DEN – HomePriceFutures.com

Majority of regions tipping toward negative HPA in 2019, falling from there in 2020.

Quotes on CME Case Shiller home price index futures have tipped over toward being consistent with negative HPA in 2019 for five of the ten regions (NYM, CHI, LAX, SDG, and SFR). Of the other fiver regions none are much above zero HPA, with BOS, DEN, and WDC just below 1%. Only BOS and LAV are priced for more than 1% gains against today’s spot levels.

The graph below is a candle graph that I use in monthly recaps. Price quotes on each of 11 CME regions (the 10-city index contract (HCI) and each of the ten components) have been converted into percent vs. spot for bid, ask and mid. For example, the BOSX19 bid, ask, and mid are 218.0, 221.0, and 219.5, while the BOS spot index is 216.56. Each bar thus shows the relative width of the bid/ask spread as well as the pricing vs. spot for each region, standardized on percentage terms. The outliers include LAV (priced consistent with gains for 2019), and SFR (priced at 2-3% declines through 2019 and 2020.) There are 22 bars, one for X19 (Nov ’19) and one for X20 (Nov ’20) for each of the 11 regions.

The graphs shows which contracts are above 100% (i.e. where prices would be unchanged versus spot), and compares the X19 to X20 ratios. Note that as a general rule, regions with lower prices for X19, tend to have even lower prices for X20. Hence, the net inference one can draw is that quotes are consistent with falling home price indices in 2019 for half the contracts, but that prices are lower in 2020 (vs. 2019) for almost all.

I’ve written recently how all CME quotes need to be taken with a huge grain of salt. The biggest point is the thinness of trading, as well as my belief (that I will explore in an upcoming blog) that longer-dated (i.e. more than 9 months) futures prices tend to be quoted at a discount to expectations. (See Dec 11 blog: Pulsenomics survey: Why are surveys results more bullish than Case Shiller futures? for more perspective). That said, several contracts are offered at discount to spot, or lower in 2020 than 2019, and no one’s “disagreed” (via an improved bid or purchase). The contracts need buyers to balance hedging inquiries I receive. Any takers willing to add what it likely a non-correlated risk to their corporate risk portfolio?

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

Observations on Bid/Ask spreads -1 Year to run

I’ve compiled an interesting set of data that I’ll use to illustrate how the CME S&P Case Shiller home price index futures have traded over the last 7+ years. It may help traders understand how to better trade the contracts, as well as quirks within the contracts. I will be blogging about over the next few weeks, to include an analysis the robustness of contract prices in forecasting, contract biases, and volatility. I’m open to ideas on what readers might want to see, and would be open to slicing and dicing the information to address any longer-term questions.

I’ll start with a presentation on bid/ask spreads for a one-year horizon. (Views using other time periods to follow).

The graph below shows the bid/ask spread on the one-year forward contract at the point nearest the quarterly expiration cycles that I could find. For example, the information for Nov. 2012 shows the difference between the bid and offer on the Nov 2013 contract. (The bids and offers come from information I’ve tallied over 7 years as market maker). Spreads have been compiled for all 11 regional contracts (the 10-city index as well as each of the ten regional components). There are 29 quarterly observations for all 11 contracts (except in May 2015 on where 7 quotes can’t be found. Note gap in graph for some regions.).

I’d draw a few observations from the graph:

Bid/ask point spreads have generally compressed since 2013 ( with the narrowest bid/ask spreads, for all 11 regions, having occurred in Nov 2017 (for the Nov 2018/X18 contract)). I attribute this first to getting past the large rally that started in May 2012. The strength of that rally created uncertainty about how much indices might rise, after falling and wandering around lows for 3-4 years after Financial Crises. Tighter bid/ask spreads since then seem to have been: 1) a function of greater participation by third parties, 2) greater confidence in my willingness to post tighter spreads, and/or 3) lower expected volatility. All three factors, and the resulting tighter spreads, are conducive to increased trading.
Note that bid/ask spreads are shown in points. Since some indices (and contract prices) are now double what they were in 2013 (e.g. the SFRK13 (May 2013) contract had a mid-market value of 132.3 in May 2012, vs. a spot index level today of 267.24) so bid/ask spreads on a percentage basis have narrowed even more. (See Graph in Reports section showing bid/ask spreads in both points and percent, or access here). BTW -The widest % spread across all 11 regions. in Nov. 2017 was 1.39%.
Bid/ask spreads have for the HCI 10-city index (shown in red) have generally had the tightest bid/asks spread. LAV and DEN have recently been the tighest as prices have not sold off as much as other regions.
All regional spreads exhibit “seasonality” in that bid/ask spreads have been tightest on November expiration cycles. (The one-year forward May contract has tended to be the widest). The relative narrowness in November contracts seems to be a function of Nov being the longest contract. As such, it has more time to attract open interest which may be important as traders have a vested interest in quotes.
I’ve tried to be more “democratic” about bid/ask spreads over the last year (putting a personally-imposed cap of bid/ask spreads for much of early 2018), and the distortion between May and Nov quotes (as well as other quarters) has been less pronounced over that last 15 months. I’m trying to promote more trading in Feb expirations, particularly in OTC trades, as that expiration references year-end Case Shiller values. As such, Feb contracts will be better in sync (from a timing perspective) with the term that most forecasters use (i.e. year-end numbers).
HCI bid/ask spreads seemed to bottom out at ~1 point bid/ask spreads in 2015, 16 and ’17, but then widened this past November (2018). I attribute that to the large sell-off seen across many contracts as California contract prices collapsed, and that I’ve written about in past blogs: CME Price declines since Sept 5 and Diagram to reflect changes in forward SFR markets. Bid/ask spreads have continued to widen since early Nov as these contracts prices have not found a bottom (i.e. a level where third-parties will buy). Only when we see two-sided interest would I expect bid/ask spreads to tighten back to mid-2018 ranges.

