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Special Report: Extended S&P/Case-Shiller futures debut
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JCK



Joined: 15 Feb 2007
Posts: 559

PostPosted: Wed Sep 19, 2007 12:51 pm GMT    Post subject: Reply with quote

admin wrote:


Part of the 29.40% decline has already occurred. The futures are predicting an additional 21.49% decline over the course of the next 4.25 years. That works out to an annual decline of 5.53%


I would guess the perceived opportunity cost of investing in a future would be about 5%/year, roughly equivalent to what a CD would yield over that same time.

I would therefore conclude that the futures are projecting flat, rather than falling prices, over this time.
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admin
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PostPosted: Wed Sep 19, 2007 1:04 pm GMT    Post subject: Reply with quote

JCK wrote:
I'd really be curious to see what these future were predicting in 2004 and 2005.


Unfortunately, they weren't predicting anything as they didn't exist back then. Maybe we could test the reliability of futures in general. If we had historical futures data for a stock market index we could see how well it identified tops and bottoms. That probably wouldn't be directly applicable to the housing futures since the volume would probably be a lot higher for the stock index futures, but maybe that's a good thing - it would give a hint as to how good of a predictor the housing futures would be if the volume were to grow to the point where they are efficient.

JCK wrote:

I would guess the perceived opportunity cost of investing in a future would be about 5%/year, roughly equivalent to what a CD would yield over that same time.

I would therefore conclude that the futures are projecting flat, rather than falling prices, over this time.


Unless I am misunderstanding something, your money is not tied up when you purchase a contract, only your margin is. That is much smaller than the actual value of the contract, so the opportunity cost would also be a lot smaller than the 5%. Also, can the margin account not earn interest? (I don't know - I'm asking.) If it can, then the opportunity cost is even smaller. I do think there might be an opportunity cost factored into the price, though I doubt it accounts for the bulk of the apparent decline.

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JCK



Joined: 15 Feb 2007
Posts: 559

PostPosted: Wed Sep 19, 2007 1:23 pm GMT    Post subject: Reply with quote

Good point. I realized after I posted that you're not tying up the full amount for five years.

Housing futures are a bit different of beast than oil or stock futures, because the houses themselves aren't traded like stocks or oil. I don't know exactly how that gets factored into the analysis or how it affects the predictive value of these futures.
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admin
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PostPosted: Wed Sep 19, 2007 1:51 pm GMT    Post subject: Reply with quote

Another thought on the opportunity cost just occurred to me... If both parties of the contract are required to keep the same margin amount (I'm not sure if that is the case or not), shouldn't that balance out any distortion that opportunity cost would have on the contract price? The buyer would want a lower price to cover his opportunity cost, but conversely, the seller would want a higher price to cover his opportunity cost. It seems that the two could cancel each other out when the price is viewed as a predictive tool.

I clearly need to read more on the mechanics of futures contracts and derivatives.

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BigDot
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PostPosted: Thu Sep 20, 2007 12:33 am GMT    Post subject: Fantasy Land Reply with quote

I think real estate has long since arrived in Fantasy Land, the place where a half-million dollar fixer is a "real bargain". So many people bought into this, literally, that now we have to maintain the fantasy -- that prices will only correct "slightly", even tho the cost of a the average house is totally beyond the average income, the buyer pool is no longer inflated by exotic loans, and historically low interest rates are likely to rise. I have seen comparisons to the post-1989 price drops, but even then, prices were much lower and within reach of potential buyers using conventional mortgages. Now we've got lunacy.
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Mike



Joined: 01 Nov 2006
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PostPosted: Thu Sep 20, 2007 3:36 am GMT    Post subject: Reply with quote

JCK wrote:
I'd really be curious to see what these future were predicting in 2004 and 2005.

Also keep in mind that future values are necessarily discounted, because, if you purchase the future, you can't invest the same money elsewhere. In that sense, the future value may already be effectively "inflation adjusted," even if you're the betting itself is on the nominal price. The "correct" value for the future would be the predicted nominal price minus the opportunity cost of tying up you money for, say, five years, as opposed to investing in stocks, a certificate of deposit, etc.

This would also be consistent with Guest's observation that the Nov 2007 value has gone up as we have gotten closer to that date.


