Housing Futures Let Investors, or Homeowners, Hedge Their Bets, but They Attract Little Action
Saturday, November 22, 2008
Your house may be special to you, but to a futures trader dealing in housing contracts, it's just another data point.
"At 10,000 feet, housing is a commodity," said Fritz Siebel, a broker at TFS Derivatives who specializes in housing-related securities. And housing futures are one way to hedge real estate investments.
When the Chicago Mercantile Exchange launched its housing futures and options market about two years ago, housing futures struck some investors and economists as an appealing way for real estate buyers to hedge against huge losses in equity. But those products have caught on slowly among institutional investors and even more slowly among individual investors. The reluctance of the latter is not necessarily a bad thing, financial planning and futures trading experts said.
The basic idea behind these products is to be able to bet on the direction of home prices, creating the possibility that a property owner -- in theory, even an individual homeowner -- could hedge against a sharp decline in a property's value. The futures offered by the Chicago Mercantile Exchange are based on the S&P/Case-Shiller home price index for each of 10 areas: Chicago, Boston, Las Vegas, Denver, Los Angeles, New York, Miami, San Diego, San Francisco and Washington.
Investors can also buy contracts based on a weighted composite index for all 10 cities.
All futures and options are intended to help protect buyers and sellers from market volatility. For example, a buyer who knows he needs a future supply of a commodity can purchase contracts from a seller to guarantee a set price for it on that date. Housing futures operate similarly to traditional commodities such as oil or wheat, although they do not represent the individual homes. Instead, you're essentially betting on a trend.
In essence, trading futures is a way to "make money on housing without buying the house," Siebel said. Compared with the nothing-down mortgages that were widespread during the boom, he added, "this is less crazy."
Housing futures have drawn interest from "a variety of commercial and non-commercial traders, including housing developers, mortgage lenders, hedge funds and even individual homeowners," said Michael Shore, a spokesman for CME Group, parent company of the Chicago exchange. "Both retail and institutional participants have access to the product. However, for the most part, futures markets tend to attract more institutional investors."
For example, Siebel said, a residential developer who plans to deliver $5 million worth of homes in a year but fears that the value of those homes will decline can hedge against that risk by buying what are called put-option contracts.
A single put-option contract costs $250 multiplied by a premium derived from the Case-Shiller index. In Washington, where November 2009 futures contracts are pegged at an index value of 169.80, the developer would have to buy 120 put-option contracts to cover his $5 million. Generally, an investor puts up 5 percent in cash to buy these options, or a total cost of about $250,000.
The index would have to fall 4.7 percent lower than the current November 2009 futures settlement level for the developer to recoup that investment. (And that 2009 level is already almost 9 percent below the November 2008 level.)
If the index falls more than that, the developer would profit, receiving, for example, $515,000 net profit if values fall by 20 percent.