Posted on 03/23/2006 10:47:50 PM PST by Attention Surplus Disorder
New way to bet on real estate
New financial instruments are being launched to let you wager on the direction of home prices in major cities.
By Les Christie, CNNMoney.com staff writer March 22, 2006: 12:00 PM EST NEW YORK (CNNMoney.com) - There's finally going to be a viable way to cash in on the housing price boom -- or to guard against its decline -- without going through the messy business of actually buying and selling properties.
On Tuesday, the Chicago Mercantile Exchange and Tradition Financial Services, together with Fiserv Case Shiller Weiss and Standard & Poor's, announced the launch of S&P CME Housing Futures and Options. These derivatives will enable investors to take a position on the direction of home prices either for the nation as a whole or for 10 major cities to start, including New York, Los Angeles and Chicago.
Of the three major asset classes, the bond, the stock and the housing markets, only the housing market, which represents some $20 trillion in assets, cannot be speculated on easily, said Robert Shiller, the Yale economist and author of "Irrational Exuberance," the 2000 book that foresaw the bursting of the tech-stock bubble. [snip]
The S&P CME Housing Futures and Options will be based on the data accumulated in these indexes, so accuracy is crucial for building trust among potential investors. Who will use them? Shiller sees these derivatives mostly as tools that large, institutional investors can use to reduce risks. Mortgage bankers, for example, could hedge against falling real estate markets that would increase their exposure to delinquencies and foreclosures. But John Labuszewski, of the CME, says, "Although the main customers will be institutional, there is a surprising amount of interest on the part of retail consumers." So how would an ordinary consumer employ these tools?
(Excerpt) Read more at money.cnn.com ...
I'm going to buy foreclosures. I don't trust Wall Street after working in the zoo for a few years.
Your statement regarding options is entirely accurate. You can indeed hedge a long position in futures or in shares by either writing a call (a partial hedge) or by buying a put (an insurance hedge).
Your question: In the futures market, would I purchase a contract to protect my downside? is unfortunately inchoate. Before it can be answered, one must know your present-day position in whichever market. If we're considering these housing/real estate index futures, and assume that you're a homeowner, then the answer is ''yes'', you might indeed sell short, not purchase, some number of futures. The contract size is $50,000, so a nominally ''perfect hedge'' (somewhat of a misnomer, but that's another discussion for another day) of a home appraised at $250K in, say, Chicago, would be the sale of 5 contracts on the Chicago-area index.
The term ''natural short'' refers to those who would use a futures market only from the short side. A wheat grower has wheat to sell, sooner or later. He or she can lock in a price for the wheat to be grown by using the futures market (i.e. by selling the wheat in advance of its production, for delivery in future). This is the wheat grower's ''natural'' use for a futures market, hence the term ''natural seller''.
There's a different term for wheat growers who buy futures: they're called ''Texas hedgers'', which, trust me, is a term of considerable disdain. After all, the wheat grower already OWNS, or will shortly own, some amount of wheat; to buy futures means that he or she may own even more in the future.
There's a technical term for these folks: gamblers.
Possibly the best way to view the difference between futures and options is to consider that, in a futures contract, the goods are already sold (on the one hand) and bought (on the other) the moment the trade is made. Delivery of the goods from seller to buyer may or may not take place thereafter (doesn't, in the vast majority of cases), and btw the decision about delivery (in delivery-settled markets such as wheat) is entirely the seller's.
In an option contract, no purchase or sale of goods is made at all. What has actually traded are a set of rights and obligations. The option writer guarantees to sell X amount of Y goods at Z price on or before date D (if he's written a call) or to buy X amount of Y goods at price Z on or before date D (if he's written a put), at the option buyer's demand. If the option buyer, for whatever reason, makes no such demand, the writer pockets the premium received and goes out and has a nice dinner.
Of course, the typical reason for an option buyer to NOT demand specific performance from the writer is that the price of Y is unsatisfactory, at or near the option's expiration, from the option buyer's viewpoint.
The ''cash flow'' is exactly as you say: he who buys pays, he who writes collects...but may have to pay back substantially more in future, depending on how the underlying market moves.
In futures trading, there is NO -- zero -- cash flow in either direction until one party has liquidated the position. Indeed, the position may be liquidated and re-liquidated any number of times (I know, that sounds screwy, but it's literally true).
