Home Price Derivatives Lessen Investors Risk

(The housing market has been in the media spotlight for months now, as we watch the slowdown gradually unfold. )

Home sales are down as the market becomes more and more saturated with houses waiting to be sold.

On top of all this, home prices are already sliding in many parts of the country and things do not seem to be getting any better.

So, if you, like the rest of the millions of other home owners in America are worried about the future of the market and the value of your own house, there may be some good news for you in the form of stocks and futures.

A September 17, 2006 article by Barbara Kiviat of Time.com, “A new hedge for your house,” discusses this exciting new development.

No, new home-price derivatives make it so investing in this so-called risky housing market is safer for everyone.

“If all the jabbering about a weakening housing market has made you glum at the prospect of your own home's losing value, then has the Chicago Mercantile Exchange got a portfolio addition for you. Since May, investors have been able to buy and trade options and futures contracts pegged to home prices in 10 U.S. cities, giving property owners a way to hedge against a bear market--and letting speculators place bets on the direction of house prices in San Francisco, New York City, Chicago, Las Vegas and elsewhere.”

These new options and futures contracts now enable investors to try and predict our once completely unpredictable housing market.

Now, these contracts will not enable traders to predict the market, but it will give them a tangible shot at it, instead of just talking about what everyone thinks is going to happen.

“Think of a guy who is anxious that his hacienda in Miami might be caught in a bubble but doesn't want to cash out and move. If he buys a put option on the Miami housing-price index and the value of homes in Miami (including his) slides, the money he makes on the derivative offsets his loss.”

“A put option is the right, but not the obligation, to sell a security at a set price. A futures contract is an agreement to buy or sell something at a future date. Both are derivatives because they derive their value from an underlying asset, in this case, real estate. If that sounds complicated, well, it is.”

Right now the market for housing futures is quite small, but is slowly gaining more steam. The interest is much greater in the Miami, New York City and Los Angeles areas; as opposed to the Denver, Chicago and Boston area.

Investors hope interest will grow, although the outlook for the overall housing market is not looking so good.

“Based on going trades, the market predicts a 5% to 8% drop in housing prices over the next year in each of the 10 cities. Don't put too much stock in those specific numbers (a market like this, with so few participants, doesn't necessarily yield an accurate forecast), but the sentiment is, nonetheless, unmistakably downbeat.”

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