Bear market in housing futures

Trading in the Case Shiller indices say prices are heading down.

NEW YORK (CNNMoney.com) -- Home prices fell from July to August in seven of the 10 major housing markets covered by the S&P Case Shiller indexes. The composite index for all 10 cities fell 0.36 percent.

But prices are heading down a lot more, if the investment pros who trade in housing futures can be believed.

Housing futures based on the Case Shiller indexes and traded on the Chicago Mercantile Exchange have predicted a decline in the 10 markets around the country of 7.3 percent from August 2006 to August 2007. Prices in all 10 cities are projected to fall.

The S&P CME Housing Futures and Options, launched this past spring, enable investors to hedge against a drop in the value of residential properties in the future or to bet that those values will go up.

Miami, according to the futures, will experience the steepest plummet at 8 percent, and prices in Boston, at minus 5.8 percent, will hold up the best.

"I've been poring over the data for a long time now, given the anecdotal information we've been reading about home prices," says Fritz Siebel, director of housing derivatives at Tradition Financial Services, an institutional brokerage that trades futures of the Case Shiller indices. "I think the latest price drops are significant. These are pretty big numbers."

One month does not a trend make but Siebel points out that because of the gap between contract signings and when the front door keys actually change hands, August prices reflect closing prices of sales initiated earlier in the year, when many believed the housing market was still truckin' along.

Since them, markets have probably fared worse. Says Siebel, "The underlying metrics of the market - inventory, rate of sales - have not cleared. I don't see it getting better soon."

Neither, it seems, do speculators.

If the predicted decline happens, however, it may not be as severe as the futures trading indicates. According to Robert Shiller, the co-creator of the indexes, there is a risk premium to be taken into account; at this point, more traders are interested in protecting themselves against loss than are interested in buying into a growing market. That imbalance drives down the futures prices.

In addition, the futures have been traded very thinly to date and the smaller the sample size, the greater is the margin for error. As the market in housing future trading expands, the accuracy of their predictive value should increase.

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