sfr – Page 2 – HomePriceFutures.com

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

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

Futures can also be used by buyers to hedge -San Fran story

An excellent piece of research by Paragon RE on the San Francisco housing market and a tweet by one of my favorite journalists (Mike Rosenberg at the Seattle Times -see tweet here ) prompted me to air the idea of using the SFR (San Francisco area) Case Shiller home price futures as a potential hedge against runaway home prices in San Francisco, for those on the sidelines watching 10% year-on-year gains.

To recap, futures allow a user to lock in a price (long or short) on a contract that will settle on the Case Shiller SFR index value at some point in the future. While there has been near no volume, there have been a few trades over the last few weeks in the longest-dated SFR contract (the X22 contract that expires in Nov 2022). Today, that market was quoted 287.0/290.0, and the spot index for the Case Shiller SFR index is 264.29. (Contract notional values are $250* point, so ~ $72,000/contract at 288.) Such pricing may be informative -if only to viewers/not traders -as the contracts “cash settle” on the SFR index value in Nov 2022. That is, purely as an illustration, if someone bought a contract at 290, and the index settled in (Nov 2022) at 300 (about 13.3% gain over 4+ years) the buyer would have gained $2,500/contract (before any fees). If index levels were unchanged (i.e. at 264.29) at expiration, a seller at 287 would get about $5,750. (Note that there may be many reasons why people buy/sell and contract prices might vary substantially prior to settlement- beyond even these examples, but eventually -as contract expiration approaches -they must converge.)

I share the illustration not to encourage speculation, but to note to viewers, that the quotes are not merely opinions, or forecasts based on past history, but levels were users are willing to back up their exposure with money. While SFR prices have been screaming higher, these CME prices are consistent with continued home price gains, but at a slowing rate.

Futures (despite some negative press) may be useful tools for investors to consider if have more or less exposure to the commodity (in this case San Francisco home prices) than they care. While much as been written about homeowners looking for ideas to protect against a decline in home prices, those looking to buy homes in the future might also consider looking at futures if they want to add to their San Francisco exposure today.

Bids on the SFRX22 (Nov 2022 expiration) contract are consistent with gains of 8.6% (cumulative over the next 4+ years) while the offer is consistent with gains of 9.7%. Someone expecting, or fearful of, or negatively exposed to, 6-10% gains in home prices across San Francisco over the next few years (so 25-40% gains over 4+ years), might consider learning more about these futures. As an example, someone in Dec 2016 looking to buy in San Fran in Nov 2018, could’ve bought SFRX18 (Nov 2018 expiration) contracts at 241.2. The gains from a purchase of those contracts (which today were bid 270.6) would have offset a portion of higher prices they now face. A future buyer of a home in San Francisco, might be able to reduce some of the risk of prices running up 10+% for the next few years, with prudent hedging.

Now there are number of qualifiers (that include more than these) that this is now financial advice, that you should talk to your own broker about any decisions involving futures, that the markets are very thinly traded (so don’t use market orders), that markets may be volatile, and/or not even quoted in the future. That said, anyone looking to learn more should feel free to review the material in the Reports section on this website, or contact me (johnhdolan@homepricefutures.com) if they have any questions on these products, or if they’re interested in trading.

Thanks, John

CME Markets post today’s Case Shiller #’s

Quotes on the CME Case Shiller home price futures contracts were generally higher after this morning’s release of the Case Shiller numbers for April. The table below highlights prices from near the close yesterday versus early this morning. There are three key highlights;

Average mid-market prices rose by 0.4 for the Nov ’18 contracts. (see right side of table). Across the 121 contracts prices rose, on average, by about 1.0 point with bigger gains concentrated in longer-dated expirations.
While prices are higher this morning, there are outliers -most notably NYM, which is down more than 2.0 points, and LAV which is up more than 2.0 points. (Note that there were 3 LAV trades late yesterday with offers lifted, that may have contributed to higher prices.)
Bid/ask spreads are wider on the day (see lower right). This is typical of the first few hours post the release of Case Shiller #’s. Look for bid/ask spreads to contract as other users check markets, and as month-end nears.

Note that there have been 14 trades this month. Activity has been concentrated in LAV and SFR regions with 3 and 9 trades in each region. Unlike past months, activity has been spread across the expirations with trades in both the Aug ’18 contracts (2) as well as the longest Nov ’22 contracts (3).

Please feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions on this blog, hedging of home price indices in general, or have any trade ideas that you’d like to discuss.

Thanks, John

A reader explains the basics of home price hedging

One reader -Justin Welsh- wrote an 11-page description of why a homeowner might want to consider hedging with home price futures. Justin’s report goes into a lot of detail, provides a number of graphs, and walks through various scenarios. The report has quite a bit of detail. I’ve attached it here (as received, without any editing) for your consideration.

Anyone wishing to contact Justin can do so at justinlw@earthlink.net

I’d be happy to take other contributions that relate to the topic of hedging home price risk.

Thank you Justin for your effort, and your insights.

John

johnhdolan@homepricefutures.com

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

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.

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.

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.