Making money on sliding property prices - Derivatives!

[Aaron Sice]

okay i'm gonna break this up - bear with me here.

well, yes call prices falling can cause 'fear' but what I said is they directly don't influence the market as they are not connected..

yes but anything remotely linked to housing causes the channel 7/9/10 bandwagon to jump on board and create fear and panic to keep people watching - if everyone is watching and they see this - then sentiment will be down - so it affects it indirectly. wave in a pool kinda thing.

ie a hedge fund cant keep short selling stock to artificially force the price down as they can with CFD's in the stock market. This is why I don't believe shorting direct stock should be legal. it can/is been used to manipulate the market without you even needing to produce real stock.

my point is, to have an option, you need stock for the option to exist. so they must create a stock, have an IPO for AUS property, and launch a ticker on the ASX. otherwise, no option can exist if there is no stock to trade it. therefore, if there is stock, it can be shorted, regardless of the derivative market effects or actions. therein liles the issuse. what is the stock tied to?

if this stock dips below $5 - is derivative trading halted?

I would say there would be selected suburbs which are traded, say top 20 in each suburb.. and it would work on the medium price.. so you could have Toorak Dec call $960,000

that's a good way of thinking - but still is a very micromarket system. if people in Toorak see these derivative values and/or stock values falling, does it make them more likely to want to sell?

 

[Aaron Sice]

and i'm not haviong a go at you - just to be clear - these are just burning Qs for me.

 

[pendo]

Some more on this

Australia's Freddie & Fannie
Every morning we scan through the Australian Financial Review for any news items of interest. We don't rely on it for Money Morning because what is written in today's newspaper is news from yesterday. Our aim is to bring you today's news today.

This morning we scanned it as usual. And as per usual our eyes glazed over on reaching the property section, expecting to be bored rigid by the tens of commercial property ads.

One news item did enough to unglazed the eyes. The headline was "House prices go to market." The gist of the story is that the bright sparks at the Australian Stock Exchange are looking to release a new listed product.

A quick side note on this. The ASX is under massive pressure to increase its revenues. There are two reasons for this. First, it has seen a drop in volume as brokers tell their clients to sit tight. Second, it is about to face stiff competition from two new exchanges that will take some of the institutional business away from the ASX.

With this in mind, the ASX needs to develop as many ways as it can for investors to trade on the ASX.

The product the ASX has in mind is a derivative based on the property market. You can see why it caught our attention. It got us thinking. Haven't we seen a couple of stories around about a few small problems with property and complex products in the US?

This Could Be a Real Housing Crisis
Don't get us wrong. Personally we have no problem with derivatives. We don't fall into the Warren Buffet camp of describing all derivatives as "Weapons of Wealth Destruction." We also don't fall into the camp that claim derivatives are far too complicated for retail investors. And that they are far too dangerous for retail investors.

In fact we would be tempted to argue the opposite. How often has a retail investor or even a group of retail investors 'blown up' a market using derivatives? Not often. It tends to be the pinstriped boffins on Wall Street, the City of London or Martin Place that inflict the most pain on markets. Anyone heard of Long Term Capital, Barings Bank or NAB's foreign exchange trading comeuppance? There wasn't a retail investor in sight.

The products will be promoted RP Data and Rismark International. According to its website, Rismark is a "global funds management business that has expertise in the execution of sophisticated real estate investment, research, securitization and active portfolio management strategies."

Any alarm bells yet? The company claims that its products can help with the so-called "housing affordability crisis" in the Australian property market. A market which it tells us is "valued around $3.2 trillion."

A Trillion Reasons to Worry
Trillion. That's another word we've heard a lot of recently. More worryingly, Rismark's Equity Finance Mortgage (EFM®) has "bi-partisan" political support.

Having just finished reading Liar's Poker by Michael Lewis, it seems remarkably similar to the birth of the securitized mortgage market in the US during the 1970's and 1980's. A "smart" Wall Street banker invents a new way to tap into a pot of illiquid cash tied up in housing. The product is marketed to Savings & Loans companies as a hedge on their investments in the housing market. These are then packaged, or securitized into investments and sold to investors.

That much of it is fine. However, the consequence is that once those mortgages have been hedged away the S&L can loan out the money again to someone else, and so the spiral continued over nearly thirty years until we see the mess currently happening in the US.

We can almost guarantee that the products will be initially promoted to hedge or protect an asset. It won't take long before the whizz kids move in and market these products to Australia's equivalent of S&L's (Credit Unions) and other non-bank lenders.

The only positive to this is that the ASX has a woeful record when it comes to non-standard products. So there is just as much chance that the whole idea could fall flat on its face.

