no surprise as the people that like the attributes of one region seem to see similar attributes in another.

^2 Recall that correlation means that they move in the same direction at the same time, but not necessarily by the same amount/percent.

^3 Note that these are changes on the index, not any particular expiration of a futures contract.

^4 Even for those moving between two highly correlated regions, futures might be a useful tool should one be increasing/decreasing exposure.

^5 Contact me for details on how one might trade any home price index, not listed on the CME.

Time for another example of quarterly expirations/convergence example

The August 2018 (Q18) contracts will stop trading on Monday Aug 27 at 3 PM Eastern (note one hour before other contracts), and will be cash-settled on the Case-Shiller index values released by S&P on Tuesday Aug 28. Recall that this August release of CS #’s covers the period April, May, and June. Since the contracts cash-settle in just over a week, and since the index calculations are done on home transactions that have already taken place, it can be argued that (for the most part) buyers shouldn’t pay more (on the Q18 contracts) than they expect from the index release on Aug 28, while seller should not sell for less. As such the CME quotes might offer an excellent tool for (at least short-term i.e. next week’s) bracketing forecasts.

However, despite the fact that all data for Case Shiller index calculations is already available, in most quarterly expirations there typically are a number of index results that “surprise” this market. ( I define a surprise as an index that is either lower than a bid, or higher than an offer, from the day before. In theory, that shouldn’t happen, but it consistently does on some number of regions.)

The chart below includes historical index values, yesterday’s quotes on all 11 regions (one for the HCI-10 city index, and one for each of the ten components), and the bid/spreads. Bid/ask spreads average just under 1.0 across all Q18 contracts. (This is slightly tighter than historical average.) Note that the DEN contract was 216.8/217.0 for the minimum 0.2 spread. On the other hand, the SFR bid/ask spread is the widest.

Finally, I’ve shown the mid-market price for the Q18 contracts versus the index value from a year ago. The percentage gains show LAV and SFR CME quotes as consistent with > 10% HPA (looking backwards), while the CHI and WDC contracts are priced at levels consistent with those regions having (once again) the lowest HPA of the ten regions.

I’ll compare the actual Case Shiller numbers against final contract prices and will also offer my perspective on how forward contracts (X19) react, around mid-day on the 28th.

In the meantime, please feel free to contact me (johnhdolan@homepricefutures) if you have any questions on this blog, or any aspect of hedging home price indices.

Thanks, John

Approaching May ’18 expiration w/convergence => CS (10-city) HPA expectations (6.4%)?

Every quarterly expiration of a CME Case Shiller home price index contract is an opportunity to remind readers about the cash settlement features of these contracts, and how quotes on the expiring contracts might be used to get a sense of “market-implied” HPAs.

For example, the table below shows (in red) the most recent Case Shiller indices for the HCI (10-city index) and for each of the 10 regional components. Below there is a section that has quotes on the 11 CME home price index contracts. I’ve average Bid and Ask to create a mid-market level (“Mid”). Note that all Mid’s are above the current CS index.

Further, I’ve compared the Mid values on the contracts to the index level from a year ago (i.e. from the release dated May 31, 2017) to generate a percentage gain. If the Case Shiller numbers released on May 29th are close to these Mid levels, then these percent changes should be the year-on-year gains that you’ll read about in press reports that day. The headline that day should be that the 10-city index rose ~6.4% on the year and that, once again LAV (Las Vegas) will be the best YOY performer and CHI (Chicago) and WDC (Washington, DC) indices will be the laggards.

So (rhetorically) what gives these mid-market values credibility as projections on the upcoming Case Shiller release? The answer is that the May ’18 contracts will settle on the index values released this month. So, to pick an example, if someone “knew”, had researched, or just had a strong view that the Case Shiller NYM index for May will be 199.4, they could buy a futures contract at 198.4, and pocket the $250/point/contract difference when the 199.4 number printed. (Not a bad return for 3 weeks exposure when required margins might be as low as $2500.) Alternatively, if they believe the actual number , is lower (e.g. the 197.9 mid-market value) they might also try to be the best bid (in case there’s a sale) and bid greater than the current bid of 197.4.

If they were had much more bearish views they could do the opposite, either hitting bids, or offering lower.

The point is that this market allows both bullish and bearish predictions to play out in a (theoretical) way, such that bids and offers should reflect conservative expectations. Buyers will bid where they think that can make money (versus their expectations), while sellers will do the opposite. Net, bids and offers, when averaged (i.e. to the mid-market levels) should do a reasonable job in revealing market expectations, for such short time frames.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any question about this blog, or any aspect of hedging home price index exposure, or would like to discuss a trade.

