Las Vegas – HomePriceFutures.com

LAV -The quintessential region for home price index trading?

My sense is that the best conditions for a home price index hedging market exist when you have:

Pronounced different views on the future
Recent history to color participants interest (or need?) in hedging
A mindset that trading (or hedging, betting) is an acceptable activity.

No regional market satisfies these three conditions better than Las Vegas (and therefore the LAV contracts traded on the CME).

First, opinions as to where LAV home prices are headed range, on the one hand, from the National Association of Realtors designating Las Vegas as one of its Top 10 Housing Markets for 2019 (with projected price gains of 7.9%), and Zillow also forecasting 7.74%), while on the other, the Greater Las Vegas Association of Realtors notes that inventory for sale has nearly doubled from the lows, and Fitch has designated Las Vegas as the most overvalued Top 20 city (at 20-24% overvalued).

Las Vegas home prices have the tailwinds of population growth and the headwinds of accessing sustainable water supply, adding to the debate over future home price forecasts.

Second, while current LAV index value (189.97) has more than doubled since the low in 2012 (of 89.88), the index is still only ~80% of the 2006 peak value (234.78). The LAV index suffered the greatest percentage decline of the Case Shiller 10-city components (~-62%), and the second largest increase from the bottom of 211% (trailing only SFR at +225%). Such volatility validates the benefits of hedging.

Third, other than possibly the Wall Street derivative community, where else in America is there a more open mindset to hedging one’s bets? LAV residents seem to have the biggest need for hedging (given both the uncertainty and history).

However, volume and open interest (OI) in the CME LAV contracts remains low. I tallied six LAV contracts trading in 2018, and current OI is three.

Recent LAV contract prices are consistent with MUCH lower home price growth for 2019, but well above levels (measured as percent of current price to spot) of the three California CME contracts (LAX, SDG and SFR). For example, LAV hedgers should note that the LAVG20 (Feb 2020 expiration contract) settles on the value of the LAV index through Dec. 2019, and is offered at 1.2% above spot levels. As I’ve noted before I don’t know whether this is due to market imbalance (w/ bias that contracts have typically traded lower than expectations), change in fundamental outlook, an opportunity, and/or reflects lack of depth in this market.

On the depth of market issue, recall that each contract has a notional value of $250* price, or just under $50,000.^1 Most quotes are 1×1, e.g. one lot bid vs. one lot offered. While posted quotes are actionable – and in bite-sized pieces that lend themselves to partial hedging^2 -my goal is not to be the market for LAV but to post initial suggestions on the market (or “line” in LAV parlance) while then bringing in as many participants on each side, to narrow the bid/ask spread and make more exposures available -on both sides. While there are some efforts that offer home price hedging products at the individual home level, I think that the CME represents the best public, trade-able, play on forward home price indices.)

In any case, I’m not suggesting that the G20 contract prices represent what I or other traders think the index will be a year from now (as traders have multiple reasons for trading) but it does reflect a level where some traders are willing to buy/sell LAV home price index risk.

In addition to futures, the CME also allows for option trading on the futures (both puts and calls). Since a change in futures prices might result in a margin call, options have a benefit of limiting the total outlay for a hedge. The table to the right has offering levels where I’d offer either puts or calls on LAV futures.

Net, the LAV market seems to have the biggest need for hedging of the larger US cities. Those who might like to have more/less exposure to regional-wide LAV home price risk, might consider the CME futures and options.

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

Footnotes:

^1 Note that initial margin is often less than 10% (or $5,000 in this case). The CME sets minimum margins, but clearing brokers may charge more.

^2 See Feb 2nd blog for more details on bite-sized hedging. http://1a1.50a.myftpupload.com/reduce-the-stress-of-100-rent-vs-100-buy-decision-with-bite-sized-pieces/

As Nov. expiration approaches

The last day of trading for the Nov 2013 contract is Monday. (Recall that the Case Shiller indices will be released on Tuesday and that the Nov 2013 contract will settle on those numbers.) With only a few days to go I thought that I’d tweak quotes and post a market status.

The attached table shows bid. ask, and mid-market levels for the 11 CME futures contracts (from earlier this morning). All bid-ask spreads are <= 2.0 points, although none is tighter than 1.4 points. In past expirations we’ve often seen one contract where value is being more hotly “debated” with a tighter bid/ask spread. Given that open interest for Nov. is 81 contracts (including 46 in CHI) there may be some traders looking to unwind (or roll forward) Nov positions. I’d expect some outright and short calendar spread trading over the next few days. The Nov /Feb calendar spread markets are wide at this point (not shown) probably due to the combination of changing seasonal factors (warm vs. cold states) and concerns about the underlying momentum in home prices. (Look for a blog on Nov /Feb spreads in the next few days.)