Cheers.
Kris

 

[crc_error]

and i'm not haviong a go at you - just to be clear - these are just burning Qs for me.

thats fine... but your point on 'creating fear' is not really valid.. suburb medium prices are already published, so today tonight can run stories how x suburb dropped 10% etc.. We all know how the REIx loves to run stories on the booming market trying to push buyers to pay more at auctions.. all in the interest of real estate agents.

I have never seen stories published saying "BHP calls dropped 90% due to stock market crash" they always report the market as a whole and the underlying stock prices, not the stock options..

 

[boomtown]

Cmon one of you bright sparks explain to me how you can have a market in an asset without *someone* who participates in the market having ownership rights in respect of the underlying asset being traded.

Show me one example. For example with stock lending - someone actually owns the stock.

 

[crc_error]

Cmon one of you bright sparks explain to me how you can have a market in an asset without *someone* who participates in the market having ownership rights in respect of the underlying asset being traded.

Show me one example. For example with stock lending - someone actually owns the stock.

a option is a agreement between two people to buy or sell something at a agreed price.

Its a bit like insurance. You pay a insurance company money and in return you agree for them to protect your car. Should your car be stolen, then the insurance company will give you another car. However the insurance company wont have cars sitting there ready to give you..

If your car is stolen the insurance company will have the option to pay you cash the value of the car, or purchase a car from the market and give it to you.

This is how options work, they are agreements between two people, and if a condition is met, the person receiving the premium has to deliver the stock or pay the cash difference.

In the case of property, you would pay someone a premium and agree to sell them your property at a certain price, if the property value doesn't exceed the agreed price by the agreed date, then the agreement becomes void. Why would the other person buy your property if the price is below what you agreed upon, cause he can go to the market and get the same thing cheaper..

So essentially with property options, if the suburb medium price is above the agreed price, the other person will demand the difference be paid in cash, which the person who received the premium has to come up with... the reverse is the case in of a short position.

 

[Aaron Sice]

but that's just a property option - not a publicly listed option aganst stock that somehow pulls it's own price value from the CG value of AUS RE...!

i agree whole heartedly with this

Having just finished reading Liar's Poker by Michael Lewis, it seems remarkably similar to the birth of the securitized mortgage market in the US during the 1970's and 1980's. A "smart" Wall Street banker invents a new way to tap into a pot of illiquid cash tied up in housing. The product is marketed to Savings & Loans companies as a hedge on their investments in the housing market. These are then packaged, or securitized into investments and sold to investors.

That much of it is fine. However, the consequence is that once those mortgages have been hedged away the S&L can loan out the money again to someone else, and so the spiral continued over nearly thirty years until we see the mess currently happening in the US.

We can almost guarantee that the products will be initially promoted to hedge or protect an asset. It won't take long before the whizz kids move in and market these products to Australia's equivalent of S&L's (Credit Unions) and other non-bank lenders

.

BHP's stock value is a direct result of it's market cap vs perceived value vs dividend etc etc. there's is an underlying asset - the company - which owns and mines it's own little patches of dirt and refines it into the stuff it sells.

whent he value of a company's stock declines, so does the value of said company - yes?

YOU CAN'T HAVE A DERIVATIVE WITHOUT AN UNDERLYING STOCK!

i can't go and buy a Nov BHP $40.00 call (the derivative) if the stock called "BHP" doesn't exist! derivatives are tied to stock.

so, they need to create stock. from what? AUS RE prices and CG values?

if so, that means that the RE stock price is a direct result of it's market cap vs perceived value vs dividend (where will that come from? maybe like BLY today...they just won't pay any). the underlying asset is....? it owns what...? how does it make it's money....?

if it's money comes from CG - then a short sell of that stock would artificially deflate underlying asset's value, yes? just like BHP?

 

[Aaron Sice]

thats fine... but your point on 'creating fear' is not really valid.. suburb medium prices are already published, so today tonight can run stories how x suburb dropped 10% etc.. We all know how the REIx loves to run stories on the booming market trying to push buyers to pay more at auctions.. all in the interest of real estate agents.

I have never seen stories published saying "BHP calls dropped 90% due to stock market crash" they always report the market as a whole and the underlying stock prices, not the stock options..

like i said, it's more about the mainstream media jumping on board scaring hte begeezus outta mum-n-dad's. no one really gives a s__t if BHP drops 90% in options prices - unless you are holding it on the day of expiry.

but they will begin to care if the PERCEIVED value in whatever market suddenly drops 90%. it's sensationalist headlines.

think like a joe-schmoe here - not an investor.

