Thursday, November 29, 2007

Don't Sell Your Home Short

...or maybe you should.

In the housing market, the bad news just keeps coming. Nov. 27 gave us the latest release of one leading index which shows that home prices are falling at their steepest rate in 21 years. And there may be much worse ahead: Futures traders are betting that home prices will fall more than 20% in markets such as San Francisco and Miami over the next year.

Futures contracts traded on the Chicago Mercantile Exchange (
CME) show that traders expect double-digit declines in nine out of the 10 biggest housing markets in the U. S.

Options contracts these days are available on a lot of crazier things than home prices. You can "bet" on elections, sporting events and many other obscure future events.

The funny thing is, options contracts can be fairly accurate predictors of the events they are tied to.

Investors' predictions about these real estate markets are certainly not guaranteed to be accurate. But they do provide insights into what people with skin in the game think lies ahead. These types of "predictive markets," have proved surprisingly accurate in forecasting everything from housing movements to the outcome of political elections. They tend to be especially on the mark when the participants have money on the line, as they do in Chicago.

So if you think that the value of your home is going to fall in the coming year, you could theoretically "sell short" options on the housing market in your home town. As your home decreases in value, the value of the option should increase, thereby offsetting some of the decline you are experiencing.

That's the theory. In practice, the housing contracts may not have yet evolved to the point where they would work well for individual investors. The futures contracts for individual cities are thinly traded and on some days, certain contracts don't trade at all. A spokesman for Standard & Poor's says that it's normal for such contracts to start off with low volumes and higher volumes typically come after a catalyst, like the current housing slump.

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