WDC – HomePriceFutures.com

AMZN/HQ2 possible impact on DC home prices- Using the buzz for a primer on call options

The DC press has been all abuzz about the prospects of Amazon picking the DC/ Northern Virginia area as the site of their HQ2 and the potential impact on home prices in the region. However, speculation on how to play the real estate market in the run-up to the anticipated year-end announcement has not resulted in many tradeable strategies (other than JBG Smith Properties REIT -JBGS). If one has a view that DC home prices might pop, Case Shiller WDC home price call options, that can be traded on the CME (Chicago Mercantile Exchange), might be an ideal strategy. As such, let me use the AMZN buzz as an opportunity to discuss call options. Note that while my comments here relate to the Case Shiller WDC index, calls (and puts) can be traded on the CME for nine other regions, and I’d be open to structuring options on any other home price index).

For those new to futures and options, WDC is one of ten set of regional contracts listed on the CME. Each region has expirations that will settle on the value of the respective Case Shiller index at the end of the expiration month. Contract expirations range from Nov 2018 to Nov 2022 (but I’ve only listed the first eight here). Options (both puts and calls) can be quoted on any of the expirations, for any strike.

Contracts have notional values of $250 * price (i.e. each point =$250), so a contract priced at 230 has notional value of $57,500.

The table below has offering levels for nine contracts (three strikes for each of three expirations). As with most options, the longer the time to expiration, and/or the lower the strike (relative to futures contract value), the higher the premium.

The graph below shows the payoff of two options (the Nov ’19 235 and 240 strikes) at expiration, and illustrates that for index values less than the strike, the call buyer doesn’t receive anything, but then participates 1:1 with gains in the index. (Options and futures prices can vary between inception and expiration for any number of reasons. A benefit of options is that regardless of any price moves, the option buyer cannot lose more than their initial premium.

A few notes:

There has been no volume in WDC futures and options for many months, but I’m trying rejuvenate interest and as such, am happy to answer any questions, and/or facilitate trading inquires.
Calls on other strikes and expirations are possible. Contact me if you’d like a quote.
While I’ve shown suggested offering levels, I’d also be happy to buy calls.
My focus here has been on calls, to address interested parties that may want to put up some money for the option of a particular event. Futures could also be used to express a bullish view (and I’d be happy to accomodate any inquiries) but a futures buyer runs the risk that prices may drop, requiring more money to be posted.
To reiterate my comment from above, my observations here related to the Case Shiller WDC index. I’d be open to structuring an OTC option trade on other home price indices.
There are not many futures brokers who trade Case Shiller options. Please contact me for names if your broker does not.
WDC contract covers a broad geographic area (see page 8 in CS Methodology in Reports section for listed counties).

As always, feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions or would like to discuss any trading strategies.

Thanks, John

(BTW -See Core Logic’s report on Amazon HQ2)

Oct recap of activity in CME Case Shiller futures – busiest month in the last year.

I’ve posted a recap of activity in the CME Case Shiller home price index contracts for October. The recap is in the Reports tab or you can access here.

Highlights of recap include:

–There were 22 futures contracts traded in October, across 6 expirations, and 3 regions. Trading, and third-party quotes, in SFR contracts (where 12 lots traded) dominated activity. There have been only 3 months since Nov 2013 with higher volume. Beyond that, activity was scattered across the month and often throughout trading days (particularly when the equity markets were volatile).

–The LAV, SDG and SFR contracts had the most regional activity, with LAV (and WDC) breaking away from other contracts is not falling much. Forward HPAs across regions have started to diverge from the 10-city index (some priced for better HPA / some for worse), consistent with either different outlooks across regional markets, or given limited trading, pressure on regions where traders are looking to hedge.

–There were no options trades (but many inquiries.)

–Bids and offers collapsed across most regions in the largest sell-off in CS contracts since the Financial Crises. The LAXX22 contract saw the biggest decline of ~12 points. LAV and WDC were relatively unchanged.

–Forward curves flattened with some calendar spreads in longer-dated expirations bid at negative spreads (i.e. sell front contract/buy back one for a lower price).

–Increased volatility, combined with flattening of forward curves, led to much higher put option quotes. (My standard page of one-year puts is not included in this recap, but will be the topic of a blog early next week)

–Despite volatility, bid/ask spreads only widened a small amount (as more traders weighed in, often throughout trading days). Such widening was concentrated in X20 and longer contracts.

–OI on futures increased from 47 to 49, consistent with some positions being closed out, or intra-month trading.