 

[crc_error]

but they will begin to care if the PERCEIVED value in whatever market suddenly drops 90%. it's sensationalist headlines.

would you like to link a headline of this sort which happened to a stock option?

I don't think you will find one..

so why should it happen to a property option..

 

[Aaron Sice]

mate with stocks - no-one is compelled to buy. no-one needs to be engaged.

with property, EVERYONE in the COUNTRY is engaged. we all need somewhere to live.

so it's PERFECT headlines for the distractionist media - which WILL affect sentiment.

you're comparing apples and oranges.

 

[boomtown]

If property prices double and you have no exposure to the underlying assets - you have just created the worlds biggest uncovered put.

Get a handful of redemptions and you will be smashed harder than HIH.

I just dont see how its sustainable.

 

[Aaron Sice]

would you like to link a headline of this sort which happened to a stock option?

I don't think you will find one..

so why should it happen to a property option..

and we're not talking property options - we're talking publicly listed property stock with derivatives...

 

[crc_error]

mate with stocks - no-one is compelled to buy. no-one needs to be engaged.

with property, EVERYONE in the COUNTRY is engaged. we all need somewhere to live.

so it's PERFECT headlines for the distractionist media.

you're comparing apples and oranges.

So your saying with stocks, no one needs to eat, buy electricity, use banking services, buy cars either?

Business is just as important as shelter.. without business, no shelter is built and maintained.

 

[Aaron Sice]

If property prices double and you have no exposure to the underlying assets - you have just created the worlds biggest uncovered put.

Get a handful of redemptions and you will be smashed harder than HIH.

I just dont see how its sustainable.

"i see the light!!!!"

 

[Aaron Sice]

So your saying with stocks, no one needs to eat, buy electricity, use banking services, buy cars either?

Business is just as important as shelter.. without business, no shelter is built and maintained.

w...what?

where did i say that? are you trying to distract the fact that you're confusing property options with a publicly traded options?

 

[boomtown]

Ok Ive worked it out.

Its like the TAB. You dont take positions against the market maker (there is none) you take positions against other punters. The movement of the index determines the winners and losers.

 

[crc_error]

w...what?

where did i say that? are you trying to distract the fact that you're confusing property options with a publicly traded options?

Your saying everyone needs to be engaged in property, but not in stocks.

Last time I checked, we need more than shelter to live..

So stocks/business's are just as important as property if not more so..

Property is publicity traded every Saturday, and price movements are published by a number of agencies..

I don't see why in order for you to live, you need your property to double in value every 7 years.. if property prices did crash,, who cares.. its all relative .. you sell your house at 50% discount due to a crash, and you will only buy another house as it to has 1/2 in value as well..

if anything raising prices make it harder for new people to enter the market and buy shelter..

so really if they did publish "property values crashed 90%" I would say, great.. easier to buy a house now..

the only people who would be affected by falling property prices is people who are trying to profit from housing not to simply have shelter.

 

[crc_error]

Ok Ive worked it out.

Its like the TAB. You dont take positions against the market maker (there is none) you take positions against other punters. The movement of the index determines the winners and losers.

bingo!

bets placed on dogs doesn't alter the outcome of the race...

 

[Aaron Sice]

if property prices did crash,, who cares.. its all relative .. you sell your house at 50% discount due to a crash, and you will only buy another house as it to has 1/2 in value as well..

if anything raising prices make it harder for new people to enter the market and buy shelter..

so really if they did publish "property values crashed 90%" I would say, great.. easier to buy a house now..

the only people who would be affected by falling property prices is people who are trying to profit from housing not to simply have shelter.

riiiight ... i'm going to walk away now and let the quality of that last post shine through and do all the talking.

 

[GreatPig]

explain to me how you can have a market in an asset without *someone* who participates in the market having ownership rights in respect of the underlying asset being traded

I don't think it's necessary at all. As long as the derivative can't be exercised for the underlying asset, then it's just an agreement between you and the MM to value the derivative at some fraction of the underlying asset value. Neither of you need to have rights to the underlying asset (although it might make the MM's hedging strategy more complicated).

For example, a company could potentially offer derivatives against the country's GDP, or unemployment rate, or anything that some regular and reasonably reliable figure is available for. As long as all settlement is in cash, then nobody in the derivatives market has to have anything to do with the underlying.

If property prices double and you have no exposure to the underlying assets - you have just created the worlds biggest uncovered put.

Hedging without exposure to the underlying might be difficult. I'm sure the issuers would find some combination of things to use to synthesise it though.

GP