Puts as Hedge against Real Estate Decline

[squiffy]

Someone suggested buying puts as a hedge against real estate decline. I have heard this idea before, but I don't think it really works. Puts are way too expensive because the market basically expects a huge decline.

Put another way, there is no market for specifically hedging against a California real estate price decline.

And honestly, who in their right might would take the other side of that bet? Who would insure against a California real estate price decline? Insurers need to make money.

If you live in a flood plain next to a huge river that floods regularly, if you live on a hillside with frequent landslides, and if you live near an active volcano in a lava flow area in Hawaii, you simply cannot get insurance because no insurer is stupid enough to insure against such a high likelihood high loss occurrence.

See this article from the Irrational Exuberance author Shiller who has been promoting the idea of insurance against property price declines. It makes sense in theory. But not sure it can work in practice.

http://cowles.econ.yale.edu/P/cd/d10b/d1098.pdf

[squiffy]

I bought my CA home for 200K in May 2002. Appraised last week at 420. So in theory 220K in equity. What are my options for hedging huge risk of large decline.

First, sell home. No way. I have a good job. Enjoy living here. Home might still go up in value for 2-3 more years. Home prices might decline but not crash. All other homes nearby are outrageous so where would I live? I could rent, but rents have gone up a bit too. And don't like living in apartments.

Second, borrow 220K in equity from the bank and invest in something. Problem. I cannot borrow 100% of the equity because I bought the home for no money down. So I still owe 192K with monthly mortgage payments of 1200. Tax and ins. add another $300 a month.

SO I cannot afford the payments on loan of 220K plus 192K or 420K. The payments would be too high.

I can refinance for 300K, get 100K in cash and I can afford the 1700 a month payments.

But now what do I do with the 100K in cash?

Someone suggested buying puts on home builders and mortgage lenders. But I think puts are too expensive and too risky.

If you believe puts are realistic. Identify a specific stock, specific put prices, and specific ways to hegdge. It's one thing to spout theory. But in reality, I think it's probably just safer to go long and collect dividends. Then your holding period is infinite. Puts expire in 2-3 years. Short term puts would be too expensive.

Though I would certainly consider putting some money in puts. More as an investment option than as a specific hedge against decline of the CA property value.

The way I figure it. The home is overvalued and really isn't worth 420K. But like Amazon in 1999 and Yahoo in 1999 it might still go up. BUt the problem is I live in the home and will not sell it now.

The best I can do is borrow the equity while it's still there. Just like AOL American Online bought Time Warner while AOL stock was high and before people figured out it wasn't worth the sky high prices being paid. Such prices are unsustainable.

So I figure borrow as much money as I can at cheap interest rates before the bank and the appraiser figure out that the home really isn't worth that much.

[alekhine8]

If there was some product that I could pay $2,000 or so a year to lock in my gains on my house, I would consider it. But there isn't, and there's nothing even remotely close.

There is no way that buying puts on homebuilding stocks or any other sector is going to be a good hedge. Nor would any sort of interest rate plays.

You can refinance and take some of it in cash, but you still have to pay it back. Unless you have a business plan or investing strategy to beat your tax-effective interest costs by several percentage points, I wouldn't bother. The last thing you want is to lose money on some investments and see a correction/bubble/crash in the real estate market and have no equity left in your house.

[Sniper]

Here is an example of a company offering Home Value Protection insurance, for syracuse home owners...

http://www.syracusesni.org/equitysite/

[ QUOTE ]
If you live in a flood plain next to a huge river that floods regularly, if you live on a hillside with frequent landslides, and if you live near an active volcano in a lava flow area in Hawaii, you simply cannot get insurance because no insurer is stupid enough to insure against such a high likelihood high loss occurrence.


[/ QUOTE ]

You can find someone willing to provide insurance on just about ANYTHING! The question becomes is the cost worth it.

[cwsiggy]

What an interesting question. I suppose you would have to find a product that has a high correlation to your housing price. Not likely - eh? I suppose you could short treasuries at various maturities but I can't imagine that would correlate very well with your specific house or area.
It is interesting that insider selling of home builder stocks is on the rise.....

[imported_bingobazza]

[ QUOTE ]

And honestly, who in their right might would take the other side of that bet? Who would insure against a California real estate price decline? Insurers need to make money.


[/ QUOTE ]

Smart insurers will always have a margin...it will be there if you look for it...but it will be -EV for you by definition, as they are better odds layers than you.

Bingo

[IlliniRyRy]

short IYR then, its a real estate index..equity instead of option

[Sniper]

Here's a recent article on playing the housing market using options, and a strategy for reducing the cost using a calendar spread.

http://www.thestreet.com/_tscs/pom/p.../10237407.html

Options are not for everybody, so please make sure you understand how this works before you try this at home [img]/images/graemlins/smile.gif[/img]

[Emperor]

Isn't this scenario like buying covered calls to hedge against a stock price decline?

After 30yrs of investing my parents lost every dollar gained, AND some invested principal, after the tech bubble burst.

I was managing a friends stock account at the time and told him that 90% of the companies were lieing on their quarterlies and he should liquidate his portfolio. He did all except on one big holding. He then sold covered calls on that holding WEEKLY. He ended up making money during the bust.

Too bad my parents didn't take my advice.

So in other words there are always people willing to take the other side of the bet. You just have to find a price.

The reason that the puts are so expensive is because the demand for them is so HIGH, EVERYONE is betting against the RE market right now.

[Sniper]

[ QUOTE ]
Isn't this scenario like buying covered calls to hedge against a stock price decline?

[/ QUOTE ]

With covered calls, you are limiting your upside potential in return for a small amount of downside protection.

With Puts, you exchange a small amount of upside for unlimited downside protection.

The calendar spread strategy suggested in the article I posted, is most successful when you are early in your decision to protect the downside, as you are actually able to reduce the cost of the insurance (sometimes to below 0)and still receive full downside protection long term.