Tag: spreads

Basics: Intercity Spreads: How to read them: Boston/New York example

If inter-city spread trades are going to be a focus for 2013 then it might help to explain what they mean.  That was the “constructive criticism” from one reader.  Point noted.

Let me use a rivalry that New York traders might relate to: New York vs. Boston.  After all saying that the BOS/NYMX15 spread is -12.0/-8.0 doesn’t convey much.  The spot indices and futures contracts trade at different levels so the question is how can one translate an intercity quote into something more relevant.  The answer is that just as with calendar spreads, intercity quotes can be translated into relative HPA comparisons.

The table (to the right) shows how one might evaluate the BOS/NYMX15 intercity spread.  Recall that all spreads are quoted front value versus back and that most intercity spreads (except the CUS/HCI 10-city index) are shown in alphabetical order.  Thus one would talk about BOS/NYM, not NYM/BOS.

That table shows the spot levels and Nov 2015 markets for both BOS and NYM.  The mid of the BOSX15 market 172.7 is shown and the percent of that number over the spot value (150.6) is also shown (14.65%).  Thus one might say that the mid-market quote for the BOSX15 contract is consistent with a rise of ~14.6% in the BOS Case Shiller index by the Nov 2015 release.

The intercity bid (-12.0) and intercity offer (-8.0) would be equivalent to OFFERS on NYM of 184.7 and BIDS of 180.7 when compared to the BOS mid-market.  I’ve added emphasis and color-coded the prices to remind readers that an intercity bid is the difference between a bid on the front contract combined with an offer on the back contract.  Thus the -12.0 bid would be consistent with a 172.7 bid for BOS and an OFFER of 184.7 on NYM.  Similarly, the -8.0 intercity offer is consistent with a 172.7 offer on BOS and a BID for NYM at 180.7.

Given these “implied” 180.7/184.7 quotes on the NYMX15 contract, price relative to spot can be calculated in the same way as BOS above.  The implied 180.7 NYMX15 bid is consistent with a rise of 12.83% over NYM spot (160.15) while the implied 184.7 NYMX15 offer is consistent with a rise of 15.33% over the NYM spot.

By comparing the 14.65% rise in the BOSX15 contract with the 12.83%/15.33% rises implied by the intercity derived NYMX15 quotes one can translate the -12.0/-8.0 intercity BOS/NYM quotes into something that says “the intercity seller is quoting a level where BOS will outperform NYM by 1.82%, while the intercity bidder is quoting a level where BOS will outperform NYM by -0.68% (so under-perform)”.

One can take implied out-/(under-/performance and solve back for intercity quotes that would be consistent with one’s views.  In the table I’ve reversed the algebra to solve for the level where BOS would out-perform NYM by at least one point -any intercity quote wider than 12.5 points.  Similarly, one can solve for the level at which a seller of the intercity quote (selling the front contract relative to the back) would see NYM under-performing BOS by at least 1% or -9.3 points.

Net, the -12.0/-8.0 quote is consistent with a view where the bidder believes that BOS will outperform NYM by almost 2 percent, and the offer is consistent with the view that the seller believes that NYM will underperform BOS by only a small amount.

Of course, any combination of regions and expiration is possible and total over/under-performance can also be translated back into implied HPA differences.

Note that the -12.0/-8.0 intercity market at four points is tighter than either outright market (12.6 points on BOS and 9.0 for NYM) and MUCH tighter than an “arbitrage” market of the two contracts (-18.6/3.0 or 21.6 points, or the combination of the two outright bid/ask spreads).   This is the relative attractiveness of intercity spreads as a way to potentially develop market interest.  Recall that an intercity trade results in limited outright market risk (the notional values aren’t the same, an issue that would be most pronounced in an LAV/WDC quote), and no calendar risk.  Since BOS and NYM (much like LAX and SDG) are also highly correlated (see upcoming blog) the risk of one contract moving very different from another is reduced.

Net, one can take a view on RELATIVE movements between two regions for a fraction of the risk of the outright risk on either region (particularly if the two regions are highly correlated).

I’m open to discussing this blog, and any other combination of intercity quotes.  Feel free to contact me at johnhdolan@homepricefutures.com.