Thanks, John

CME Market reaction to CS #’s (Jan 2018 release)

Quotes on CME Case Shiller home price index futures were generally higher on Tuesday, albeit with wider bid/asked spreads, following the January release of the Case Shiller #’s for November. As highlighted in table below, the big movers were the California contracts (w/ SFR much higher, and SDG lower) and CHI (much lower). (Note, I’m using the Nov ’18 – X18 – contracts for illustration. In general price movements were of a similar direction along the expiration curves, with longer-dated contracts, particularly SFR offerings, moving more than shorter-dated contracts.)

There were 3 trades -an outright CHI trade, and a CUS (10-city index)/CHI Intercity trade (that showed as two legs).

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

Thanks, John

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.

First Option trade for 2016?

I believe that the CME markets saw their first option trade for 2016 over the last few days. Eighteen puts on the CHIQ17 120 strike traded (FYI CHIQ17 = 134.6/139.4 today) at 2.0 points.

This trade played out in a manner consistent with other inquiries. A buyer of slightly out-of-the money, relatively short-expiration puts approached me looking for a hedge to certain real estate exposures. We negotiated prices offline and then executed trades on the exchange. (I have to give a shout out to Insignia Futures for their willingness to post and clear option inquiries.)

Consistent with other inquiries – and out-of-the money options in general – while both parties believe that CHIQ17 settling below 120 is low probability, there may be benefits to the put buyer in hedging (e.g. lower interest rates on bank lines, smaller loan haircuts due to their bank perceiving a reduction in tail risk, or just peace of mind).

I’m open to seeing if there’s further interest in this option (and the market is 1.5/2.5 5×5 today) or others. As noted before I am in touch with other parties with potential interest in buying puts on LAX and MIA indices. Recall that while LAX (and CHI, CUS and NYM) are electronically listed, options on the other 7 Case Shiller regions with futures (i.e. BOS, DEN, LAV, MIA, SDG, SFR and WDC) would have to be traded ex-pit and for a minimum of 20 lots.

My sense is that put prices look relatively attractive versus the >$10 billion credit risk transfer (CRT) notes that both FNMA and Freddie Mac have issued over the last years as 1) the term is so much shorter, and 2) CRT bonds are exposed to tail risk, while for a put to go “in the money” the entire index has to drop a meaningful amount.

Feel free to contact me (johnhdolan@homepricefutures.com) about this blog, or any other aspect of hedging home prices.

Basics _Bid Ask spreads for Case Shiller futures contracts

My last blog talked about which contract expirations get most of the (limited) trading. This one shows (see table below) where the tightest bid/ask spreads are (today). That’s important as the markets with the narrowest bid/ask spreads tend to be the ones with the greatest likelihood of a trade. After all, if a buyer and seller are 4 points apart the difference may be too much to surmount, or there may not be market events that would cause a buyer or seller to change their price so much very quickly. However, a market with a bid/ask spread of 0.20 points (the minimum price move) might result in trade should either side (assuming that the bidder is not the person offering) should either party changes their mind even slightly.

The table also shows that there are two-sided markets in all contracts out to Nov 2017, but after that only in a few contracts (ones that I think other traders might have an interest). (Note that a new Aug 2017 contract will appear when the Feb 2016 contract expires.)

The two tightest bid/ask spreads (by expiration) are highlighted in green, while the two widest are highlighted in red. I try to keep the CUS (10-city index) as always one of the tightest bid/ask contracts as CUS contracts are of national interest and they can be used as one side of Intercity (IC spreads). Bid/ask spreads are shown in points, so lower-priced contracts (e.g. CHI) might show up as one of the tightest contracts, but not necessarily on a percentage basis. Conversely, any higher priced contracts that show up on the tightest list, will be even more relatively tight on a percentage basis.

Bid/ask spreads tend to widen the longer the time to expiration, but not uniformly. As I’ve noted in other blogs the November expiration contracts are outstanding the longest, are the only contracts for hedging 3+ years, and thus tend to have the most open interest and tightest markets.

Some contracts might have wider bid/ask due to volatility (e.g. SFR) but some are wider just because they don’t seem to get much interest (e.g. DEN, and LAV).

I’d appreciate any help in narrowing any of these spreads with bids and/or offers or feel free to “adopt” one contract (or region) and make the markets yours.

Feel to contact me (johnhdolan@homepricefutures.com) if you like to chat about this table.

Option Quotes

Here’s my long overdue template for option quotes. I wanted to get this done for the month-end report AND to inquiries I’ve had for HCI (CUS 10-city index), LAX and NYM contracts. (I figured that I’d toss in numbers for CHI to show all four regions where one can post electronic quotes).

