Tuesday, May 22, 2007

Hedging a Home Purchase?

Using my play money in my play account, I recently purchased a few long-dated call options linked to D.R. Horton, America's biggest homebuilder. Call options are basically a leveraged bet that a stock is going to go up.

There wasn't a whole lot of news on the housing front in the past couple of weeks until today, when treasury secretary Henry Paulson went on CNBC and said that the housing slump is largely over.

As a result, DR Horton's stock (NYSE: DHI) was up about 4%. Being a leveraged bet, and due to a general lack of liquidity, the particular DHI options I own traded up about 25% today.

This got me to thinking... as a young couple looking to buy a house in the next few years, how could my wife and I protect ourselves from an increase in home prices? We have a chunk of money (approaching $100k) saved for a down payment, but how could we protect ourselves against an increase in prices? What if the housing slump doesn't last like we're hoping it does and prices jump next year or the year after?

One thing we could possibly do is to spend a portion of our savings (say $5-10k) buying call options on - you guessed it - homebuilder stocks. This way, if the housing market rebounds, the value of our options will increase, hopefully offsetting the increased prices of our target homes. If the prices on target homes go up by, say, $20,000, the value of our options would ideally be $20,000 or greater.

Of course, this is just a rough sketch of an idea that I haven't thought through fully, and homebuilder options in no way represent a perfect hedge on housing prices due to the fact that the homebuilder's stock price is not directly correlated to prices of homes in the areas we are targeting.

Anyway, that's just food for thought. It would be irresponsible for me not to insert another disclaimer here... that you should NEVER put the money you've saved for a house into an investment as risky as options unless you completely and fully understand each one of the myriad of risks that would be associated with such a strategy. I'm not going to actually do this, but I thought it was an interesting idea nonetheless.

2 comments:

TFB said...

There are some more direct hedge vehicles you can look into. They tie to home prices instead of stock prices of home builders. Not sure whether they are feasible for individuals. See this link:

http://www.marketwatch.com/News/Story/Story.aspx?guid=%7BE4377F92-6516-4DC0-A04E-C7773B0C5446%7D

MoneyMan said...

Great point! I actually found out about the relatively new home price futures and options while surfing the web today and was just going to add that as a comment to this post, but you saved me a link, thanks!