 

 

Basics: Selected intercity quotes for Nov 2015

I’ve mentioned before that I think inter-city spread trading might be the key to growing volume, liquidity and interest in the CME Case Shiller futures for 2013.  Here’s some quotes for the Nov 2015 contracts:

Recall that the bid side of an inter-city spread is the front contract minus the back contract.  I’ve colored the intercity bid in green (and the offers in blue) so that one can compare the intercity quotes with what I refer to as the “arbitrage quotes”.  (An example of an “arbitrage quote” would be the bid between HCI (now the label for the electronic trading in the 10-city CUS contract) and the NYM contract.  The 177.4 outright bid on HCI (shown here, not necessarily live) minus the 185 offer on NYM, would be -7.6 points.  The “arbitrage” offered side would be 9.6.   The intercity quote (-3.0/2.0) is much tighter.

The pairs shown represent either the two largest markets (NYM and LAX) against the CUS/HCI 10-city index, or intra-region (LAX/SDG and BOS/NYM) that have shown high correlations.  (More next week).

Quotes can be found on the CME website http://datasuite.cmegroup.com/dataSuite.html?template=hsng&leadMonth=CUSG3&strategyType=IS&category=Housing&exchange=XCME&selectedProduct=CUS&selected_tab=real-estate  Scroll down on the “Spreads” pull-down menu to move from calendar to inter-city spreads.  While many inter-city spreads will be posted, the vast majority are “arbitrage” quotes that are automatically populated by the CME.  According to my filters, these four quotes are the only non-arbitrage quotes posted as of 9:30 Friday morning (Feb 1.)

I’d appreciate any reaction to these quotes, or inquiry on other combinations (or expirations).  Contact me at johnhdolan@homepricefutures.com if you’d care to discuss or like to see other quotes.

 

 

Basics: A template for Inter-City spreads

I mentioned in an earlier blog that Inter-City spread markets might be a good opportunity to express relative value views, and to promote trading.   While the CME website has a pull-down menu that shows inter-city quotes (click here), they sometimes include what I describe as automatically generated “Arb markets” in their display.

An “Arb” inter-city bid results from pairing the outright bid of the front contract with the outright offer of the second contract, and an inter-city offer results from pairing the outright offer of the front contract with the outright bid of the second contract.  For example, if the CUSX12 market is 159.0/161.0 and the LAX12 market is 175.0/176.0, the the inter-city CUS/LAX X12 arb markets would be -17/ -14.  The -17 inter-city bid is the 159 CUS bid minus the 176 LAX offer, while the -14 inter-city offer is the 161 CUS offer minus the LAX 175 bid.  (Note that the “Arb” inter-city bid/ask spread (3 points here) is the combination the bid/ask spreads on each of the two underlying contracts.)

As such, a -17/-14 quote, by itself, doesn’t tell you if someone is bidding the inter-city spread.   A trader would need to test all inter-city bids and offers to see if there is a real inter-city bid (or offer) at better than “Arb” levels.  This table does that.

The table shows the results of filtering all inter-city quotes for the Nov ’12 markets that are better than arbitrage levels and highlights those markets in the Mkts* line.  The degree to which an inter-city bid is better than the arbitrage level is shown in yellow.

So while there are 55 possible pairs where quotes are shown on the CME website (all shown), one can see that there are only 8 pairs that have at least one inter-city quote that is better than “Arb” levels.  Five pairs have CUS on one side of the trade, but there are also quotes for BOS/NYM, BOS/WDC and LAX/SDG.  (Note that with the exception of CUS, the front contract is the one that comes first alphabetically).

The BOS/NYM quote of -8.0/-7.0 is both the tightest inter-city quote (at 1.o point) but also the only where both sides are inside arbitrage levels.  (Recall from above that if both BOS and NYM have 1.2 bid/ask spreads, that the BOS/NYM inter-city arb level should have a 2.4 bid/ask spread.  It is only 1 point because the bid is 0.2 inside arb levels and the offer is 1.2 inside the arb level, which combine to reduce the inter-city bid/ask spread by 1.4 points.

