I visit a few agriculture/farming forums and I found an interesting question last week. The quote below is from a guy who is looking for a way to hedge land value against a commercial real estate market crash. The event he wants to hedge against is very unlikely but has happened in the past. It was the worst consequence of the farm crisis in the early 80’s. His grandpa probably had lots of neighbors that lost their farms because of a sharp quick equity drop that triggered the acceleration clause in their mortgages. How would you use futures and options to hedge against a real estate crisis? You could buy out of the money puts on the SPX, but would it be correlated enough to do the job? The full thread I’m referencing is here: https://newagtalk.com/forums/thread-view.asp?tid=1139290&DisplayType=nested&setCookie=1 “I’m considering a land purchase that is on the edge of town so developers have the appraisal pretty high. I can afford the payment easily with my current income but I’m concerned about a drop in real estate values. The current interest rates make a downward adjustment of land value a real possibility and could change that appraisal figure substantially. If the lands appraised value was to drop by 50% a lender would likely ask that the principal be paid down to get the balance below the new valuation. This would pull the brakes on my other ventures pretty hard and I don’t know if I could stomach it. Is there a way to hedge land value after a purchase? An insurance policy? Some financial market option I’m not aware of?”
I think one should ask his lending bank for an insurance in form of a Put option, ie. a private agreement between the two parties. The bank should make such an offer, and you can decide whether acceptable or not etc... Of course it will cost you some bucks...
FYI: in the other thread he later said "I’ve been googling and there are some index options that could be used but I don’t think they would be correlated closely enough with a small farm town real estate market."
It sounds like the land he is wanting is priced at development prices so it might not be correlated to Agriculture industry stocks. The fact that it is still farm land will give it a bottom if there is a commercial real estate bubble. I’m guessing the land is currently valued at twice the price of farmland in his area. Also, shorting a stock would be very risky for him and he’s wanting to reduce risk. If the bubble doesn’t burst he will be paying someone for the stock price increases and also have to maintain a significant margin balance to hold the shorts. He mentioned buying cheap puts to use as a monthly insurance policy but he’s worried that it might not be correlated closely enough if the black swan actually happens. Are there futures contracts on an index that is weighted heavily in real estate stocks? Or banking stocks? I mean ones that have options available?
Here's an another method by buying T-Bills and rolling them...: https://www.armstrongeconomics.com/investments/how-to-hedge-real-estate/
I’m in a rural farming area and can tell you that the local bankers have never done anything like that. I doubt that it could be an option for him and that’s why he is looking for an instrument outside of his bank.
Asking doesn't cost anything Someone just ask the bank and let us know So, the risk then goes over to them. All that's needed is the Volatility rate (%) of the object in question, or of similar objects. Then one can feed all the data, incl. time, into the Black-Scholes options calculator to calc the Put price (ie. the theoretical fair value).
I’ll have to read that…..but Martin Armstrong? WOW! I read up on him a few years ago and it’s a crazy story.