To avoid the awkward bookkeeping that this condition of contest implies, the exchanges perform a daily 'mark-to-market' of all traders' positions. This procedure may or may not require any given futures trader to provide more capital (the infamous ''margin call''), according to how the trader's various long and short positions have fared during any given day.
Naturally, I've elided some details here, and my apologies for that, but I hope this post is some use to you regarding your questions.
And, btw, good trading to you!
You can download this great housing price spreadsheet. Prices in the major markets from 1972 to 2005.
http://www.cme.com/files/HousingData.xls
It looks like each contract size will cover about $55K - $65K of housing. You can buy options also.
LOL! I've literally turned around some S+P contracts in 30 seconds. Those were on 'crash days' when you were just 'catching' freefalls below major support.
PING
How about your perspective?
Hi Stu.
Your post is very logical on the first read. After some thought and re-reading, I have a question for you:
Who are the natural longs for the stock index futures?
We both know just how successful these contracts have been, yet I can't come up with an answer.
By the way, your service looks very interesting. I may give it a try sometime soon. I'm just too busy right now.
bank
Sometimes the market makers, knowing better than the rest of us of how many shorts are out there at what prices, will bid the price up just to clean out the overhang of shorts. What fun!
Say, you're just like Attention Surplus.
Why do people insist on pontificating regarding things about which they know little?
Wow. I'll bet Vegas is kicking itself for not thinking of this first!
Unless it's a Naked Short.
Well, SAJ is obviously the expert in this area. My humble opinion as a commercial credit guy in a bank is that any type of hedge contract is very risky and should be left to specialists. We do use interest rate hedges from our own capital markets folks, but only in very specific cases. I really can not see us being able to use this type of instrument to do something like lock in a collateral value.
However, I just forwarded this article to our CFO and will let you know what he thinks.
You worked on Wall Street? What did you do?
It turns out that the major index futures mkts do have large crowds of naturals, on both sides. The reason why it's perhaps harder to see who is in which camp is because the population of each camp is constantly in flux.
Natural longs? They're fairly easy to locate. Any NYSE specialist or NASDAQ dealer who is short in his book, which possibility, of course, changes over time. Numerous hedge funds, at times, depending on their other positions. Arbitrageurs, when the futures trade at discount to cash. Anyone who prefers to lever up and use futures as a replacement for shares, which is fairly commonplace these days courtesy of the liquidity of the major index futures.
Make sense?
Thanks for having a look at the site. We intend to become the encyclopedia of American futures markets' historical data sometime in the next 90 days. Not far away from it right now, but there are several more features I want to add. And European futures, too -- when I can obtain good historical OHLC data, which is remarkably difficult to do. You cannot believe the EUREX people's attitude. Simply bizarre (shrug).
Good trading to you!
Just another derivative speculative "investment" instrument of which to steer clear.
There's one exception to this, but only one. If the value of the homeowner's home in the case described above does not keep pace with the rising index, then the homeowner will actually lose capital. This implies directly that only those with relatively more attractive properties, i.e. ''nice neighbourhoods'' and so forth, should use this market to hedge.
I expect the mortgage industry to make a good thing of this market, as long as it lasts (which I don't think will be very long; see my other posts here), by offering a package of complete hedge services to upscale homeowners. The usual homeowner is not going to be terribly savvy about the possibilities here, and I daresay the mortgage bankers can generate quite nice fees from this service. The fly in the ointment will be the title industry, although they might decide to play here, too -- who knows?
For the most part, I agree with you, and you are correct in that I've never traded futures; only equities and equity options. What is unquestionable is that these new products, like most new products from the geniuses on Wall St./CBOT/CME are designed with the (profits of the) casino in mind.
I just thought it was a sort of interesting concept, and being generally bearish on housing, my fellow bears always ask "how do we bet on housing going down?" Other than shorting or buying puts on the homebuilders or their basket ETF.
Rgds,
It's all very well to be cynical and describe the exchanges as 'casinos', but it serves little purposes. No futures market will survive, as noted elsewhere, until it conveniently meets the needs of both buyers and sellers in a market. If a mkt meets those needs, then clearly some one (the exchange, in this case) has provided value to these buyers and sellers, and has therefore quite legitmately earned an honest profit.
REIT insiders have been dumping stock like crazy over the past six months. They must know something, do you think?
We'll just increase our national wealth by giving the daytraders another tool to gamble with.
We don't need to make or invent anything anymore, since we'll all get rich trading paper assets back and forth!
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