CUS – HomePriceFutures.com

Pricing of longer-dated contracts- imbalance or opportunity?

There’s been an ongoing inconsistency between forward prices in the CME Case Shiller futures, and the quarterly Pulsenomics survey of home price forecasts. CME futures (at least those for 2020 and beyond) are priced at levels that appear to have a much less bullish outlook than the Pulsenomics surveys. There may be several reasons for this (to be touched on below) to include that the risks associated with futures trading (at least versus participating in a survey) have created an opportunity for those who embrace the survey results.

To be clear, I am a huge fan of the Pulsenomics survey (as well as a contributor). I’m just highlighting this inconsistency to prompt discussion, and hopefully more trading in CME futures.

Prices for the rolling 11 expirations of Case Shiller futures have been consistent with sharply declining HPA (post 2020) for at least the last year. The graph below shows the YOY gains for the published Case Shiller indices in black. To the right, marks show bids and offers on futures contracts (either against historical index values -e.g. Aug ’18 contract vs. index value released in Aug ’17 – or for one futures contract versus another -e.g. Nov ’21 contract vs. Nov ’20 contract) are shown. Note how YOY gains (using the mid-point between bids and offers) trends down to 1% YOY price differences for 2021 vs. 2022. (The low level of YOY gains is even more pronounced in the SFR -San Francisco -contracts).

By contrast a review (see diagram below) of the Pulsenomic survey results for 2018 Q2 show a much less gradual decline in explicit expectations. CME quotes fall from having ~6% YOY gains priced in for the Nov ’18 contract (vs. the index released in Nov’ 17) but then fall to ~1% in 2022, while the Pulsenomics survey of expectations tapers off to about 3%.

Now I appreciate that there are differences between Case Shiller and Zillow indices, and that the Zillow survey represents contributions from around May -while the CME prices are today, and finally that CME bar chart values are comparisons of the CME quotes on the November expiration cycles (thus referencing the September Case Shiller index) while the Pulsenomics survey is for year-end index estimates. That all said, the observation that longer-dated CME contracts appear to be priced at levels that are much less bullish that the survey results of 100+ economists, seems valid.

I’ve spent the last few months wondering if there is a technical issue driving this, or do longer-dated CME contracts represent a good risk/reward versus expectations, or is there some other factor. I offer no concrete views, but here are a few things worth considering:

There are few parties involved in the CME futures. I’m often on both sides of many markets. The prices I’m willing to buy/sell could be “wrong” (air quotes).
The vast majority of inquiries I receive (or where I’m asked to trade) typically involve individuals looking to hedge. Thus in the small world of CME trades that have existed over the last few years, it may be that the capital looking to be deployed on the sell side is larger than the capital I’ve been willing to deploy on the buy side. As with #1, the arrival in this market of a large participant on either side might move prices up (or down).
The markets could be turning (as many have long touted). Toronto and Sydney -two previously frothy markets -have both turned lower.
Does having “skin in the game” (i.e. traders with positions) allow for different result from surveys?

Markets are wonderful platforms for traders to observe, debate and actually trade. Trading tends to increase when markets turn, or when there are stronger differences of opinion. Is this one of those times? Are longer-dated contracts distorted by an imbalance of hedgers, or do longer-dated contracts represent an opportunity to “lock in” lower than historical gains? Will rising rates, and/or inflation, be kind or harmful to home prices? Should surveys or markets guide forecasts (or both)?

Please join what looks like an ever-more vigorous debate. Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions about this blog, or any aspect of hedging home price indices.

Thanks, John

Recap of activity in CME Case Shiller futures for July

I just posted an 18-page recap of (the very limited) activity in the CME Case Shiller futures for the month of July. There are pages with tables of recent outright prices, and price changes, calendar and intercity spread quotes, indicative option prices, and volume and open interest (OI) figures. The recap can be found in the Reports section (along with some background material and historical reports) or can be linked here.

The key points from July report include:

–There were 5 futures contracts traded in July in 2 regions (DEN and SFR) across 3 expirations. (4 of the 5 trades were in SFR contracts). Volume has been very low for the last 12 months, but with more commentary on social media about a bubble, and ever-tighter bid/ask spreads, I remain optimistic that trading volume will increase dramatically.

– There were no options trades. The recap has a page showing where I’d be open to buying/selling puts on one-year forward, at-the money strikes (but recall that any options -both puts and calls -can be arranged for any region, for any expiration, on any 5-point interval). I’d be happy to respond to any option inquiry and/or to tout any “trading axe” that a reader wants to share.

