From Time:
If all the jabbering about a weakening housing market has made you glum at the prospect of your own home’s losing value, then has the Chicago Mercantile Exchange got a portfolio addition for you. Since May, investors have been able to buy and trade options and futures contracts pegged to home prices in 10 U.S. cities, giving property owners a way to hedge against a bear market–and letting speculators place bets on the direction of house prices in San Francisco, New York City, Chicago, Las Vegas and elsewhere.
Think of a guy who is anxious that his hacienda in Miami might be caught in a bubble but doesn’t want to cash out and move. If he buys a put option on the Miami housing-price index and the value of homes in Miami (including his) slides, the money he makes on the derivative offsets his loss. A put option is the right, but not the obligation, to sell a security at a set price. A futures contract is an agreement to buy or sell something at a future date. Both are derivatives because they derive their value from an underlying asset, in this case, real estate. If that sounds complicated, well, it is. The notional value of the futures contract is about $50,000 and is bought on margin with just a few percent down, which means you can get badly burned. Since the May debut, developers and hedge funds are among the big buyers.
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Trading volume at the Chicago Merc has been thin so far, with interest in Miami, New York City and Los Angeles far eclipsing Denver, Chicago and Boston. But a slow start is often the case with derivatives. Shiller, who helped design the housing-price indexes the Merc contracts are based on, points to S&P 500 futures, which were half-heartedly received in 1982 but today are a Merc staple. For housing futures, the exchange is already looking to add more cities and contracts past 2007; homebuilders who want to hedge new subdivisions have requested the longer horizon. The Chicago Board Options Exchange is considering housing derivatives too.In the meantime, the contracts provide a window onto the state of residential real estate. Based on going trades, the market predicts a 5% to 8% drop in housing prices over the next year in each of the 10 cities. Don’t put too much stock in those specific numbers (a market like this, with so few participants, doesn’t necessarily yield an accurate forecast), but the sentiment is, nonetheless, unmistakably downbeat.
I wonder, if this exchange could be expanded to included other traditional expenses of Americans – others with price-inflation correlation, long-term debt typical, and geographic differences. Yes, I’m saying housing is an expense, while his housing market premise is that housing is an asset.
For example, could we hedge the college education we give our children? Many want one at a huge cost, and it’s seen as an “investment” in both our future and our children’s.
Now, you might say…well, duh, open a 529 and save for the darn thing. Same could be said for housing. Save for it. But saving doesn’t fully remove risks, like the risk of huge tuition increases at your selected instituion, or the risk that your kid will turn out to wear long black trenchcoats after you’ve paid for the education.
So, we can make his assumptions for other expenses – that holds true – and it doesn’t appear there is any special hedge need unique to housing go on here.
My second comment is that the home OWNER does not seem to be the primary beneficiary of this hedge. If the owner cannot hedge the asset, or doesn’t have the knowledge or wherewithal to do so, then is this truly a hedge for the ASSET of housing, or is it really something else related to the economy and politics?
BTW, your new blog looks great, J.B.
I can’t see any of the commnets I post :(
Stay away. Can they assume that individuals that don’t don’t have a clue about their ARM’s/I/O’s can actually understand puts/calls,spreads, futures and margins???? Yes, margins. There is risk management in place. Should have been the same in RE over the last few years.
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