This approach might lead to discussions of what pairs traders might want to see.  All regional contracts can be compared to CUS to express a view on the relative strenght of a region versus the 10-city index, (or to hedge the incremental performance of a region).  Regional pairs (e.g. BOS/NYM, LAX/SDG) should be highly correlated and might make sense for hedging, and one might express a view on judicial friendly versus “slow workout” regions.

In looking at other expirations,  I don’t see any non-arb inter-city quotes today.  (I’ll try to post if/as I see them.)

Please feel free to contact me if you have any questions on the table, or any interest in discussing ideas for inter-city spread trades at johnhdolan@homepricefutures.com.

 

 

Inter-city spread trades: my new reality- they work!

When you’ve been wrong, there’s no sense hiding as sooner rather than later the world will know.  I have been working with (and have previously touted) an incorrect understanding of inter-city spread trading that I now need to reverse.

Inter-city spread trades work!  One can enter an inter-city spread trade at a level, and if the level is matched a spread trade will result.

Yesterday an inter-city spread order that I had entered (offer of CUSX12/CHIX12@ 45.2 ) was executed as another trader lifted that spread offerering. Somewhat similar to a calendar spread, I am now short an additional CHIX12 and long an additional CUSX12, while the other side has the opposite positions.  (I’m still reviewing how the trades impact volume and open interest as yesterday’s trades were recorded as volume of two, while a calendar spread trade would show four.)

(As an aside, inter-city spreads “worked” before in that they may have improved a quote on one side of a trade.  I’ve seen inter-city spread orders executed in the past when each leg was better than the outright quotes in the two legs of a trade, but yesterday was the first spread order that was executed as a spread in recent memory).

Net, now that inter-city spread trades “work” there is the potential to open up new areas for trading, particulary within regional areas (e.g. the three west coast, or three northeast contracts) where the correlation across regions might be very high and traders want to opine on differences going forward.  (Note to self, need to test/blog).

The table above shows six working inter-city spread orders on the two contracts with the greatest open interest (CUS and CHI).  I’ve included implied levels for each leg to help traders visulize how these inter-city orders narrow the effective bid/ask spreads on each leg. The implied prices on the inter-city spread orders are within the bid/ask spreads of the outright CUS and CHI market. (In fact, outright bids and offers were improved on three of the six outright quotes this morning as a result of these orders.)

I’m open to teeing up other “pairs” trades if there’s an inter-city market that someone wants to see quoted.  Please contact me at johnhdolan@homepricefutures.com

Using “Chords” and Calendar Spreads to Trade HPA

Many home price traders think in terms of implied HPAs (Home Price Appreciation).  HPA -as I define it here -is the percentage price difference between one contract and the expiration one year forward.  So if the CUS Nov 2012 (X12) mid price is 150, and the  CUS Nov 2013 mid price is 154.5 (X13) then I might infer that the CUS market for Nov ’12/Nov ’13 is trading at an implied 3% HPA.  (One can generate implied HPA between any set of contracts, but if not year-to-year (or a mulitiple set of years), that introduces seasonal biases.)

While mid-point to mid-point may be interesting, one can trade mid-points at all, much less simultaneously.  The trading venue for debating HPAs is the calendar spread market.  For example, someone might be willing to bid CUS Nov ’12/’13 at minus 6 points, while someone might offer the same spread at minus 3 points.  A -6 bid (on a CUS Nov ’12 mid-market of 150 would implay a 4% HPA, while the -3 ask would imply a 2% HPA.

Thus HPA from calendar spreads tend to bracket mid-point to mid-point spreads.  The narrower the bid/ask spreads in the calendar markets, the more likely the implied HPAs are to converge toward mid-mid implied HPA (the outright markets also trade tight).

The following table shows the mid-mid implied HPA for all 11 contracts, bae for what I describe as each of the calendar chords (e.g. Nov ’12/Nov ’13), as well as the spot/May ’12 (K12) and K12/X12 chords.  As each of these results refers to a mid-point number, the chords can be linked to generate total index improvement over any period of time.  Thus the mid-point of the CUS contract from Nov ’13 to Nov ’16 is 8.06% (1.0252)*(1.0258)*(1.0276)-1.

