option, candle stick, max pain and Irvine real estate

[tourbillon_IHB]

Today I discussed the state of CA real estate with a couple of my trader friends during a nice afternoon coffee break. It suddenly dawned on me that real estate is a lot like option trade. Option can expire, and so can real estate, especially when it is financed by 100% interest only loan. Essentially, the owner is buying the option of purchasing his/her home sometime in the future with today's price. If the real estate goes down below the purchase price, then the option becomes worthless. Option has a expiration day, so do RE. The day when the loan adjusts is essentially the same as when the option expires. If that is the case, then we can assume certain parameters and use max pain theory to predicate the trading range of a house. I have a matlab based max pain program and when I have time during the next several weeks, I shall try to see if the RE market can be modeled as max pain.


I also tried to model the Dow Real Estate index with Japanese candle stick, I think it is pretty clear a piercing pattern is developing, and the RE index will go down in the near future.

 

[IrvineRenter_IHB]

tourbillon,





When 100% financing became available, speculators were essentially purchasing call options on real estate everywhere. With real options you have to pay a premium which disappears over time (time decay.) The real estate call option speculators were purchasing were free. The only "price" they were paying to walk away from this option was a ding to their credit. If the real estate went up, they made all the profit; if the real estate goes down, the lender absorbs all the losses. Is it any wonder speculation was so common?





BTW, I look for the DOW to roll over and die this week. The market internals on Friday were very, very bearish. Much more so than on the other 200+ point selloff days we have had recently.

 

[tourbillon_IHB]

IR


I agree with you totally. Although the monthly interest payment is a pretty big cost in itself (more so than average margin account interest due to the large amount), so I think maybe one can use that as the option price. (The total amount of interest payment).


You are more bearish than me on the stock market. I am a bear myself for the short term, but I think the market will more or less be a pig until the fed rate day.