The Nov 2013 mid-market contract values are consistent with news headlines touting continued (but slowing) gains in all regional indices (at least those traded on the CME). The LAV, SDG and SFR will lead the year-over-year increases, while the Northeast areas of BOS, NYM and WDC will show as the laggards.

Finally, note that with the expiration of the Nov 2013 contract, the CME will introduce a new contract for Nov 2018. I would expect that most contracts roll out with 2-5% implied HPA gains over mid-2017 levels. With gains implied by such HPA, the forward level of CS indices will move even closer to full recovery versus 2006 “highs” in selected key regions. I would expect some push-back, increased interest in hedging as we get to “back to past high levels”.

Basics: What If CUS Index composition weights change?

The weighting for Case Shiller composite indices (e.g. CUS 10-city, referenced in the CME contracts) may be adjusted 2- 3 years after the 2010 census, per the Case Shiller index methodology. I raise this notion to: 1) increase awareness, 2) minimize concern, and 3) invite those who better understand index calculations to weigh in. I have no idea if, or when, this might happen, but as it might have an impact on CUS values, I wanted to start a (more public) discussion.

As a test, I used the changes in population for loosely defined geographic regions to try and estimate what the new weights might look like and how those changes might impact CUS values. I made the simplistic leap of faith that population growth is correlated to housing stock, which I believe, will be the denominator for assigning weights by region. The analysis is not intended to be precise but to illustrate some key moving parts in how a change in weighting might impact (if at all) the CUS index.

The population gains are primarily in the West (DEN, LAV, LAX, SDG and SFR) and South (MIA) while the losses are in the North (BOS, CHI, NYM). The WDC region bucks the Northeast trend. Given my “What If” weights, the CUS index would be impacted in this analysis by -0.18.

The reason that an adjustment (using my “What If” weights) is so small is that weighting is taken away from NYM (which trades at a fairly close level to the CUS index) and redistributed to both the low priced index areas of LAV and DEN (which would pull down the CUS value) AND the high-priced areas of SDG and WDC.

(Note that any change in the allocation to SFR should have a small impact on spot CUS values as both indices have about the same value. However this (a change in redistribution to SFR) would not be neutral to longer-dated contracts where SFR contracts trades at a premium to CUS.)

Key to any estimation/conclusion is how future index weightings might vary from this simplistic analysis. Changes from/to the low index areas (DEN, LAV) to the high-priced index areas (LAX, WDC) might result in more pronounced changes to CUS.

Feel free to contact me (johnhdolan@homepricefutures.com) if you care to discuss this theme, or any other aspect of trading home price indices.

May ’13 contracts – 3 weeks to go

With the May ’13 expiration in just three weeks, and a handful of recent K13 trades (LAV, MIA, NYM), I thought that it might make sense to focus on front-contract markets.

The following table shows the recent history of each of the 11 traded CME reference indices as well as recent bids, offers and mid-market levels. These mid-market levels are then compared to Feb ’13 and Mar ’12 index levels to show what index increases might be.

(Recall that the May 2013 futures settle on the March 2013 Case Shiller index which measures the period Jan-Mar 2013. This makes trading in the expiring contract different from other expirations as trading becomes an act/art(?)/ of anticipating how the already-known repeat-sales price data points will be assembled into the March 2013 index. Since the futures settlement price converges to the next CS index release, it can be strongly argued that the expiring contract prices should reflect expectations.)

Posted bid/ask spreads for the May ’13 contracts were all between 1.0 and 2.0 points, but as these have to be kept live throughout the day, it’s likely that larger amounts might be traded at inside posted levels.

Mid-market prices for the May contracts are slightly higher than the Feb indices indicating that negative seasonal factors are likely to be offset by growing buying interest.

The headlines for Wed. May 29th will highlight the year-on-year gains in SFR and LAV (each ~>19%) and contrast those against the lagging NYM and CHI markets.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on this table or any aspect of trading home price derivatives.

CME Futures: Post Case Shiller release

The futures markets are generally unchanged after this morning’s release of the Case Shiller indices, although there is a mix of up and down markets.

I’ve posted prices that I’ve observed over the last 24 hours. (That is these are neither fed by the CME, nor are they live.) I’m showing prices for Jan 28 and Jan 29 for the CUS contracts to the right. (See the reports section for a table with the changes on each contract.) Typical of many contracts the bid/ask spread has widened as (in this case) some bids are lower, while some offers are higher.