I know some of you guys have been on here for 2 years or more. We should start tracking the futures now to see how accurate they are a year or 2 from now. Can someone save them and archive the predictions on this site somewhere?
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PostPosted: Thu Sep 20, 2007 4:19 am GMT    Post subject: Composite Index Reply with quote

Y'all might check out the composite index: http://futuresource.quote.com/quotes/quotes.jsp?s=CUS&t=future%2Cindex%2Cforex

This is interesting because it shows a few things:
A smaller overall decline than forecast for Boston
Increases down the road in 2010
Downward trends for short-term contracts (in contrast to Boston)

Overall, this stuff is really all over the map and I'm not sure you can make much of it... Looking at the composite index is interesting though for comparison.
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Mike



Joined: 01 Nov 2006
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PostPosted: Thu Sep 20, 2007 11:51 am GMT    Post subject: Re: Composite Index Reply with quote

Anonymous wrote:
Y'all might check out the composite index: http://futuresource.quote.com/quotes/quotes.jsp?s=CUS&t=future%2Cindex%2Cforex

This is interesting because it shows a few things:
A smaller overall decline than forecast for Boston
Increases down the road in 2010
Downward trends for short-term contracts (in contrast to Boston)

Overall, this stuff is really all over the map and I'm not sure you can make much of it... Looking at the composite index is interesting though for comparison.


The composite index doesn't forecast just Boston. It is a 20-city composite, so Boston is just a small part of this forecast. The fact that the composite is showing declines through 2010 shows how bad things can get in Boston, considering how property here is more overvalued than the average US city.
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admin
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PostPosted: Thu Sep 20, 2007 2:48 pm GMT    Post subject: Reply with quote

Quote:

I know some of you guys have been on here for 2 years or more. We should start tracking the futures now to see how accurate they are a year or 2 from now. Can someone save them and archive the predictions on this site somewhere?


That's partly what the graph at the start of this thread was for. I've peppered other threads with futures quotes in the past too. A more organized strategy would probably be better. I would propose taking a snapshot of all contract quotes on the day that a contract expires. That would be the last Tuesday of every February, May, August, and November. Anybody is welcome to post the quotes then and I may make an updated graph at times too.

I went hunting around a bit more for historical futures data. I found some sites that have it for other futures, but not the S&P/C-SI yet. However, I did find something else that was very interesting. The Chicago Mercantile Exchange lists real time quotes of the futures, including the current bid and ask prices. Check it out:

http://housingrdc.cme.com/

The current bid price for Boston November 2011 (which corresponds to prices in September 2011) is 120.00 and the ask price is 161.60. That's huge! That would suggest the buyer thinks prices will be down from the peak by less than 34% in 2011 and the seller thinks prices will be down more than 11%. The last settlement value was 141.00, which corresponds to a decline of 23%.

I just realized that my math was incorrect in the original post. I had said that the total implied decline was 29.4%. In actuality, the proper interpretation of that number was that the peak is 29.4% above the implied value for September 2011. That means that the implied decline is 22.72%. I'm terribly sorry for the error. Here are the corrected numbers:

  • The implied decline from the peak is 22.72%, not 29.40%.
  • The implied decline from the most recent value of the index (June 2007) is 17.69%, not 21.49%.
  • The implied remaining decline of 17.69% over 4.25 years works out to be an annualized decline of 4.48%


Quote:

Overall, this stuff is really all over the map and I'm not sure you can make much of it... Looking at the composite index is interesting though for comparison.


That is pretty interesting, thanks. Perhaps there may be an arbitrage opportunity in there once the volume picks up a little.

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admin
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PostPosted: Sat Sep 22, 2007 4:25 pm GMT    Post subject: Reply with quote

I just received word from the author of the excellent Paper Economy blog that the extended futures contracts don't have any open interest yet. He had contacted the Chicago Mercantile Exchange to determine why the prices weren't showing up in the settlement sheets. The new contracts should show up in his S&P/Case-Shiller charting tool once there is an open interest.

The Chicago Mercantile Exchange does list a "Last" price for the contracts on their real estate site. I am guessing that this price was the average between the most current bid and ask prices. So with this in mind, the chart at the start of this thread should be viewed as even more of an estimation.

Hopefully these futures will catch on as I think they are a great tool.

