Why not offer an options market for homes?

Discussion in 'Economics' started by KINGOFSHORTS, Mar 8, 2010.

  1. Maybe this will get people back into housing? Sell property value insurance via Puts and calls.

    That way you can hedge against losses (minus the premium of course and deductible if you buy cheaper lower strike puts)

    And allow homeowners to sell covered calls on their home as well so they can collect a premium. (of course of the house gets called away, they have 24 hours to move out on assignment notice)

    IF the house price collapse, you can call up the bank and exercise your put and whoever sold that put short will be forced to take 1 house unit, bank gets cash and you are good to go free and clear.

    This would provide transparency and a more liquid housing market.
  2. I can't find the original article.

    "Shiller is worried that we don’t have a way for a household to write a put options on its assets. For a simple example, let’s say a household has a house worth $500k (assets), and a debt worth $400k (liabilities), and there’s a very high probability that it can make the payments on those liabilities.

    People like Shiller wants you to be able to pay a small fee so that if the asset is suddenly worth $300K you get $100K in value – the put option is presumably written at the level of liabilities. He also wants you to be able to hedge income, so that if the probability of you being able to make the payments decreases – long unemployment spells, health problems, etc. – you can get a payout that would reduce the liability to the point where the house can manage them.

    Notice that if the household goes bankrupt, because assets are less than liabilities, liabilities are marked down accordingly, directly as if a put option has been exercised. In an ideal bankruptcy, it would be marked down that $100K in the example above, or marked down to the point were payments have decreased so they are manageable."
  3. The housing market is still highly inflated. How can their be an options market where nobody knows the intrinsic value of the asset?
  4. it would be extremely hard to hedge such options. Thus, the contract would trade at an exceedingly high premium and probably not worth it for the buyer.

    The banks can hedge their exposure via interest rate derivatives, but it would be pretty hard to have options on real estate.
  5. Probably will never work as an exchange-traded product as houses are not all identical. And as an OTC product, like the previous poster said, they're too hard to hedge so they'll be expensive.

    Everyone has an implied put option who lives in a non-recourse state and is financed 100% to start with.

    There are housing derivatives listed on the CME but I don't think they are very liquid. They're based on the Case-Shiller indices for various cities.

    It would be kind of nice though. The usual thing said to people who don't want excess real-estate exposure is to rent. But what if you want a nice house, say 500k, but only want 100k of downside risk?

    This kind of talk comes up all the time on Fatwallet finance forum. A guy could probably make a few bucks writing OTC contracts to the punters there who are scared of interest rate risk on their 100k floating-rate loans.
  6. Houses aren't a commodity, like an ounce of gold or a bushel of corn. They are all different; some have hot tubs, others have shag carpeting.

    But we can average them together by aggregating them into a package of similar priced houses, like a large contract of 1000 $100k houses (some might be 95k, some might be 105k).

    Now we have to hire people to take care of these houses so they don't decay into worthlessness. We can get away without paying them anything by letting them live in the house, and plus these people will pay their own cost of carry on the contract leverage in the form of mortgage payments, (plus a little extra vig for our trouble.)

    And we don't really care about the actual value of the underlying houses, all we care about is that they generate revenue. Plus, we aren't in the real estate game, we never want to take physical delivery of the underlying house. All we want is a check each month.

    So let's do away with actual ownership of the underlying houses, and just trade on the revenue they produce. That's what we will really want to insure.

    Now instead of naming them "puts" and "calls" we name them Credit Default Swaps, and those we can trade.

    But then, that's how we got into this mess in the first place. Because the only counterparty big enough to backstop something of this magnitude is the US Gov't. Whether they knew they were going to be or not.
  7. options on individual houses seems good in theory but bad in practice. presumably, they could be purchased by the homeowner to protect against their home's decline, but how many of them could actually afford it? in bubble markets the put option would be insanely priced.

    i know that if i was a seller of a put that protected a $300k las vegas home against a $50k decline over 2 years, i'd be expecting $20k for that option. do you think someone who put down $0 and is living beyond their means would have that kinda cash lying around?

    the lender could afford the option, but it is a poor way to hedge their risk. a better way would have been to require 20% down payment in the first place.
  8. i tried to trade these in late 2008 or early 09, and the spreads were so wide you could fly a 747 through them. i assume they still suck these days
  9. lakai


    trade futures on it
    #10     Mar 9, 2010