Tuesday Futures Thoughts - Hedging Your House

The decline has hit most severely in California where the median home price has dropped over 29% in some local markets. Nationally, home values have declined 7.7% in the first quarter of 2008, the steepest decline in over 29 years per the National Association of Realtors. Prices have declined in 100 out of 149 markets with Lansing Michigan and Sacramento California leading the pack in percentage losses.

For most people, one's home is the largest single investment one will make in a lifetime. With the above facts in mind, and the likelihood of continued decline in prices, I started looking for a way the savvy consumer/futures trader could hedge their home against the declining home prices and/or speculate in this market in both directions. What I discovered is quite exciting and a useful tool to protect your home from potential future depreciation.

The Chicago Mercantile Exchange CME offers a suite of housing futures and options that are traded in a similar manner to the standard futures and options traders' trade everyday. These innovative and unique products are based on the S&P Case/Shiller Home Price Indices. These indices are considered the most accurate representation of home prices across the country.

Shiller is the Yale economist who wrote the book that most traders are familiar with: Irrational Exuberance, which focuses on the tech bubble. These indices are focused on 20 metropolitan areas and provide 2 composite indices created from the regional ones. Real estate is such an illiquid market, how is value derived for the index? The value is based on the repeat sales pricing technique. Data is collected on single family home re-sales, recording re-sold sales prices to create sales pairs. The Indices are calculated monthly and published with a 2-month lag. New index levels are released the last Tuesday of every month at 9:00 AM.

The Case Shiller indices reflected a 14.1% decline in home prices nationwide which is the largest in history. Its ten city index plunged over 15% this quarter.

Now that I have given a very cursory overview of the underlying indices, just what instruments trade based on these indices and how are they used to hedge or speculate? Here is a brief overview to get you started. The contracts are traded on the CME and 250X the index; therefore 1 point equals $250.00. The composite index symbol is CUS with each region having its own easily recognizable symbol. Examples are Boston-BOS, Miami-MIA, Chicago-CIA, and New York NYM. They are traded on GLOBEX and are listed February, May, August and November. These are not day trading instruments but rather tools for long term speculation and hedging. The investor/trader can utilize them in several ways. The most direct is simply by buying or shorting depending on your opinion of if the bottom is in yet. The next way, and what I find most interesting, is to use these contracts to hedge or "lock in" the price on your home. If you intend on selling within a year or 2, you can short the futures, in effect, recapturing the losses of the actual sale with the gains made in the short contracts. Other more created uses of these contracts/indices are to link the sales price of your house to the index for the city it is in. This will provide confidence to both the buyer and seller that the price is a fair representation of value.

There is much more to these contracts than I was able to cover in this brief article. The CME is a good place to continue your research, should these innovative future products interest you.

Good Luck!

Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.