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

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

Playing the Amazon HQ2 announcement

Many are waiting for Amazon to announce the location of HQ2, their new second headquarters. The thinking is that the “winning” city will see home prices soar in anticipation of the need to house thousands of new employees. While there’s been lots of buzz about what Amazon might do, there’s been little offered in ways to play this announcement. Calls on CME Case Shiller home price futures might be one tool worth exploring. (Note that there has been almost no trading in such CME options, but as market maker, I am looking to facilitate -at first by taking the other side – trading inquiries).

The two sets of tables and graphs below show information from the CME Case Shiller contracts on two of the leading candidates: 1) the Boston area, and 2) the Washington DC area. (Note that both areas are defined in the Case Shiller methodology and may/may not/ incorporate specific locations being considered by Amazon. However, each may be viewed a generally reflective of home prices for the broader areas of Boston and Washington.)

I’ve added quotes on the futures, as well as indicative offering levels on a variety of call options on those futures (see lower left of each display).

So, if one thought that home prices in the WDC or BOS area might pop, one might consider buying calls. I’ve shown contracts for Nov ’18, ’19 and ’20 expirations (the X18, X19 and X20 contracts) with strikes ranging from 220 to 250. (Other strikes and expirations are possible). As with most options, the more time to expiration and/or the lower the strike, the greater the premium.

As an example (and ignoring fees), if one bought a WDC 240 (strike) November 2019 (expiration) call for 4.5 points (at $250/point = $1,125/contract), and the Nov ’19 WDC contract settled at 250, then one would have a 5.5 point profit/contract (equal to 250 settlement price minus 240 strike minus premium of 4.5 points, or $1,375). While there has been no volume in either call, there also would be nothing limiting a call holder from selling the call before expiration, or hedging with the underlying futures contracts.

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. As noted above I’m very interested in facilitating any inquiries, matching potential buyers and sellers, or in buying calls.

Thanks,

John

Approaching May ’18 expiration w/convergence => CS (10-city) HPA expectations (6.4%)?

Every quarterly expiration of a CME Case Shiller home price index contract is an opportunity to remind readers about the cash settlement features of these contracts, and how quotes on the expiring contracts might be used to get a sense of “market-implied” HPAs.

For example, the table below shows (in red) the most recent Case Shiller indices for the HCI (10-city index) and for each of the 10 regional components. Below there is a section that has quotes on the 11 CME home price index contracts. I’ve average Bid and Ask to create a mid-market level (“Mid”). Note that all Mid’s are above the current CS index.

Further, I’ve compared the Mid values on the contracts to the index level from a year ago (i.e. from the release dated May 31, 2017) to generate a percentage gain. If the Case Shiller numbers released on May 29th are close to these Mid levels, then these percent changes should be the year-on-year gains that you’ll read about in press reports that day. The headline that day should be that the 10-city index rose ~6.4% on the year and that, once again LAV (Las Vegas) will be the best YOY performer and CHI (Chicago) and WDC (Washington, DC) indices will be the laggards.

So (rhetorically) what gives these mid-market values credibility as projections on the upcoming Case Shiller release? The answer is that the May ’18 contracts will settle on the index values released this month. So, to pick an example, if someone “knew”, had researched, or just had a strong view that the Case Shiller NYM index for May will be 199.4, they could buy a futures contract at 198.4, and pocket the $250/point/contract difference when the 199.4 number printed. (Not a bad return for 3 weeks exposure when required margins might be as low as $2500.) Alternatively, if they believe the actual number , is lower (e.g. the 197.9 mid-market value) they might also try to be the best bid (in case there’s a sale) and bid greater than the current bid of 197.4.

If they were had much more bearish views they could do the opposite, either hitting bids, or offering lower.

The point is that this market allows both bullish and bearish predictions to play out in a (theoretical) way, such that bids and offers should reflect conservative expectations. Buyers will bid where they think that can make money (versus their expectations), while sellers will do the opposite. Net, bids and offers, when averaged (i.e. to the mid-market levels) should do a reasonable job in revealing market expectations, for such short time frames.

Feel free to contact me (johnhdolan@homepricefutures.com) if you have any question about this blog, or any aspect of hedging home price index exposure, or would like to discuss a trade.

Thanks, John

“Gauging Confidence in US Housing” Pulsenomics, Scatter Diagram

I continue to be a fan of the work done at Pulsenomics regarding the use of surveys to gauge sentiment related to home prices (either among forecasters, or home owners). The Pulsenomics quarterly survey is (IMHO) the best survey of forward home price expectations by those in the business of making forecasts (to include, in the interest of full disclosure, myself).