–Despite low volume, activity (third parties bidding and offering) picked up, especially in SFR. The SFRX22 contract had at least 3 parties bidding and offering, and was quoted much of the month with <3 point bid/ask spread.

–For July, bids and offers were higher across many regions (except DEN, NYM, and SDG).

–There were 2-sided quotes in all 121 contracts, for most of July. While most quotes are 1×1 (one lot bid vs one lot offered), I’m open to facilitating retail-sized inquiries (up to 10 lots) in any contract. (A benefit of two-side trades is the resulting graphs showing YOY implied price changes). I’m preparing a blog for later this week detailing observations on forward implied YOY price gains/HPA, with a focus on opportunities in calendar spreads.

–Bid/ask spreads tightened slightly across all expirations. Spreads on the front contract (Aug ’18) are just over 1.0 point (about normal with one month to run), while bid/ask spreads on the Nov ’18 contract (which has been my benchmark contract for the last year) are tight at 2.0 points. The CUS, DEN, and SFR contracts have the tightest bid/ask by region due to recent trades and interest from other traders. By contrast, LAX, SDG and WDC (all regions with low OI) have the widest bid/ask spreads.

–OI on futures rose from 39 to 44. There are three regions (BOS, MIA and WDC with no OI. I’d be eager to accommodate any trade in those regions.)

–Home price index futures for Paris are still on schedule to be rolled out this fall. Key to the Paris contracts is much more narrowly defined geographic reference region. See tab “Paris Futures” for more details.

–I’ve received inquiries on hedging Seattle risk, which since not listed on the CME will require an OTC trade. Seattle presents an interesting trading opportunity as it’s had some of the highest home price gains, but some worry about a bubble. I’m looking for OTC counterparties for either forward or option OTC trades.

–Additionally, with so much interest in SFR, I’d like to hear from any looking to engage in an SFR options trade (put/call –either side.

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

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

Dec/2017-recap posted

I’ve posted a brief recap of activity in the CME Case Shiller home price index contracts to the Reports section (or you can access here).

Highlights include:

–There were 3 futures contracts traded in Dec. in 3 regions across 2 expirations. There were no options trades.

–Volume for futures and options during 2017 (182 lots) was higher than 2015 and 2016 primarily due to increased in options trades. That said, activity has slowed dramatically over last 3 months.

–For Dec, bids and offers generally rose across most regions and expirations (except ask side of MIA).

–Bid/ask spreads were about unchanged

–Front contract (G18) bid/ask are just under 2.0 points.

–At month-end, there were bids in all 121 contracts, and two-sided quotes in all contracts out to Nov ‘19, and then X20.

–OI on futures and options remains unchanged at 34 and 17.

–OI remains very concentrated in November expirations (74%).

–Put writers still needed! I sense that options trading is the way to grow volume, as strong retail preference for taking one-sided risk exposures.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you care to discuss any aspect of this post (or the recap) or any other aspect of hedging home price indices.

Best wishes for a healthy, happy, prosperous 2018!

John

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

Mid-month option update

There’s have been 7 options trades this month (to go with 10 from August).

Here’s a table of my suggested offering labels. (Note table was updated for current spot values on Sept 21). Again, given the huge number of potential contracts (combining strikes, expirations, puts and calls) I’m only going to be posting a few live prices (mostly in the HCI-10 city index contracts). Also, note that while I’ve generated quotes via a model for this table, actual prices might vary.

Finally, note that these quotes are for relatively short-term, slightly out-of-the-money strikes. Other expirations and strikes are possible (as well as calls.)

Feel free to contact me (johnhdolan@homepricefutures.com) if you have a question or trading axe.

Thanks, John

California falling, or an opportunity?

Since home prices turned up in 2012 the California markets (i.e. LAX, SDG and SFR indices) have consistently outperformed the CUS-10 index.

The graph (to the right) shows year-on-year percent changes in the CUS-index (in black) along with those for LAX, SDG and SFR. It has been a near truism for the last 4+ years that the rebound in California home prices has outperformed the CUS-10 index.

However, recently, pressure on longer-dated California CME futures prices has resulted in levels that are consistent with the California markets under-performing the CUS-10 index.

The chart below shows contract values for CUS-10 and the 3 California regions for the Nov ’17, ’18, ’19 and ’20 expirations translated into percent changes versus spot levels. (The height of each bar is the bid/ask levels and the mid-market value is shown with a green bar).