Note that my focus (and the inquiries) has been on slightly out-of-money puts for the Nov ’17 expiration. Any other permutation of (round) strikes, expirations and puts vs. calls is possible. However, I think that the futures contracts already suffer from enough fragmentation of interest, so I’m going to focus on these four contracts for now.

The HCI and LAX quotes are 5×5, but I’ve only 1×1 on the others to get things started. I’m open to quoting prices on larger amounts.

(Again, options can be cleared at the CME but they have to be done ex-pit and for a minimum of 20 lots. Feel free to contact me for details.)

Users will need to decide what kind of option pricing model they want to use. I’ve teed up my belief to some academics that while the Case Shiller indices are both a) highly auto-correlated and b) can’t be shorted (or bought and carried) that options on the spot indices might be challenging “although some retail products do reference spot indices. By contrast, data on the closes of futures contracts makes price moves look pretty random, and you can hedge options vs. futures (e.g. delta hedging) so option models might work. (That said, I might consider different estimates for vol as go longer, or skew as you go way out of the money. All the more reason to stick to near at-the-money, relatively short expirations.)

The topic of options is both theoretically interesting (to me) and seems to be an area where there is client interest. I’d be very happy to brainstorm with someone on the topic and/or to tout any trading axes. Please contact me (johnhdolan@homepricefutures.com) if you care to talk about either.

If I live in Chicago, I live in Illinois….could that be a problem for home prices

I have a side interest in public pension plans so the news from Chicago over the last few days (that Illinois is struggling to deal with one of this country’s most underfunded (as a %) pension plans NY Times article and that Chicago debt was downgraded to junk Chicago Sun Times article) was not a surprise, but a wake-up call/reminder that underlying financial trends may have long-term secondary consequences. In the end, for Chicago to place debt going forward, it would seem that either pension benefits have to be cut, other budget line items reduced, or revenue raised (as Chicago, unlike the US Government, can’t print currency).

Now even if only one of the three categories could solve Chicago’s fiscal woes (and I doubt that), I’m not going to suggest which is more likely, or “right”. I would highlight to readers here that revenue increases are often associated with higher taxes, and that taxing things (or activities) that are captive are often viewed attractively by those charged with raising revenue. That leads me to a concern about home prices in the CHI index over time. (After all, wage earners, companies, and shoppers can move to avoid personal income, corporate and sales taxes).

Now I don’t often express market views, and clearly what’s taking place in Illinois is not unique (California has similar pension issues and both LAX and LAV are dealing with potentially crushing water issues). However CHI may reach a level (similar to upstate NY) where real estate taxes become a higher cost to homeowners than their mortgage! The combination of a 4% mortgage (on 80 LTV) plus 4% tax rates (on 80% assessed values?) might present of formidable headwind against the ~15% gains implied by CHIX17 prices.

I would imagine that much of the CHI index gains (as with other regions that experienced distress) over the last few years has been a function of the % distressed being sold at deep discounts dropping. Gary Lucido’s Getting Real blog is great source for following the CHI real estate story. This graph to the right is from his blog and is shown here to illustrate how far the “% distressed sales” have fallen. Can it fall much further, and if not, might the absence of that tailwind show up in lower HPA?

Finally, while the Chicago/Illinois problems are well known, forward CHI prices reflect higher % gains that the CUS index. The three Northeast regions (BOS, NYM and WDC) are all priced at levels consistent with slower gains by Nov 2016 than the CUS index. What makes CHI unique among “winter” cities?

As market maker I’m happy to foster trades that would allow someone to sell CHI outright (or on spread vs. CUS) or to allow CHI bulls (pun intended) to express even more positive views.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions about this blog or hedging home prices in general. In addition, I encourage you to follow Gary’s blog.

CME Futures -Post April CS #’s

Prices of CME housing futures were generally higher after this morning’s release of the February Case Shiller indices.

By the close, prices moved higher (as measured by mid-market levels) in 9 of the 11 contracts (all but BOS and LAV). Advances were lead by the 3 California markets (and Miami). (Note that the SFRX15 price of 218.0 form April is a quote from a the 26th. There was no offered quote at the close of the 27th. Note also that the CS index history does not include any revisions posted today).

In several cases offers moved up much more than bids, resulting in wider bid/ask spreads 7 contracts. Much of the spread widening took place in the X16 and X17 contracts as bid/ask spreads for the HCI X16 and X17 contract widened. The X16 contract is one leg of several IC (intercity spread) orders so wider HCIX16 quotes spilled into other regions. (Note: this is the first time over several months that HCIX16 closed with wider than a one point bid/ask spread. I could use some help tomorrow on that single contract.

There were trades across the three front CHI contracts and the first two HCI contracts. There was a flurry of quote changes in CHI and DEN so those might be the two likeliest contracts to trade tomorrow.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions.