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Reply #41: Seeking Cover if the Prices of Homes Fall (New game in town) [View All]

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54anickel Donating Member (1000+ posts) Send PM | Profile | Ignore Mon Apr-17-06 08:48 AM
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41. Seeking Cover if the Prices of Homes Fall (New game in town)

YOU'RE worried that the law of gravity, as it applies to home prices, has merely been suspended, not repealed. Short of selling the attic (or a few outbuildings, if life has treated you very well), how can you hedge against a decline, if it ever comes?

A cheap and practical solution may be on its way. The Chicago Mercantile Exchange expects to begin trading this month in a series of futures and options that will allow homeowners and others to bet that indexes of home prices in each of 10 metropolitan areas will rise or fall.


Take a New York couple with a $1 million house who want to trade up to something on the market for $1.5 million and are worried that it might be snapped up while they try to sell their current home. Assuming they have the means, they go ahead and make the purchase, more than doubling their exposure to the market.

"As an adviser, that gives me huge concern," Mr. Cordaro said. "If the market takes a turn down, they could lose a lot of money." The new futures and options provide "an easy and low-cost way to hedge out the excess real estate costs they don't need."

This couple could sell futures contracts with a lifespan of three months on the S&P/Case-Shiller home price index for New York. Each contract is worth $250 times the index level, which recently was around 210. To hedge against a $1 million home, the couple would need to sell about 20 contracts.

If home prices declined in the region during the three months, the couple would receive $5,000 for every point that the index fell, an amount that should offset a drop in the value of their home. If prices rose, they would have to pay $5,000 for every point of increase in the index, but their house should be appreciating by a similar amount. The other regions covered are Boston, Miami, San Diego, Washington, Chicago, Denver, Las Vegas, San Francisco and Los Angeles.

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