CME Housing Futures & Options May 2006
Executive Summary Residential real estate is an asset class of equal significance to stocks and bonds but with no viable derivative markets THUS Case, Shiller and Weiss articulated concept of real estate futures in 1992 [f]utures and options markets should be established that are cash settled based on indexes of real estate prices, and there should be separate markets for each of the major geographic regions at present no real estate futures contract exists in the world; nor are there good substitutes for such markets. CME Housing futures & options fulfills that vision Targeting Spring 2006 launch Major Domestic Asset Classes Fixed Income $25.3 tril (39%) Housing $21.6 tril (34%) Equities $17.0 tril (27%) 2
Executive Summary $26 $24 $22 $20 Value of Domestic Fixed Income, Equity and Real Estate Residential Real Estate Equities Fixed Income $18 Trillions $16 $14 $12 $10 $8 $6 $4 $2 $0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 3
Executive Summary 280 260 240 220 200 180 160 140 120 100 80 60 40 S&P/Case-Shiller Home Price Indices Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Boston Chicago Denver Las Vegas Lo s A ngeles Miami New York San Diego San Francisco Washington DC 4
Executive Summary CME Housing Futures & Option specifications Contract Size Minimum Price Fluctuation Trading Hours Futures $250 times the S&P/Case-Shiller Home Price Index, e.g., Los Angeles Index @ 264.78 in 4th quarter 2005 contract value = $66,195 (=$250 x 264.78) Minimum price fluctuation or tick shall be 0.20 index points ($50.00) Offered exclusively on CME Globex electronic trading platform on Sundays Thursdays 5:00 pm-2:00 pm next day (central time) Options on Futures One futures contract Minimum price fluctuation or tick shall be 0.10 index points ($25.00) Traded via open outcry in CME GSCI pit Monday Friday, 8:00 am 2:00 pm (central time) Contract Months Final Settle Date Cash Settlement Strike Prices February Quarterly Cycle of February, May, August and November Trading in expiring contract ceases at 12:00 noon (central) on last Tuesday of contract month Cash settlement based on S&P/Case- Shiller Home Price Indices of home prices by Fiserv CSW Inc. (CSW) for Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, Washington DC and Composite Index of the 10 cities NA Exercised into the associated futures contract At 5 index point intervals above and below prevailing market price 5
Outline The Housing Boom S&P/Case-Shiller Home Price Indices CME Housing Futures & Options 6
The Housing Boom Median US home value =$213.0K at end of 2005 per NAR An advance of 13.6% over past year and 85% in past 6 years Many metro areas are appreciating much faster, e.g., New York United States New York-Northern New Jersey-Long Island, NY-NJ-PA New York-Wayne-White Plains, NY-NJ NY: Edison, NJ NY: Nassau-Suffolk, NY NY: Newark-Union NJ-PA Norwich-New London, CT 2005 Median Home Price $213,000 $459,600 $537,300 $384,600 $472,400 $427,600 $262,100 Change over Past Year +13.6% +16.0% +19.2% +11.9% +9.4% +14.7% +11.2% 7
The Housing Boom These significant advances in median home value have been major impetus for development of housing futures & options Available housing measures National Association of REALTORS (NAR), Office of Federal Housing Enterprise Oversight (OFHEO) Or S&P/Case-Shiller Home Price Indices published by Fiserv CSW Inc. 400 380 360 340 320 300 280 260 240 220 200 180 160 140 120 Mar-85 Mar-86 Mar-87 Mar-88 Mar-89 OFHEO House Price Index (US) Mar-90 Mar-91 Mar-92 Mar-93 Mar-94 Mar-95 Mar-96 Mar-97 Mar-98 Mar-99 Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 8
The Housing Boom Median Single Family Home Value $250,000 $200,000 $150,000 $100,000 $50,000 $0 $75,000 $67,500 $60,000 $52,500 $45,000 $37,500 $30,000 $22,500 $15,000 $7,500 $0 Home Prices vs. Mortgage Rates 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Median Home Value Mortgage Rate Median Annual P&I vs. Household Income Median Household Income Annual Median P&I 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1981 1982 1983 1984 1985 1986 1988 1989 1990 1991 1992 1993 1995 1996 1997 1998 1999 2000 2002 2003 2004 2005 30-Year Fixed Mortgage Rate Housing boom driven by increasing affordability as mortgage rates fall and household income advances Mortgage rates have fallen from all-time highs near 16% in 1981 to 6% by 2005 Principal & interest (P&I) on median single family home at $1,040/mth ($12,480/yr) or 21.4% of median family income Down from high of 39.1% in Nov 1981 when mortgage rates @ 16.38% up slightly from low of 17.0% in 1998 THUS median US home value broke $200K in April 2005 and hasn t looked back 9
The Housing Boom NAR Housing Affordability Index Rallied strongly throughout 1980s into early 1990s but has been in a stall since mid 1990s currently starting to decline as home values advance sharply A figure > 100 suggests that median household (earning $58,303) can afford median home (valued at $209,300) in December 2005 150 140 130 120 110 100 90 80 70 Affordability Index 60 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 10