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions from this blog, have any ideas how to analyze this new data, or have any questions related to hedging home price indices.

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.

CME Futures -post Sept release of Case Shiller #’s

Quotes on the CME Case Shiller home price index futures are marginally higher this afternoon (relative to yesterday, and as measured by mid-market values) after this morning’s release of the Case Shiller indices. The biggest gain took place in the LAXX18 contract (where there was one trade today). DENX18 is the only contract that is lower.

Across all contracts, bid/ask spreads average about unchanged. Bid/ask spreads in the front X17 contract now average 1.9 points. The CUS (10-city contract) has the tightest spreads. The SDG/SFR pair has the widest.

Year-on-year price gains in the indices (so ~HPA) were highest in BOS, LAX and SFR (not shown here). HPA gains slowed slightly DEN.

The largest monthly revision was a downward revision of 0.24 to last month’s LAX index (making today’s increase in HPA more impressive).

Month-to-date volume is 27 contracts with 7 in options and 20 in futures. There have been trades in 5 regions, and 5 expirations.

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

Thanks, John

Using DEN G18 puts to illustrate options

I recently did a trade in DEN.G18.P2000 (that is, puts on the Feb ’18 DEN contract with a strike of 200. Here’s a graph that shows the P&L of the trade, were one to sell (write) those options at a price of 4.0.

I think that this is a useful exercise to review as while there may be many more natural hedgers (i.e. buyers of puts), this market would benefit from better two-way flow. As such, I’m illustrating a way that a put writer might look at this trade with the hope of building some put-writing interest.

To recap, the DENG18 market this morning is 201.0-203.8, so the mid-market is 202.4 (as noted in the blue horizontal line). The numbers along the primary horizontal axis are the index values at settlement. The brown line shows that, if one wrote puts at 4.0, and if the settlement in Feb ’18 was higher than 200.0, there would be a profit of 4.0 points (ignoring as fees your broker might charge), but that profit would decline 1:1 for every point below 200.

The second horizontal axis (on top) lays out what each of the individual prices on the primary horizontal axis would translate into on a percentage changes versus the Case Shiller DEN index released in Aug 2016. (I’m using the most recent Aug 2016 value, which may have been updated from the one originally released in Aug 20016). Note also that I’m using YOY differences to reduce seasonality issues.

While the most recent YOY gain in the DEN index was ~7.6%, that gain, and HPA for all indices has been falling, and, futures market prices across many contracts are consistent with even further declines.

While a put buyer may have many reasons for buying a put (e.g. hedging real estate development, or a property that they are looking to flip, or to give their lender comfort that tail risks have been addressed, or a more bearish outlook) a put writer needs to form their own opinion of the risk-reward of this pay-off, and how such a new position might fit into their own outlook, all in the context of whether they expect to trade the position or hold until expiration. (Note that this graph only shows price ranges of ~189 to ~208. The risks increase should prices fall below 189, but the reward doesn’t increase above 208. Note also that this put is relatively short.)

I’m currently open to buying 5 lots at a price of 4.0 (or sell 5 lots at 5.0) should anyone want to sell.

Recall that while some CME option contracts can be electronically quoted and traded (e.g. all the CUS, CHI, LAX and NYM options), trades in some other regions first need to be agreed to off-exchange and then cleared on the CME. That is, if someone wanted to trade a MIA option, the two sides would need to arrange the trade. (That’s where I can help any party looking to take an exposure in another option, whether put or call). However, since there any already been a trade in this particular region, strike and expiration, the DEN.G18.P2000 contract can be traded electronically. (There may be few futures brokers that will accommodate such a trade. Please contact me if you need the name of one that will.)

Please feel free to contact me on this trade (johnhdolan@homepricefutures.com), or any other aspect of hedging home prices.

Thanks, John