Note that the CUS bars are all higher than the California markets (barely so for LAX, but with obvious premiums over SDG and SFR). Net, the CUS-10 index is priced at levels that would reflect California index values under-performing over the next four years.

Now, as I noted in my monthly recap, this could be due to a variety of fundamental factors but I have two thoughts: 1) Given the lack of trading the contract prices have been weighed down by someone looking to sell, and 2) There is an opportunity to either buy the California markets at relatively (to the CUS 10 contract) cheap levels. In fact, if one doesn’t want to take outright risk the IC spread market (where one enters an order to simultaneously buy one contract (e.g. SDGX20) while selling another (e.g. HCIX20) at a predetermined spread, might be an attractive alternative.

Markets vary from fundamental values for a variety of reasons and order imbalance is often one (particularly in such a thinly traded market.)

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this theme, or any aspect of home price derivatives.

Pre- Nov ’16 expiration

The CME Case Shiller home price index futures expire four times per year (Feb, May, Aug and Nov) settling on the index values released on the last Tuesday in month of expiration (so Nov. 28 this month). While longer-dated futures prices can be influenced by many things (e.g. order imbalance, desire to hedge, relative value to other markets) as expiration approaches, many argue that contract quotes should converge toward traders’ expectations of the indices to be released. The graph to the right illustrates the convergence that has been playing out in the Nov ’16 contract.

As the Nov ’16 contracts expire next week (last day of trading is Mon. Nov 27), we can look to CME quotes to infer what traders might be expecting from next Tuesday’s Case Shiller numbers (upon which any open positions are settled). Recall that the data used in the November Case Shiller release is compiled from July, August and September, so there is no “new news” over the last few weeks, that should influence Nov ’16 contract prices. As such, if a research firm determines that an index will be released on Tuesday with a value of 200, that firm might be willing to bid for contracts at 199 and offer contracts at 201, as every point difference is worth $250 per contract. This process of faith in one’s forecasts, should drive contract prices to convert to Tuesday’s numbers.

The chart below highlights the recent history of the Case Shiller CUS-10-city index and each of the ten regional components. Below that are recent quotes from the Nov ’16 contracts. Since those contracts settle on Tuesday’s numbers, the quotes should bracket expectations.

Note that for each contract there are bids, offers and mid-market value is calculated. Bid/ask spreads are all inside 0.6 points, which is slightly tighter than “normal” around contract expirations.

At the bottom of the chart are 1-month, 3-month and year-on-year percentage differences ASSUMING that the mid-market levels match next Tuesday’s numbers.

As such, you can imagine next week’s headlines (e.g. “Home Prices up 4% on the year”, “Denver leads housing markets”, and/or “New York market continues to lag”).

I’d note that the 2-3 trading days before Case Shiller numbers often brings a slight uptick in interest (others weighing in with quotes) and trading. After all, Trader A might have a different expectation than Trader B of next week’s CS numbers and their difference in quotes will likely have nothing to do with other markets or home prices next week.

So, I’d encourage all to review the Nov ’16 quotes and to evaluate them against your own expectations. While bid/ask spreads are relatively tight, there have often been cases where the actual Case Shiller numbers fall outside these ranges (what I label a “surprise” to the CME markets). Stay tuned to see how many surprises there are next week.

As always, if you’d like to discuss this blog or any aspect of hedging home prices feel free to contact me (johnhdolan@homepricefutures.com).

How to trade on possible impact of Trump election on home prices

Much has been written elsewhere on the possible impact of a Trump Presidency on home prices. There are macro issues (e.g. mortgage rates and the fate of the GSEs) as well as possible relative value regional issues (e.g. who will benefit from increased spending on infrastructure vs. who will be taxed to pay for it). I leave all of those very timely, important discussions for others to host.

The angle I’d like to address here, is “how does one express a view (financially) if they feel a certain way on either category of issues?”

This is where CME Case Shiller home price futures may play a role in two different dimensions.

First, outright market levels, across the CUS 10-city index and each of the ten regional components, allows one to express an opinion on the absolute level of any particular index. I’ve picked the Nov ’18 (X18) expiration series as: a) two years should be enough time for any changes to play out, b) it’s the longest contract (by expiration) that has regularly had two-sided markets, c) comparing Nov ’18 to today avoids much of any seasonality (but not all) and d) more germane to the second point I’ll make, there are intercity quotes for all regional pairs with the CUS 10-city index.

