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| Several Factors May Help Grow Demand for Housing Futures |
| Written by Jonathan Smoke | |
| 08.13.2007 | |
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Discuss this article on the forums. (0 posts) Last week the Chicago Mercantile Exchange announced it was extending the length of its housing futures and options from up to 1 year to as long as 60 months beginning September 17.  According to the CME’s announcement, contract months extending out 18 months will be listed on a quarterly cycle of February, May, August and November. Contracts listed 19 to 36 months out will be available on a biannual schedule of May and November contracts. An annual November listing schedule will apply to contracts listed 37 to 60 months out into the future. In addition, the CME said that the extension of contract durations was in response to customer requests. Contracts listed further out will allow for more opportunities for protection or profit in up or down markets in the same way that investors manage risk for other CME Group products such as agriculture or financial contracts. Some think that this extension will be all that’s needed to pump activity into the thinly traded volume in the contracts since they were launched in May 2006. For example, Steve Bedikian wrote the following for Inman News in an article that is now appearing in our Real Estate News. “These short-duration contracts have been very thinly traded compared to mature markets like commodities and foreign exchange. The slow growth has been due to the fact that residential real estate is often a long-term investment. Property developers, builders and other investors need tools that allow them to hedge risk over multiyear periods. The contracts initially listed in May 2006 only had durations of up to 12 months.”
While it is true that the limited duration did not align well with the typical length of a residential project, particularly for developers and builders, there are other factors limiting the widespread adoption of these futures. For example, the CME futures cover 10 markets and one composite of those 10 markets. That leaves out 351 MSAs in the U.S., including a few sizable housing markets like Houston, Atlanta and Phoenix, the largest markets for residential development in the country. Furthermore, as I mentioned in our very first post, there is substantial basis risk in using an MSA-level index to hedge a location-specific housing investment. While the exchange traded housing futures can be utilized, there needs to be supporting data and analysis that is neighborhood-specific to craft an appropriate hedging strategy. Don’t forget that Radar Logic’s new daily spot home price index is up and running and is attracting the attention of some major investment banks. The over-the-counter trading on that index also begins in September. It covers 25 markets. Maybe the competition and increased visibility paired with supporting data and analysis from HousingIntelligence along with the longer contract durations will help make housing derivatives more palatable for major players in housing. 
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