New Derivative Provides Hedge on Housing Prices
Investors who believe that home prices have peaked may have a way to hedge against a decline in residential real estate.
The Chicago Mercantile Exchange rolled out a new derivative Monday: futures contracts based on indexes that track house prices. The contracts are designed to let pension-fund managers bet on housing and builders hedge their losses.
They may be a tough sell. Twice the exchange delayed the debut to fine-tune indexes that potential buyers said failed to reflect a market where the underlying properties aren’t uniform.
“Houses are not the same,” said Sam Zell, chairman of Chicago-based Equity Office Properties Trust and Equity Residential, the biggest U.S. apartment owner. “It’s very hard to come up with a kind of trading instrument that would truly reflect the risk and the reward when in fact the basic asset is not the same.”
The value of U.S. homes rose an average of 11% a year from 1997 to 2005, according to the Federal Reserve. That was more than twice the average 4.7% return for the Standard & Poor’s 500 index.
The exchange is seeking to lure investors who haven’t considered housing as a way to boost returns, said Fritz Siebel, a derivatives broker for Tradition Financial Services in Stamford, Conn., a unit of Cie. Financiere Tradition of Lausanne, Switzerland.
“These people have to make sure that they are moving with the economy,” Siebel said. “This is a way for them to be in it.” He said he expected the contracts to take at least two years to catch on with investors.
Executives at the exchange, which would be the first major U.S. market to offer the futures, said they knew the new derivative posed a challenge. After the exchange’s annual meeting April 26 in Chicago, Chief Executive Craig Donohue told reporters that past success didn’t mean housing futures would be an instant hit.
“It’s dependent on us to do a lot of education and training,” Donohue said.
The Mercantile Exchange traded 52 housing futures Monday. The most active was the Los Angeles contract for May 2007 that fell 3.9% to 294 index points, said Sayee Srinivasan, associate director of research and product development for the exchange. “It’s a new market. People have to figure it out,”
Under Donohue, the exchange has succeeded with futures. The Mercantile Exchange’s stock climbed more than twelvefold to close at $449.62 on Friday from the company’s initial share sale in December 2002. Net income rose 40% last year to $306.9 million as trading in 2005 increased by a third to 1 billion contracts.
Most of the trading came from the exchange’s Eurodollar futures and options contracts based on the London interbank offered rate, or Libor, which international banks use to gauge U.S. interest rates. The Eurodollar series is the world’s most traded futures contract, driven by the U.S. Federal Reserve’s 16 interest-rate increases since June 2002.
The Chicago Board Options Exchange says it plans to release by June 30 a rival housing contract that will be based on price indexes provided by the Chicago-based National Assn. of Realtors. The indexes for both exchanges reflect U.S. housing prices in markets that include New York, Los Angeles, Chicago and Las Vegas.
In futures contracts, buyers and sellers agree to an index level in a contract month, which for the Mercantile Exchange’s futures will be August, November, February and May. The buyer would receive a cash payment from the seller should the index rise; the buyer would pay the seller in the event the index falls.