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guest
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PostPosted: Tue Sep 25, 2007 8:48 pm GMT    Post subject: F = S * (e ^ (rt)) or S * ((1 + r) ^ t) Reply with quote

The reason that the futures look to you like they predict such a dramatic decline is that you are not (as suggested earlier) allowing for the time-value of money. The implied value of the future (e.g., the Case-Shiller September 2011 index value for the November 2011 contract) is the spot price (that which is listed on the CME site and that which is paid by the buyer of the futures contract to the seller of the futures contract at the time of sale) multiplied by e taken to the power of the expected risk-free rate of return over the time between the sale and the settlement date. Alternately, and depending on the type of compounding with which the assumed risk-free rate of return is associated, the implied value of the future can be the spot price multiplied by one plus the rate of return taken to the power of the intervening time.

The idea is that the buyer of the contract pays the seller of the contract the spot price for the contract at the time of sale. The seller is then free to invest that money between the time of sale and the time of contract settlement. It is assumed that the appropriate measure of the value of this investment opportunity is represented by the assumed risk-free rate of return (e.g., that which can be achieved by investing the money in a series of FDIC-insured CDs or the like).

The currently reported value for the 11/11 Boston contract (which, as you noted, may not be an actual sale but rather an average of bid and ask prices - we should really wait until there is reliable sale volume) is 148. If there was a zero expected risk-free return between now and the settlement date (sometime in late November of 2011), then it would, indeed, be suggesting an 18.88% drop from the peak value of September 2005 and a 13.85% drop from the most recent published figure (171.79 for July 2007). However, this is not the case. A typical figure used for the current expected risk-free rate of return is 5%.

Thus, (approximately):

F = S * (e ^ (rt))
= 148 * (e ^ (0.05 * (4 + 2/12)))
~ 182.28

or

F = S * ((1 + r) ^ t)
= 148 * (1.05 ^ (4 + 2/12)
~ 181.36

depending on whether the presumed 5% risk-free rate of return represents a continually compounded or annual rate.

Let us assume, for the sake of being conservative, that the latter is the case. Instead of an 18.88% decline from the peak and a 13.85% decline from the July 2007 figure, this represents a 0.6% decline from the peak and a 5.57% increase from July 2007 to September 2011.

Of course, this is not written in stone (using futures markets to forecast actual values is somewhat risky), nor does it represent great potential for appreciation (under 6% in over four years?!?), nor still does it represent the futures-market-forecast bottom (this would be approximately 167.39 in June 2008 - the August 2008 contract). Still, it is significantly different (and a significantly less bad signal of market conditions) from that which you concluded above.
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PostPosted: Tue Sep 25, 2007 9:22 pm GMT    Post subject: Re: F = S * (e ^ (rt)) or S * ((1 + r) ^ t) Reply with quote

guest wrote:
The reason that the futures look to you like they predict such a dramatic decline is that you are not (as suggested earlier) allowing for the time-value of money.

...

The idea is that the buyer of the contract pays the seller of the contract the spot price for the contract at the time of sale.


OK, I have heard this before, so I would suspect that it is the case for some futures. However, the brochure on CSI futures from The Chicago Mercantile Exchange says it is not applicable to these contracts:

Quote:


Futures traders are not required to put up the full value
of a contract. A performance bond (a minimum deposit
in each trader’s futures account, the amount of which
varies according to what is being traded) enables the
trader to control a considerable amount of product for
a fraction of its value. The performance bond required
for CSI futures and options can be found on the CME
Group Web site at www.cme.com/housing .



See page 8 of the brochure at http://www.cme.com/files/cmehousing_brochure.pdf (PDF)

With this additional information, the opportunity cost is at least much smaller that what you calculated. Also, if both the buyer and seller are putting up identical bonds, it would seem that the opportunity costs would cancel each other out when viewing the price as predictive.

I do agree that the low volume is cause for not taking the values as reliable predictions.

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admin
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PostPosted: Fri Oct 05, 2007 2:55 pm GMT    Post subject: Reply with quote

It looks like others have been using the futures contracts as was done here to suggest where the market expects prices to be in 2011. Their methodology matches what was done here, which lends further support to my hypothesis that the opportunity costs can be ignored since they are identical for buyers and sellers. I have also been speaking with a futures broker and all indications thus far are that the costs are indeed symmetric (I still wouldn't be certain until having actually bought and sold the contracts for myself).

Here are some of the others who used the same methodology:

Realtor(R) Online Magazine:
http://www.realtor.org/RMODaily.nsf/pages/News2007100405?OpenDocument

TFS Derivatives Corp.:
http://housingderivatives.typepad.com/housing_derivatives/2007/10/index.html#entry-39699912

They both report that the expected decline at the end of Q3 2011 will have been 13.8% from July of this year, which matches what I did if you update the numbers with the latest values.

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