I encouraged the re-launch of option trading to stimulate discussions on how to price/size/ volatility on the Case Shiller indices. So far it’s been a chicken-and-egg issue of no trades leading to limited volume, leading to wide bid/ask spreads, leading to no volume, etc. Let’s go back to basics to see if some graphs can prompt a reaction (or some better option bids and offers).
(While is some ways, the strategies involved in trading options on the CME Case Shiller futures are similar to other option strategies, in other ways they are easier as a) there are no dividends on the underlying index, and b) the forward price is already established (the futures price) so the notion of calculating an implied forward price is not necessary.)
What’s the “right” volatility for the Case Shiller index? As some approaches to this question involve a view on direction, here’s a table and some graphs that get to the heart of anticipated volatility.
The table above shows quoted prices for the CUSX14 (Nov 2014) futures and options. I’ve shown the 160 puts and calls as they are closest in price to the CUSX14 futures market. Both the call and put bidders (at 5.0 and 6.0) want prices to move strongly in one direction (up for calls/ down for puts), and/or volatility to increase. The put seller (aka “put writer”) would benefit if prices move up (and vice versa for the call seller.)
A straddle buyer (one simultaneously buying both the put and call) is looking for strong price moves in either direction, that is they want volatility, while a straddle seller realizes their highest P&L if the underlying futures don’t move from the strike price.) Thus the clearing levels for a straddle give a good sense of implied volatility, without worrying about direction.
I’ve posted some suggested levels for straddle buys and sales that are inside the combined outright levels. Hopefully the 13.0/16.0 straddle market will generate some feedback or trades. (Trades would have to be orchestrated as there is no inside “straddle” market.)
So the question remains, how does one get a feeling for whether a straddle price is fair?
The top graph shows the CUS index since the Nov. 2009 release (of the Sept index), the mid-point of the 11 futures contracts (out to Nov. 2016), the mid-point of the Nov 2014 CUS contract as a black dot), and the break-end price levels for a straddle with a price of 16. A straddle buyer (who held the position to maturity) would only have a positive outcome if the futures finished about 176 (the 160 strike plus the 16 point premium) or below 144 (the 160 strike minus the 16 point premium). (Note the break-even results straddle the 160 strike price and are not a function of today’s index level). In the context of price moves over moves over the last 3 years this seems, like a low probability.
However, when one looks at price movements over the last 1o years, the window of profitability seems much smaller.
So, the question is: what type of home price volatility do you expect over the next 2+ years, and does that make you a straddle buyer or seller.
This approach can be used for other expirations and for the three regional contracts with listed options.
I’d be happy to discuss reactions to these concepts, prices, or to entertain discussion on other straddle or strategies (e.g. strangles) for trading options on Case Shiller futures. Feel free to contact me at email@example.com