In aggregate bids are about 1/2 point lower, while offers have averaged 3/4 point higher.

Futures price reflect changes in the indices with two notable exceptions that I highlighted yesterday. The CHI index came in 113.35 or 1.53 points lower, but the Feb contracts, which had traded as low as 110.2, have rallied to 111.0/113.6.

Conversely, the LAV index came in at 100.56 or +0.42, but much weaker than “expected” by the 103.4/106.0 Feb market on Monday.

The CHI/LAV trade discussed yesterday would have been the biggest 1-day mover.

The only trade, in fact has been a pair of trades in front LAV as LAVG13 traded at 103.0 and LAVK13 traded at 106.0. (Both are now offered at those levels.)

California markets continue to perform well. LAX, SDG and SFR should all have higher closes by the end of the day, while Northeast markets suffer. BOS, NYM and WDC are all lower, although index revisions in NYM and WDC account for some of the price change.

The Feb front contract now has one month to run. All bid/ask spreads are between 2 and 3 points. I expect those contracts that traded tighter yesterday (e.g. SDG and CHI) to tighten over time.

There are occasional 2 lot bids, but 90+% of the quotes seem to be for one lot.

There are bids for 115 of the 121 contracts (11 regions * 11 expirations) and 100 contracts have offers. The CUS contract is the only one with bids and offers for all expirations, although BOS, DEN, LAX, NYM, SDG, SFR and WDC are all missing no more than 3 (of 22 possible quotes).

I will try to update observations on calendar and inter-cty spreads tomorrow.

What happens in Vegas…gets posted here

Anyone looking for short-term price volatility needs to review activity in the LAV (Las Vegas) contract over the last week. Futures prices shot up 2-3 points after the Case Shiller release on Wed. Dec 26 as the LAV index posted the biggest gain (of the ten CUS components) with a 2.8% monthly rise from 97.38 to 100.14.

Then that night, when trading resumed, ten lots traded in the front contract (LAVG13) from 99.0 down to 93.6 over the course of 11 minutes. All trades took place in the front contract even though calendar spreads would have suggested that certain longer expiration contract bids should also have been hit.

Within half an hour, the bid was back up to 95.6 and crept higher to 97.0 the following morning. Today (Wed. Jan. 2nd) the LAVG13 contract is 101.4 bid (offered at 102.0).

I am puzzled as to what happened. The LAV contract had open interest of 1 contract before Dec. 26th. Night trading is noticeably thinner than daylight trading, and holiday weeks are typically less busy, so I’m not sure why someone would choose such an illiquid period to sell so many (relatively, given OI) contracts. The ten lots traded in five separate trades so it’s not as if someone “fat-thumbed” one trade, and the order had to have been entered between the afternoon close and the evening open (a gap of 3 hours) so it was relatively fresh. While many of the Feb contracts exhibit some negative seasonality, that is less so the case for LAV (and other warm winter states -see recent blog for a discussion of May seasonals http://1a1.50a.myftpupload.com/?p=2125) Besides the seasonal factors are often smaller to underlying trends and the +2.8% monthly gain suggested to some that LAV was starting a (short-term?) rebound.

There have been traders who draw a line in the sand and demonstrate their willingness to sell relatively large size at a particular prices when the market reaches their levels (both in up and down markets). I can recall at least two such incidents in the DEN contract over the last few years, but in those cases the trader maintained a fixed price.

It’s possible that someone entered a “Market” order instead of a “Limit” order and so any bids that showed up after the first trade got hit. (Let me reemphasize that I would only recommend “Limit” orders on all housing futures to avoid situations like this -or worse!)

There may be other explanations for why someone chose to sell contracts ~6% lower than the previous night’s closing bid, but I can’t think of any good ones.

The current LAV futures front-month contract prices, combined with the underlying CS index trend, makes the back-expiration LAV contracts some of the most challenging to quote. (In this situation, bids typically rise by 0-2% HPA, while offers might be +10% YOY. Compounding these trends for 3-5 years leaves extremely wide bid/ask spreads.)

This market is clearly conflicted (and this week’s trades didn’t help). There are market bids that are consistent with gains over the next few years, but as I noted in the DB report that I highlighted last week http://1a1.50a.myftpupload.com/?p=2130, there are those that believe that the housing fundamentals in LAV remain poor.

Any help on quotes, further elaboration on fundamentals, and/or ideas on the last week’s trades, would be appreciated. Feel free to contact me (johnhdolan@homepricefutures.com) with any thoughts.