Futures on the PastThis little diversion into the nature of past, present and futures markets was prompted by a review of the Chicago Mercantile Exchange's housing futures. All futures markets are based on the principle of indifference. If interest rates are at 5% and storage costs amount to 1% of the underlying asset's price, then a one-year future should be priced 6% over the current cash market price. You should be indifferent to the choice of buying the asset now and storing it yourself or buying it in the futures market for delivery a year from now. Futures markets also have a large measure of insurance built into them. Producers sell futures to lock in a price to be received, and consumers buy them to lock in a price to be paid. Risk management is understood, almost without saying, to involve events that will happen in the future.
The Risk ExistsThis is not to deny that a risk exists in the residential real estate market. The Federal Reserve's Flow of Funds data for the end of the first quarter of 2006 put household holdings of residential real estate at $20.364 trillion. For comparison, households and nonprofit organizations own $5.6845 trillion of corporate equities and $4.5374 trillion of mutual fund shares. And whether there is a real estate bubble or not, holdings of residential real estate have surged as a share of household balance sheets in recent years. We have a sideways (at best) stock market to thank for this, perhaps even more than the obvious explanation of low inflation-adjusted long-term interest rates. This latter point is critical: Housing futures are being marketed as an indirect way of playing rising long-term interest rates. The answer is simple: If you think rates are going higher, sell bond futures or something similar. They are a direct play on interest rates.
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