Let me make a few observations:

  • The front chord (spot vs. May ’12)  shows that the market is pricing (at the mid-point) that some indices will rise this month, while others will fall.  Given how home prices tend to trend, it’s not surprising that last month’s winners (MIA and SDG) are poised to rise, while last month’s loser (CHI) will drift lower.
  • All 11 contracts (with the exception of LAV) show at least 2% gains (not annualized) between the May and Nov indices.  While some of this may be a turn in prices, there are seasonal factors at work also.
  • SFR stands out as the contract with HPA >3% for each year after 2012 (and with a relatively strong “pop” from May’ 12 to Nov ’12.
  • In some chords the calendar spreads are right on top of the mid-market HPA (e.g. CUS X15/X16), while in others (e.g. LAV X13/x14) the wide HPA’s from the calendar spread quotes indicate that the bid/ask on those calendar spreads must be very wide.

You might be able to make other observations.

Net, though this is a handy table for making sense of converting what the market is saying into implied HPA and for letting you know where calendar spreads are narrow, or need work.

Please contact me (johnhdolan@homepricefutures.com) if you have any questions related to this blog or any aspect of housing derivatives.

 

One-point markets

I’ve tried to get traders on Tuesday mornings to spend some time focusing on Case Shiller futures.  Earlier this morning there were 14 one-point bid/ask spread markets across the CHI, CUS, LAX and NYM contracts.  (See table).

Several quotes are for more than one lot.  I’d be open to increasing the bid or ask size for specific inquiries.

There are also relatively tight calendar spreads- also with more than one lot – for those interested in that approach to trading.

I’m also willing to accommodate inquiries in inter-region trades so if anyone wants to take a view on NYM vs LAX or any contract vs CUS, please let me know.

Finally, I’d encourage others who want to see this market thrive to consider “just going along” by joining the bid or ask side.  Price spreads have collapsed to the point where that shouldn’t be the reason to limited trading.  Any help in adding to the depth of the market (i.e. the size available for trading) would be appreciated.

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

 

 

Bid/Ask Spreads

The 11 contracts for the CME Case Shiller futures are quoted with different bid/ask spreads.  The reasons for the differences range from time to expiration, time elapsed since last trade, whether a trader has an “axe” (often measured by open interest), volatility of the index (particularly for the ten regional indices), absolute index level (e.g. WDC is ~2x the price of the LAV index), and concerns about possible index revisions.

This table shows recent bid/ask spread differences for all 121 contracts using price on the top, and percent versus index bid on the bottom.

Looking across rows (expirations) the two tightest bid/ask spreads are highlighted in green, while the two widest are shown in red.

As noted above, since the WDC contract has the highest index value, it tends to have the widest bid/ask point spreads.   However, when bid/ask is measured on a percent of bid WDC only shows up once as a “top 2 widest”.  On the other hand, the LAV contract, which never was listed as one of the wider bid/ask point spreads, shows up as the most frequent “top 2 widest” markets when measured on a percentage basis.

The two tables show that the bid/ask spreads tend to expand with time to expiration (consistent with risk increasing with the square root of time).

I would suggest that traders use these tables for two reasons:

  1. To see where the tightest markets are, in case they’re interested in trading.  So, for example, the CHI and NYM markets are the tightest points-spread markets when this spreadsheet was created.  LAX joins CHI and NYM as the tightest markets when expressed in percentage terms.  The tightest regional markets tend to change over time.  This past winter DEN was one of the tightest markets for long periods, and there have been < 1 point markets in LAV over the last few months.
  2. To see where there’s room to bring in the bid/ask spreads.  That is, these tend to be regions (or expirations) where there’s been infrequent trading, or a lack of interest.  MIA and SDG usually top this list as there has not been a trade in Miami in a very long time, and (I expect) most of the interest in the California markets has focused on LAX and SFR.

Check the CME websites (links provided on the right side of my home page) or contact me (johnhdolan@homepricefutures.com), to find out what’s “hot” and what’s not.

 

 

Basics: Using Calendar Spreads/ Implied HPA

I thought that the long holiday weekend might be a good opportunity to revisit a powerful tool -the use of calendar spreads.  (The table and graph of hypothetical numbers will be used for illustration.)

