Let me begin with the fact that while I have been spending a fair amount of time researching housing futures for academic purposes I am not advocating this investment route for all investors.
In fact I am a brick and mortar investor across five cities and would not trade it for anything. I need to be able to “touch’ my “retirement accounts” whenever I choose. However, this is not to say I don’t see the value of the housing futures market for an investor that is comfortable in this arena.
For example, if I were flipping homes in one of the areas that the index was reflected in I may consider adding it to my portfolio to hedge my pricing risk. The reason that I say I “may consider” adding it is because of the number of contracts that I would need to buy in order to cover my portfolio.
While this would act as a form of insurance on the market price movement it does cost money and would by default reduce my maximum profitability. Similar to each of you I am fairly confident that I complete my due diligence adequately and that this insurance may not be worth the cost. The question for us is whether we should actually consider using this in our portfolios?
In 2006 CME began trading housing futures contracts and options as a result of an increased attention to risk.
The goal was to provide real estate participants and speculators of all sizes an opportunity to transfer housing risk. The futures contract discussed here is based on the S&P/Case-Shiller Home Price Index.
The ten cities that contracts were opened for within this category are Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington.
While this list is limited you need to remember that it is based on the Case-Shiller Index which has its own issues as has been discussed by other authors on BP.
Investors have argued that the S&P/Case-Shiller Home Price Index can provide a hedge or offer exposure to a single family housing portfolio without the direct investment in the housing sector.
In other words, an individual interested in this market may be able to invest in the movement of real estate prices before being able to buy a parcel.
The way this particular contract works is that the contract is set at 250 times the level of the index. As an example, if the index was at 200 the value of the contract would be worth $50,000 (200*250).
If you wanted to bet on a gain (price appreciation) you would benefit from buying the contract, and as the index increased you would profit. If you thought the market was set to decline you would sell a contract and make money when the price declines.
What This Means
With such large numbers I know that I am intimidating a few of you but when working with these contracts we don’t actually contribute this figure, $50,000.
Instead we are obligated to put up only a fraction. This allows you to use leverage in much the same way we use leverage on the brick and mortar side of real estate.
There are many other trading details to take into account such as the minimum price fluctuations and contract months, but I only wanted to introduce the topic and see if anyone in the BP community has considered using these instruments. If you are interested on reading more the two links below will give you a pretty detailed breakdown.
So the question is…
Given that these contracts were originally meant to reduce risk is there anyone in the BP community that is actually using these?
Be sure to leave your comments below!