You may be wondering whatever happened to those bright fellows that were creating the institutional financial products (like swaps and securitized mortgages) a few years ago. We don't know where they all went but some of them have moved into the retail (individual) investor market and are creating complicated but very interesting products for regular investors as well as institutions.
This article is about a specific example of a new product available to just about anyone with a brokerage account and may unlock new profit possibilities for profits in the housing market. These are called MacroShares Major Market Housing ETFs and were co-created by Robert Shiller, the economist responsible for the S&P Case-Shiller Housing Price Index.
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These are a little complicated but that does not mean they are a bad product. In fact, we believe this may be one of many new ways investors can insulate themselves from certain risks as well as make profits.
MacroShares Major Market Housing ETFs trade as a pair and are indexed to the Case-Shiller 10-city Housing Price Index. The Up version of these ETFs (UMM) will gain when the Case-Shiller index rises and the Down version of the ETFs (DMM) will drop.
If you thought home prices were likely to decline over the next few months you would buy DMM but if you thought prices were going to rise you would buy UMM. In this way individual investors have the ability to profit from falling or rising home prices without having to invest in the actual asset itself.
How these ETF shares change in price as the underlying index changes is a little complicated but we can break it down step-by-step. To understand a little better what will happen as prices change assume that the underlying Case-Shiller index were to move by 2% in a given month and that both ETFs are priced at exactly $25 per share each.
1. The ETFs are leveraged 300% so a 2% index change will translate to a 6% change in the ETFs.
2. We will take the total share price of both ETFs (currently $50) and multiply that by 6% to get $3, which will be the combined price move.
3. $3 is now divided by two and the quotient is added to UMM and taken away from DMM.
4. The closing price for UMM would now be $27.50 and DMM is $22.50
Because the ETFs are leveraged they will be volatile, which may be very attractive to short term traders. However you should be aware of how sudden price changes may affect your overall portfolio.
These ETFs can also be used to hedge risk in the housing market. For example, imagine that you are worried that your home's price will fall in the near term. BuyingDMM won't prevent your home value from falling but the profits from that investment may offset some of the losses.
Similarly, a prospective home buyer who is worried about large price increases in the near term could buy UMM. As prices rise their profits from UMM could offset some of the increased cost they will have to pay when they are ready to close.
These instruments are the latest release in a series of innovative financial products that have jumped the gap from the institutional world to the world of individual investors. Some of these products are very poor and probably won't be around for long and others seem very innovative.
The key in telling the difference between a bad financial product and a good one is education. Before you use a new product, make sure you understand what it is designed to do, what the risks are and how it will affect your overall portfolio.
what is the corelation between the actual home prices and those ETPs or the case shiller index itself?
like UMM is up from 14 to 28 100% when home prices are kind of stable for that period.
Thanks
Goel
- calculation
|2009-09-11 13:38:04
dividing 3 by 2 gives 1.5, so UMM should be 26.5 and DMM 23.5?
Gabriel
- Leverage
|2009-10-21 22:13:00
What does mean ETFs are leveraged a 300%?
John Jagerson
- Leverage
|2009-10-22 02:39:44
That means that for every 1% move in the index, these funds will move 3% up or down. Leverage can be great if you are right but it also adds risk because prices can move so much so fast.
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