It is documented that IG Index stopped taking any more opening positions on the property market at one time because they were only getting one-way sentiment (down bets) so they closed their book. David sent me the below comment/thoughts on this...
I don't get this. IG Index are just the bookie. They effectively set the price to lay off bullish punters against bearish ones and make their cash from the spread between the buying and selling prices on the trades (and of course interest on deposits). Surely the above is wrong since the bookie must run the price at all times to ensure equal numbers of up and down bettors (that's how the price is determined). Thus if they close out the book, there are as many up bets as down bets that must be closed or run to expiry. If an up bet is sold, then the price goes down and if a down bet is sold then the price goes up (though how prices are fairly determined if not by balancing new bettors is a slight mystery here? - David
This was the question I received a few weeks ago from David. Since I thought this might be of interest to our readers I'm publishing the answer here:
The price of the spread bets is determined by the Halifax House price index, i.e. it is not a balanced book like horse race betting. Usually the spread betting firm can lay off the risk associated with this implied position taking. If I buy a number of FTSE futures spread bets and everybody else goes the same way - let's say most taking a long position, the spread betting firm would buy futures contracts to offset the position. In this way they just become commission takers rather than position takers. The problem with accepting bets on falls in house prices is that it is equivalent to selling housing to IG Index. To neutralise their position they need to sell housing themselves - which they don't have: i.e. they can't neutralise the position which means they can't lay off the risk. This means that if housing does fall heavily they will take a big hit. They have clearly decided they can no longer risk this possibility given their current exposure. You could say that IG Index are now so long property that they have become worried it will fall.
The risks are two:
1) They have an overhang they can't match. I don't see how this would work in a liquid market. I mean I'm a bear here but if they put the price 9 months out for a flat in Islington down to a quid, then I'd buy as many contracts as I could beg borrow or steal the money to do because I know for certain that flats won't be going for a quid absent Al Qaeda sprinkling plutonium all over London, and even then I have doubts. So there's always a price where they can bring in more buyer, or seller, volume. Given the fascination Brits have with house prices, I don't see there are liquidity problems either.
2) They reckon bettors won't pay. Presumably they do require some deposit (what? 10%) in the accounts of bettors, and make what amount to margin calls if the market runs against any particular bettor such as to wipe out their deposit. With a balanced book, IG don't have to care where house prices go, but they do have to care if bettors won't pay. The question is whether volatility in price is now such that this has become an issue.
First here's a link to a report on house prices and spending which you will probably find useful.
Is anyone else placing bets on house prices? Six months or so ago I placed bets with IG Index on house prices to fall, shortly after I did this they stopped taking bets on prices falling since apparently everyone was betting that they would fall.
It is interesting that they are taking bets again (when most other spread betting providers have stopped taking bets on house prices) and the index is quite active. I made money on the March 2009 expiries but losing on the future dates.
UK house prices have dropped sharply in the past 18 months and prices are expected to fall by at least another 10 per cent in 2009. IG Index balances the book by setting spreads so as to encourage two-way betting. So if there is a strong sentiment that property prices will continue to fall, the spread will factor in a decline.
However, the IG prices are based on the Halifax numbers which are 'adjusted' regularly to indicate property price trends - and I'm quite wary of this since the sharp fall in the number of house sold means that price indices such as the one compiled by Halifax could at times seem inconsistent with the broader market. For instance, the Halifax index posted a small rise in property prices in January, even though other indices reported further falls. This could result in betters with short positions losing out even though property prices are still falling. The main Halifax index which the IG bets are based on is in nominal terms.
In general spread bets differ from bookmaking in that spread bets are a derivative. i.e. their price is derived from some underlying instrument. Thus the underlying instrument for FTSE cash bets is fair-value ftse. They balance their risk by taking offsetting positions in FTSE futures.
Similarly the underlying for the IG HPI bet is the fair value Halifax Index. However, there are no such thing as Halifax HPI futures and so they cannot offset their risk. This was why they had to close the book when it became unbalanced.
One would assume that they move the price to attract equal numbers of bets on each side of the spread, but if this were completely the case, the book would never become unbalanced and they would not have needed to close it previously.
Having spoken to a guy at IG Index, I can confirm that daily price moves suggest some price-move demand-supply balancing is occuring (since they are a market maker).
However, when I put it to him that a 'free-market' price would never have led to an unbalanced book, he gave me some guff about 'fast markets'. When pressed however, he admitted that to have adjusted the price in line with supply and demand so as to have re-balanced the book would have given clients 'free profit' at 'artificial prices' and would not have made sense 'if you want to run a business'.
For that I read 'we don't expect our customers to call the market better than us, and if they do, we'll just manipulate prices.'
As for 'artificial prices', I think we can all see that the only prices that are artificial are IGs. Here's my advice on what to do with a barge pole - I'm stopping spread betting on house prices and will steer clear for the foreseeable future.
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