Recently, Cityscape published a detailed report where Pulsenomics founder Terry Loebs describes both the methodology in calculating the Pulsenomics Housing Confidence Survey. It is recommended reading for anyone looking for views of homeowners (and renters) toward many questions, including homeowner confidence.

The report may have particular use for those following the CME Case Shiller futures as the results are tallied for the 20 regional components of the Case Shiller 20-city index. Since ten of those indices have contracts traded on the CME, one might be able to use the survey results in their trading.

I’ve taken a first cut at comparing survey results against CME markets here. The table to the right takes a portion of the results in Exhibit 2 (using only those cities in the CUS 10-city index). (I’m only using the homeowner confidence index, but there is larger set of results that includes renter confidence. Readers are encouraged to look at the entire report and see how use of other data might impact results.)

To the Pulsenomics results I’ve added the CME trading symbols, the gain in the Case Shiller index for the last 12 months, the spot Case Shiller index levels, the bid and offer for the Aug ’16 CME contracts, and the difference between the mid-market level of the Aug ’16 contract and spot levels. (I used the Aug ’16 contract to minimize seasonal levels. Ideally, I’d like to use a longer-dated contract, consistent with longer-dated expectations, but wanted to avoid seasonal issues. In addition, many of the Aug ’16 contract prices are mine, so caution is advised as I’m evaluating my own inputs. That said, anyone who wants to narrow the Aug ’16 bid/ask spread, or to challenge the bids and offers, is encouraged to post prices. Hopefully the following results might prompt some such reactions. Also, I use the Case Shiller indices as those are the references for the CME futures. Pulsenomics tends to focus on the Zillow indices.)

I then took the Pulsenomics Homeowner Confidence Level and contrasted it versus the mid-market implied gains for the Aug ’16 CME contracts to see if confidence levels are correlated with higher home price expectations.

The scatter diagram suggests that confidence levels seem to be generally correlated with one-year forward gains. For example, CHI has both the lowest confidence level as well as CME Aug ’16 prices with the lowest implied gains, while SFR has one of the highest confidence levels and highest CME price gains.

The outliers (e.g. DEN, WDC in particular) might be worth evaluating more thoroughly. DEN does have one of the stronger improvements in confidence levels over the last year, so momentum might play a role there, but WDC has both one of the weakest trailing 12-month gains in the Case Shiller index as well as only modest 6-mon and 1-year gains in confidence levels among homeowners (as well as weak gains among renters (not shown here)).

Might WDC CME Aug ’16 prices be too low, or might confidence levels be too high? I have no strong views BUT am very happy to accommodate anyone looking to debate the topic, and/or to trade WDC (or any other) futures.

Please read the entire Citiscape report and/or feel free to contact me (johnhdolan@homepricefutures.com) if you have any questions.

Forward HPA – a review of Q14/Q15 spreads

Forward CME contract prices are consistent with continued (albeit slowing) gains in Case Shiller index values for the next year.

The table to the right shows the outright markets (bids, offers and mid-market levels) for the Q14 and Q15 (Aug 2014 and Aug 2015) contracts for all 11 regions in the left-hand columns. In addition spot values are highlighted in blue.

The “Calendar Spreads:$” columns shows the bids (in orange) and offers (in green) in the calendar spreads. They bracket the mid-to-mid price differences in yellow. (Recall that many services, including the CME show the value of the front contract relative to the back. I’m aware that others, including IB, show it the opposite way. In this display higher forward prices translate into calendar spreads with negative values.)

Next, the column “Calendar Spreads: Implied HPA” takes each of the three calendar spreads denominated in points, divides by the mid-market level (and reverses the sign) to give implied HPA for bid, mid and ask.

Finally, the far right column shows the index value change (in %) for the most recent 12 months.

I’ve used the one-year forward markets to avoid seasonality issues.

Net, all contracts have mid-market levels that are at least 4.5% higher. The range runs from 4.5% (NYM) to 7.6% (SFR). Calendar spreads tend to bracket mid-to-mid implied HPA by about 1.5-2.0% (on each side.

Noteworthy is that consistent with talk about home price appreciation slowing, most of the regions show declining HPA (e.g. LAV from 16.9% to 6.7%). Surprisingly some contracts (e.g. NYM show almost no slowdown) and in one case (WDC) an increase in implied HPA.

