Long-Duration Derivatives Begin Trading

Long-duration derivatives based on two competing housing price indexes began trading this week. These new contracts with expirations between one to five years will allow investors, developers, builders and other market participants to express a long-term view on U.S. housing prices.

Contracts based on Radar Logic’s Residential Property Index (RPX) will be available through licensed dealers including Morgan Stanley & Co., Lehman Brothers, Merrill Lynch, Pierce, Fenner & Smith Inc., Deutsche Bank Securities Inc., Goldman Sachs & Co., and Bear Stearns & Co.  These indices cover 25 local market areas.

Futures contracts and options based on the S&P/Case-Shiller U.S. National Home Price Index with durations of 12 months or less have traded on the Chicago Mercantile Exchange since May 2006. Contract months extending out 18 months will now 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.

Contracts based on the S&P/Case-Shiller indices trade for 10 markets: Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York City, San Diego, San Francisco and Washington D.C. 

Investors that own large portfolios of mortgage-backed securities may be some of the first customers for these products. According to Rich McKinney, head of Residential MBS Trading at Lehman Brothers, “Investors holding securities sensitive to mortgage credit and prepayment performance … now have a powerful tool in managing their residential real estate risk.”

The importance of housing prices for holders of residential MBS securities was recently highlighted in an article from the forthcoming Federal Reserve Bulletin that analyzed loan data from 2006 collected under the Home Mortgage Disclosure Act. The data comes from 8,900 lenders that account for an estimated 80 percent of home lending nationwide.

The study found that the best predictor of future loan performance on a county level was not the unemployment rate, per capita income or population growth. The most important predictor was house-price appreciation. And conversely, risk to holders of these securities comes from house-price depreciation or – as it is often referred to oxymoronically in the industry – negative price appreciation.

This article also was published in Inman News.

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