Calendar spreads allow a traders to do two things:

  1. Read the market expectations as to implied HPA, and
  2. Allow traders to express a view on the pace of future price changes.

The graph shows the market-implied HPA (Home Price Appreciation) derived from differences between the mid-point of one contract to a contract a year later.  (Note that I use the same month expiration, in this case from November to November, to avoid seasonality issues).  So, for example, the mid-point of the Nov 2014 contract (162.4) is 4.0% higher than the mid-point of the November 2013 (156.1).

If “the market” became more bullish on the strength of the housing recovery, say to a 5% HPA, then one possibility would be for the Nov. 2014 mid-point to rise to 164.0 (assuming that the mid-point of Nov 2013 didn’t change).  The calendar spread would then more from minus 6.3 (156.1-162.4) to minus 7.9 (156.1-164.0).  (Note that calendar spreads are quoted with the earlier contract first, so being bullish on HPA actually means that the calendar spread becomes more negative.) If that were to happen (as had occurred over the last four months) the price curve graph (above) will steepen.   Importantly this steepening will occur whether the Nov 2013 contract falls to 150 or rises to 165 (although a 5% increase over 150 is slightly less than a 5% premium over 165).

So if a trader thinks that that the “right” implied HPA between the Nov 2013 and Nov 2014 contract is more than 4.0%,  he might want to try and sell the X13/X14 calendar spread at a level <= 6.1 points.  Unfortunately it is impossible to trade on mid-market prices and by hitting the outright Nov 2013 bid and lifting the outright Nov 2014 ask at the same time, the spread would be -9.4 points.  (The wider number is a function of introducing two bid/ask spreads.)

A step in the right direction would be to enter a spread order, for example offering (i.e. on the ask side)  the spread at -6.0 points.  That is, in entering this order the trader commits to a simultaneous sale of CUSX13 and purchase of CUSX14 at a dollar spread of 6.0 points.  (Like outright contracts, spread orders are quoted in 0.2 point increments).  Since spread orders have less outright market risk traders can usually afford to leave tighter GTC quotes in for longer periods – and for larger amounts.  In the case of our hypothetical X13/X14 calendar spread, the spread market is quoted -8.2/ -4.0 both of which are better levels that executing both outright legs at the quoted levels.    As with stated outright GTC markets, traders may have some flexibility inside of stated calendar spreads (so contact me).

Note that a calendar spread results in one long and one short position.  Before the first contract expires, traders are free to unwind either leg, or two positions simultaneously.  Over time, the front contract will expire (at the then spot index level) leaving open the back leg.   Once the front contract expires the trader will then only own one position and will be more exposed to shifts in the level of index moves.   On a one-year spread, the second leg will expire at the  spot level 12 months later.  Allowing the first contract to expire and then holding the second position to maturity is very similar to a TROR (total rate-of-return swap) of “owning” the index for one year.

The number of calendar spread permutations exceeds 600 (for the 11 contracts across 11 expirations) so maintaining calendar spreads on both the bid and ask side for all (>1000) quotes is unwieldy.  I tend to focus on November/November spreads as the underlying contracts tend to have the tightest quotes, but will be responsive to particular inquiries.   Calender spreads to express a view on expected changes in seasonal factors could also be employed, but the seasonal factors in the Case Shiller index are not too dramatic.

Again, as with all posts, please feel free to contact me (johnhdolan@homepricefutures.com)  with any questions on this post, calendar spreads or any other question on housing derivatives.

 

 

Basics – Spread trading (using CUS)

One way to trade Home Price contracts is on spread trades.  This allows one to trade on the eventual price difference between two contracts.   While trading spreads results in no net position (a spread trade results in a long in one contract and a short in another) that is not to say that they are less risky.  I’ve tallied the live spread trades for the Nov cycle maturities as an example.

Note (1st VERY IMPORTANT) that the spreads are quoted as the first contract against the second contract.  As such, the -500 quote along the CUSX11 line, and under the X12 column, translates into someone willing to buy the CUSX11 contract 5points below where they will simultaneously sell the CUSX12 contract.  (Note, I am jumping back and forth between how the indices are quoted (e.g. 150.00) and how the contracts are traded (e.g. 15000)).  So, for example if someone hit that bid, there would be two trades: one where the “-500” bidder would buy a CUSX11 contract at 150 while at the same time selling the CUSX12 contract at 155, while the seller sold a CUSX11 at 150 while buying the CUSX12 at 155.

