With the near future of real estate still in question, investors have been hungry for a fast way to play the market or to hedge against their volatile portfolios. Futures contracts have been an extremely popular method of balancing a portfolio in other markets, and real estate is, with a little knowledge, now in the same boat.
In 2006, the Chicago Mercantile Exchange (CME) started trading futures contracts for the S&P/Case-Schiller Home Price Index, which covered both U.S. residential and commercial properties. The Case-Shiller index, originated in the 1980s by Karl Caser and Robert Shiller, is widely considered to be the most reliable gauge to measure housing price movements.
Advantages of Futures Contracts Futures contracts that trade at a centralized exchange allow market participants more financial leverage, flexibility and are guaranteed by the exchange so there is no risk of counterparty default. They are also in and of themselves leveraged investments, which allow investors a way to benefit on movements in housing prices as well as provide them with the opportunity for a liquid short-term real estate investment. These futures also allow investors a way to speculate on housing prices with much lower capital requirements.
Contract SpecificationsThe CSI index futures and options are cash settled to a weighted composite index of U.S. housing prices. Contracts are available for 10 major U.S. cities, including Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco and Washington DC.
Each contract will be valued at $250-times the CSI index for that city. For example, if the value of the index for Los Angeles was reported at 270, the contract value would be $67,500 ($250 x 270 = $67,500). The minimum price fluctuation or tick will be 0.20 index points, or $50. The contract will trade only on the CME Globex platform Mondays through Thursdays, from 5pm to 2pm the next day.
The composite weight of the CSI index is as follows:
- Boston 7.4%
- Chicago 8.9%
- Denver 3.6%
- Las Vegas 1.5%
- Los Angeles 21.2%
- Miami 5%
- New York 27.2%
- San Diego 5.5%
- San Francisco 11.8%
- Washington DC 7.9%
Options do trade via open outcry in the Goldman Sachs Commodity Index (GSCI) pit Monday through Friday, 8 am to 2 pm. The options trade European style, and are exercised into futures contracts. The strike prices are in intervals of five index points above and below the underlying futures. Position limits for futures and options is set at 5,000 contracts, as set by the exchange.
The CSI futures will trade for the next 18 months, and will be listed on a quarterly cycle. Months include February, May, August and November. Futures will also trade 19 to 36 months out, but only for May and November. Futures for three to five years out will only trade for November. All contracts will be cash settled on the day the indices are released.
Seven investment banks (Credit Suisse, Goldman Sachs, Merrill Lynch and four others) have licensed the National Council of Real Estate Investment Fiduciaries to come up with an index to get into the over-the-counter market. Many people think that a liquid and specific property derivative could help smooth out pricing bubbles. A healthy derivatives market could allow investors the ability to short with relatively low transaction cost versus actually playing the market. The ability to trade real estate futures started in London a couple years before the CME.
Comparison to Other Housing IndicesAlong with the CSI, there are a couple other real estate indices like the National Association of Realtors (NAR) - which is quoted in terms of median home value - and the Office of Federal Housing Enterprise Oversight (OFHEO). Median home value can be skewed by remodeled homes or the addition/subtraction of luxury/low-cost housing in the area. The OFHEO utilizes a repeat sales methodology, similar to the CSI, but the OFHEO is confined to the mortgages of Freddie and Fannie, and is therefore biased to the low end of housing.
Market ParticipantsThere are two types of market participants for futures markets: speculators and hedgers. Speculators are investors who looking to speculate on price movements. Speculators include hedge funds, CTAs, individual investors, pension funds, etc. Hedgers are either consumers or producers of a certain commodity. In this case, hedgers would be property and real estate developers, banks, mortgage lenders and home suppliers.
Investors have been using CSI futures to speculate by investing directly for a while, but home owners looking to sell within a year or two can also go short home prices, looking to recoup losses on their homes.
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