The tightest market (as of this writing) was the NYMQ14/Q15 market of -7.8/-7.6 for a 0.2 bid/ask spread. Most other markets were 4-6 point spreads. I’m willing to “sharpen my pencil” should anyone have an interest in a particular contract.

This chart shows prices and spreads for Aug ’14-’15. Any other combination is possible but there seems to be a lot of debate about current 1-year forwards.

As always, I’d be happy to discuss this blog or any aspect of home price futures. Feel free to contact me at johnhdolan@homepricefutures.com

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.

Basics: WDC revisions -impact on trading?

Two weeks ago, when the Case Shiller index numbers for December were released, I mentioned that the WDC index came in dramatically lower than expected by the Feb ’12 contract prices. I noted then that the WDC index had been revised. (See table to the right.) As this revision impacted the settlement price of the Feb ’12 contract, and since this was the second “meaningful” revision of the WDC in the last 12 months, I thought that the process of an index revision merited its own blog.

Economic data is often revised. Many indices are based on sampling (which may not be precise) or on data collection (which may be revised if additional data is submitted at a later date). Housing indices -particularly repeat sales calculations that rely on recorded prices – fall into the second category.

While economic indices are often revised (e.g. GDP, CPI) those revisions are after the initial release. As such derivative trade (based on those economic indices) can still be settled using the initial index release. However the nature of the moving average in the Case Shiller index may give greater importance to historical index revisions.

(A note of caution here. I am using diagrams (below) merely to illustrate a concept. The underlying numbers, the weights to the indices, and actual index calculations may be very different. The numbers used here are hypothetical numbers used purely for illustration.)

This diagram (below) is an illustration of how a moving average calculation might work. Values (repeat-sales calculations) are complied across multiple time periods (in this case 3 months) and each period’s observations are weighted. Results are released with a two-month lag. Thus the index results for November are announced in January and cover the periods September, October and November. If there are no revisions, the values for the December index includes the same two observations for October and November, drops the September number and adds the results for December. As such, the December number is somewhat already ~2/3rd’s “baked” as it will contain the two of the same components (the Oct and Nov results) as in the November index. This makes predicting (or at least bounding) the December number somewhat easier.

The presumption in forecasting the December number is that the “fixed” components -the October and November results – are just that, fixed. But what happens if additional data comes in that changes the Oct and/or November components?

The third illustration shows a hypothetical example of how a revision to data previously released might impact the numbers in a current index.

If we assume (solely for ease of calculation) that all time periods have the same weighting, then the November index (to be released in January) is the average of the three months Sept., Oct., and November or 184.

If one assumes that the -2 point/month trend will remain in place, and that the result for December is 180, then the expected result for the December index will be the average of Oct., Nov. and Dec or 182.

But what happens if the Oct and Nov. numbers are each revised down 3 points? They are revisions of historical results so they shouldn’t impact prior settlements, but they do figure into the results for December. In the example to the right, I’ve assumed that the individual December one-month prediction of 180 was still correct, but now the number reported for December is 180.

As a result of the historical revisions (to Oct and Nov) the December index result is 2 points lower than expected. I believe that this is a unique feature of the Case Shiller index using a moving average calculation.

So what, you might say. Again, historical revisions occur all the time.

My concern is that these “historical” revisions impact the first release of a economic result. If these revisions occur frequently it may impact the market’s ability to narrow bid/ask spreads as contracts near expiration. (That narrowing of the bid/ask spread allows traders with positions an alternative to holding to maturity which exposes them to these revisions.)

The possibility of index revisions may make calendar spread trading riskier (as a revision to the second leg of a trade, after the front leg is released, becomes more of a concern).

Unfortunately, I don’t see a trading solution to this challenge. Front month markets in contracts with frequent index revisions may have to be wider. (In longer term contracts (e.g. Nov ’16) an eventual 1% revision may not matter if a trader is trying to hedge against a possible 10% move.)

The key is to limit revisions by making sure that all of the underlying data is collected by, and reported in, a timely manner. This will minimize future revisions, thereby limiting the uncertainty of, and volatility of, prices in expiring contracts.

Again, this has been a hypothetical illustration of a situation, but of one with real-world implications. A 2-point “adjustment” to a spot index, that is, different that what may have been projected based on past index releases, is worth $500/contract.

As always, please feel free to contact me on the material discussed in this blog, or any other topic related to housing derivatives, at johnhdolan@homepricefutures.com.