The chart below takes the CME quotes and converts bids, asks, and mid-market levels into percentages versus the spot index. The “cold” areas (e.g. the Northeast, Chicago and Denver) are to the left, the HCI (CUS 10-city index) is in the center, and the rest are to the right.

Note that all 11 contracts are priced at levels that are about 3-9% above spot levels. Implied HPA has slowed but has not turned negative. DEN and LAV are priced for the highest gains, while NYM, WDC and CHI look weaker.

One can trade any of these contracts on an outright basis, particularly if they have a view on home index changes over the two years that are different than this chart reflects.

However, and this is my second point, there may be traders who are not comfortable with an outright view but they have certain strong ideas about future levels of one region versus another. For example, some might argue that President Trump might be positive for LAV (home to construction workers), DEN (extraction industries) and MIA (where he’ll likely spend time) and less so to WDC (smaller government) and California.

The middle bar in the candle bars below express (a version of) the differences in the above chart – shown as CUS gains minus regional gains – hence DEN is shown as negative as CUS gains are lower DEN.

The top and bottom value to the candles are the implied gains from quotes on intercity spread contracts. That is, one can enter into a trade where one can simultaneously buy (or sell) the HCIX18 (10-city index) contract while selling (or buying) a regional contract, at an agreed upon spread.

While those spreads are quoted in terms of points, one can convert those point differences into implied percentage differences. (See my Sept 28th blog for a more detailed explanation of IC spreads.)

With IC spreads one can express a view about relative price moves with much less outright risk. Note though, that as with outright trades where it’s not enough to think that home prices will be higher two years from now, as that’s already priced into the X18 quotes. The same theme applies here. That is, it’s not enough to think that MIA, LAV and DEN will outperform (or NYM, WDC, or CHI will under-perform) as that is already priced into IC spreads.

What a trader/hedger must determine -both on outright and IC trades – is whether the level implied by current quotes is above/below their expectations.

A note, I’ve only posted quotes on CUS vs. regional pairs but any regional vs. regional pair can also be traded electronically. Let me know if you have any interest in such.

Furthermore, in addition to outright and IC spreads, please know that one can also trade calendar spreads (e.g. Nov ’18 vs. Nov ’16, or Nov ’20) for any contract.

Finally, options (both puts and calls) can be quoted on CUS, NYM, CHI and LAX. I’ve had a number of inquires from traders looking for options on the other regions. The CME seems to be working to make this happen.

Net, there’s a variety of tools for traders to express views on how a Trump Presidency (or any other factor) might impact home prices both to outright levels, and on relative value.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this piece or any trading axes.

Nov -All SFR

For the last two months, I’ve been writing about how quotes in longer expirations have been coming down, both on an absolute basis, as well as against front contracts. No contract reflects that trend better than SFR. In addition, I find that when you get changes in sentiment, trading volume tends to rise as those who embrace the more current thinking, are more likely to cross paths (resulting in a trade) with those who have older outright or calendar spreads.

This has been the case this month as there have been 13 CME contracts traded -ALL in the SFR contract. While 13 contracts is slightly more than the recent historical monthly average across CME housing contracts, the 13 traded lots have occurred: a) before mid-month, and b) as I noted, in one region. In addition, trades have taken place across five expirations. In making markets for five years, I’ve never seen all trades take place in one region.

The table below reflects the flattening trend. Quotes are shown for Nov 14th and Aug 31. Bids and Asks are averaged to give mid-market levels (which I find more useful for this analysis than closes). Note that mid’s have fallen over 8 points on the X20 contract. While some of this appears to be consistent with quotes falling across SFR, it does reinforce the “crack the whip” ice-skating mindset. For example, if one-year HPA assumptions changed 0.5%/ year, you might observe price changes in the four-year expiration to be some multiple of that.

While SFR forward contracts once were priced at levels where index gains (on a % basis vs. spot levels) would out-perform the CUS 10-city contract by 2-3% over four years, at current levels, SFRX20 is quoted at about parity with CUSX20 (in terms of % gains vs. spot).

Even if these price moves are unique to SFR (and there’s no reason to believe that’s so) price declines would factor into the CUS index (as SFR weighing is about 9.2% of the 10-city index) which would lower the CUS contract values. Since many other regions have quotes that are linked to CUS contracts by intercity spreads, a decline in SFR should (and has) pulled down other contracts.

I get most of my hedging inquiries about the California (and Denver) contracts, so one might expect some hedgers at work. That said, it might be a useful exercise for longer-term holders to pick a level where SFR is attractive versus CUS or other regional contracts.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you’d like to discuss this, or have any trading axes.