The Housing Boom (000 Units) 2,300 2,200 2,100 2,000 1,900 1,800 1,700 1,600 1,500 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 1981 Jan-03 1983 Mar-03 May-03 1985 Jul-03 Sep-03 1987 Monthly Housing Activity Nov-03 Mortgage Rate vs. Fed Funds 1989 Jan-04 Mar-04 1991 May-04 Jul-04 1993 Sep-04 30-Yr Fixed Mortgage Rate Effective Fed Funds 1995 Nov-04 Building Permits Housing Starts Housing Completions Jan-05 1997 Mar-05 May-05 1999 Jul-05 2001 Sep-05 Nov-05 2003 Jan-06 2005 Housing permits, starts & completions generally rising but limited supply of buildable land on east & west coasts pressures prices Exceptionally low interest rates on mortgages have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a bubble in home prices does not appear likely, there do appear to be signs of froth (Alan Greenspan) BUT will Fed tightening start to push mortgage rates higher, possibly leading to housing price declines? 11
S&P/Case-Shiller Home Price Indices Index overview S&P/Case-Shiller Home Price Indices are published by Fiserv CSW Inc. Indices originally conceived by Case and Shiller in 1980s Case, Shiller, Weiss Inc. founded in 1991 to publish indices, acquired in 2002 to become Fiserv CSW Inc. Standard & Poor s (S&P) branding applied in 2006 S&P/Case-Shiller Home Price Indices based on repeat sales methodology Must match a pair sales on same property Filters out non-arms length sales and other questionable data points Base year of 2000 when indexes are established at 100.00 CSIs available for U.S., Census divisions, state, metro areas (MSAs), county, zip code; or, high-, moderate- and low-end homes; or single family vs. condos 12
S&P/Case-Shiller Home Price Indices $270,000 Two Sales Pairs Methodology $250,000 $230,000 $210,000 $190,000 $170,000 $150,000 1995 1996 1997 Home Sale Price 1998 1999 2000 2001 2002 2003 2004 2005 13
S&P/Case-Shiller Home Price Indices Tradable S&P/Case-Shiller Home Price Indices Updated monthly & released at 2:15 pm (EST) on last Tuesday of each month with 2-month look-back Rolling quarterly indexes with 2 month overlap Produced in secure network environment with backup calculation capabilities Release Date April 25, 2006 May 30, 2006 June 27, 2006 Data Thru April 14 th May 19 th June 16 th Data From Dec-Jan-Feb Jan-Feb-Mar Feb-Mar-Apr Standard Case-Shiller Indexes Updated quarterly & typically released on last business day of calendar quarter end with 3-month look-back NEVER released sooner than tradable indexes Discrete quarterly indexes with no data overlap thus, March update reflects Oct-Nov-Dec data 14
S&P/Case-Shiller Home Price Indices 280 260 240 220 200 180 160 140 120 100 80 60 40 S&P/Case-Shiller Home Price Indices Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Boston Chicago Denver Las Vegas Lo s A ngeles Miami New York San Diego San Francisco Washington DC 15
S&P/Case-Shiller Home Price Indices Comparing S&P/Case-Shiller Home Price Indices Vs. National Association of Realtor (NAR) Indexes NAR indexes quoted as median home values and do not use repeat sales methodology Median values do not address homeowner returns and may readily be skewed if composition of housing stock changes, e.g., new luxury subdivisions are introduced to area Vs. Office of Federal Housing Enterprise Oversight (OFHEO) Uses repeat sales methodology BUT sample confined to Fannie & Freddie conforming mortgages and, therefore, skewed to low end of housing market Only perhaps 1/6 th of California housing sold with conforming mortgages Uses appraisal data to supplement sample appraisals tend to be upwardly biased? 16
S&P/Case-Shiller Home Price Indices 240 Los Angeles Housing Indexes 220 200 180 160 140 120 100 80 60 17 Q1 '90 Q4 '90 Q3 '91 Q2 '92 Q1 '93 Q4 '93 Q3 '94 Q2 '95 Q1 '96 Q4 '96 Q3 '97 Q2 '98 Q1 '99 Q4 '99 Q3 '00 1st Qtr 2000 = 100.00 Q2 '01 Q1 '02 Q4 '02 Q3 '03 Q2 '04 Q1 '05 CSI NAR OFHEO
S&P/Case-Shiller Home Price Indices Correlation between S&P/CS vs. NAR and OFHEO Indexes Boston Chicago Denver Las Vegas Los Angeles Miami New York San Diego San Fran Wash DC United States Average 1990-2000 NAR OFHEO 0.771 0.922 0.155 0.703 0.733 0.891 0.525 0.414 0.790 0.871 0.168 0.604 0.834 0.757 0.845 0.931 0.806 0.871 0.081 0.490 0.234 0.809 0.571 0.745 2000-2005 NAR OFHEO 0.627 0.680 (0.106) 0.442 0.914 0.963 0.990 0.974 0.875 0.931 0.908 0.918 0.165 0.372 0.862 0.863 0.955 0.851 0.702 0.944 0.394 0.858 0.689 0.794 18
S&P/Case-Shiller Home Price Indices A unique asset class Housing uniquely different from other assets such as stocks, bonds or even the value of REITs Housing values have performed on par with other asset classes over past 10 years but with far less volatility Movement in housing values has been negatively correlated with movement in bonds, stocks and REITs underscores value of diversifying with housing Performance (1995-2005) Return Volatility Housing 8.00% 1.44% Bonds 7.74% 2.25% Stocks 8.66% 7.13% REITs 6.61% 6.99% Correlation (1995-2005) Housing Bonds Stocks REITs Housing - Bonds -0.169 - Stocks -0.390 0.052 - REITs -0.074 0.177 0.153-19