The -160 spread offer represents someone who is willing to sell the CUSX11 contract  “only” 160 points below the CUSX12 price.

Spread quotes may also be the basis for an outright bid.  For example, the -1100 offer between CUSX11 and CUSX15 means that someone will sell the CUSX11 11 points under the CUSX15 contract.  This is the same as someone being willing to buy the CUSX15 contract 11 points above where they can sell the CUSX11 contract.  As such, if there’s a 150 bid in the CUSX11 contract (as shown) the -11 spread (CUSX11/CUSX15) will result in the CME computers generating a 161 bid for CUSX15.  This bid will exist as long as both the 150 bid exists in CUSX11 and the -1100 spread offer is working.  If the 161 bid is hit, the spread order will simultaneously hit the 150 bid in CUSX11.

Net one trader will be short a CUSX15 at 161 (as he wanted).  One trader will be long a CUSX11 as they wanted, and (possibly) another trader will be short the CUSX11 and long the CUSX15 at an 11 point price difference.

Finally, even-year spread differences can be easily translated into forward HPAs (Annualized Home Price Appreciation).  Using the above example, if someone is willing to buy the CUSX11 at 150 while selling the CUSX12 at 155, it may be inferred that they expect CUSX12 prices to be no more than 5 points (or looking to the right side of the table~7.3%)  higher by the time the CUSX11 contract expires.  It may be interpreted that the buyer of the spread at -160 thinks that prices will rise by more than 1.3%.

Any spread order can be translated into a forward HPA assumption, and (importantly  for trading) any HPA can be translated back into a spread order.

2nd Important Note- A spread trade is a buy/sell of a front contract combined with a sell/buy of a back contract.  When the front contract expires one is left with an outright position in the back contract.  That is why I’ve taken pains here to say “one may interpret/infer”…  There are other reasons one might buy or sell a spread.

Basics -Implied HPA using prices

Many housing economists and traders prefer to quote home price changes in terms of HPA (annualized Home Price Appreciation).  For a one-year holding period this is simply the (End Price/Begin Price)-1 expressed in percentage terms.  

For longer periods one must discount the End Price/Begin Price fraction by time, so a three year holding period HPA would be:

((EndPrice/BeginPrice )^.3333) – 1

With that math, with quotes in all  the Nov 2011-2015 expirations, and with the Nov 2010 as the most recent Case-Shiller release, one can easily compute implied HPA for both long-term holding periods (say spot vs. 2015), or for interim periods (say Nov 2013 vs Nov 2014).  The results for mid-price quotes are shown here.

Reading the table one can see that the implied annualized  HPA over the five years from Nov 2010 to Nov 2015 is 1.7% (lower right).  This is a result of a total price increase of 1425 points or 8.8% over five years.

The path to higher prices is not a straight-line.  Prices dip in 2011, and then rebound at ever slightly higher annualized rates (e.g. 2.4% between Nov ’11 and Nov ’12 to 3.9% between Nov ’14 and Nov ’15).

Note that prices shown here are mid-market prices.  Since bids will be lower, the price gains, and therefore annualized HPA will be lower.  Offered prices result in higher implied HPA. (next blog).

A final point (to help trading) is that while one might have a weak view on the level of home prices for a particular year, one might have a strong view on the HPA for any given year.  Spread trading, allows a trader to express such views on particular years.

So, for example, while the difference between Nov ’12 and Nov ’13 mid points is 440 points or 2.8%, someone thinking that home prices will rise more than 2.8% during that period might think the spread should be wider and could enter such a spread trade order. 

(A warning -spreads are quoted backwards from what a layperson might think.    Since the earlier contract is quoted first both in terms of action and price, someone looking for the spread to widen would put in a spread order to sell the front contract at a discount to the back contract.  The more negative the number, the more the person thinks that back contract prices are going to rise -relative to the front contract.  More later, but this is an important qualifier.)