S&P/Case-Shiller Home Price Indices 300 275 250 Housing Bonds S&P 500 REIT Housing vs. Other Asset Values 225 200 175 150 125 100 75 1995 1995 1996 1996 1997 1997 1998 1998 1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 20
CME Housing Futures & Options Introducing CME Housing Futures & Options Chicago Mercantile Exchange (CME) will introduce futures & options on tradable S&P/Case-Shiller Home Price Indices Have targeted ten cities Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, Washington DC and US Composite Index of the 10 cities Aiming for a launch in Spring 2006 21
CME Housing Futures & Options Likely users of market include Real estate owners who wish to hedge risk that the housing bubble may burst sending real estate values lower this may include home builders with inventory and extend to individual homeowners Mortgage investors and mortgage insurers exposed to the risk of high loan-to-value (LTV) ratios and exposed to risk of default Government sponsored entities (GSEs), agencies and other mortgage issuers Investors at large including hedge funds seeking exposure to housing without the attendant logistical difficulties 22
CME Housing Futures & Options Economic benefits Nowhere in the world today are there markets that would allow investors to invest in a widely diversified portfolio of real estate without incurring enormous transaction costs. Since they cannot invest in a widely diversified portfolio of real estate, they cannot invest in a truly diversified portfolio at all. Thus, the presumed diversification that is supposed to be practiced by all investors according to modern financial theory just isn t happening. Nor are there markets that would allow individuals and institutions with large exposure to specific real estate risk to hedge these risks. Individuals usually prefer to own their own homes But they cannot easily hedge the risk of these holdings. In order to hedge their portfolio, these owners of real estate should sell real estate futures or buy put options that are closely correlated with the real estate that they live in or operate. At the same time, everyone should invest in a broad portfolio of real estate futures and options, which they can do by holding a portfolio of the opposite sides of the futures and options contracts that those who own real estate concentrated in a certain area undertake. Thus, the long sides of any given futures or options contract should be taken by a wide spectrum of investors, presumably primarily institutional, who invest in many futures contracts and options as a means of diversifying their portfolios; the short side should be taken by owners of region-specific real estate: individual homeowners, managers of rental properties, developers, corporation, and farmers. (Case, Shiller, Weiss, 1992) 23
CME Housing Futures & Options Economic benefits The establishment of real estate futures and options contracts might be described as having the effect of spectacularly lowering transactions costs for trading real estate. The modern theory of the transaction costs stresses the importance of traders with superior or inside information: dealers must announce bid-asked spreads wide enough that they are not routinely picked off by more informed traders. Baskets of corporate stocks and other financial assets are inherently subject to lower bid-asked spreads than are individual assets because there is less informed trading about the aggregates. The same would be true about the baskets of real estate on which the index is used to settle real estate futures and options contracts is based. Those who invest in real estate would be spared the concern that they are buying lemons, they can thereby forego the enormous costs and risks associated with buying individual properties. (Case, Shiller, Weiss, 1992) 24
CME Housing Futures & Options CME Housing Futures & Option specifications Contract Size Minimum Price Fluctuation Trading Hours Futures $250 times the S&P/Case-Shiller Home Price Index, e.g., Los Angeles Index @ 264.78 in 4th quarter 2005 contract value = $66,195 (=$250 x 264.78) Minimum price fluctuation or tick shall be 0.20 index points ($50.00) Offered exclusively on CME Globex electronic trading platform on Sundays Thursdays 5:00 pm-2:00 pm next day (central time) Options on Futures One futures contract Minimum price fluctuation or tick shall be 0.10 index points ($25.00) Traded via open outcry in CME GSCI pit Monday Friday, 8:00 am 2:00 pm (central time) Contract Months Final Settle Date Cash Settlement Strike Prices February Quarterly Cycle of February, May, August and November Trading in expiring contract ceases at 12:00 noon (central) on last Tuesday of contract month Cash settlement based on S&P/Case- Shiller Home Price Indices of home prices by Fiserv CSW Inc. (CSW) for Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York, San Diego, San Francisco, Washington DC and Composite Index of the 10 cities NA Exercised into the associated futures contract At 5 index point intervals above and below prevailing market price 25
CME Housing Futures & Options May 2006