Bet on inflation to beat the downturn
The market climate has created just the right conditions to make a mint, says Katie Hope
It’s pretty grim out there at the moment. Food and fuel prices are rising at the fastest rate on record, contributing to soaring inflation. Even Bank of England governor Mervyn King, who is charged with keeping inflation at around two per cent, recently conceded that inflation was likely to peak at around five per cent, potentially even higher. The traditional way to cope with the tighter squeeze on your income was to re-mortgage, releasing some of the equity on your prime asset, your house.
However for most people, plunging house prices (an estimated 10 per cent on average over the past year) and banks’ stricter lending criteria mean this is no longer possible. Most investors are left with no option but to sit on the sidelines, waiting until the situation gets better. But some contract for difference (CFD) providers are now offering an alternative for investors tempted to try and get even with the current situation.
Last week, CFD and spread bet Contracts For Difference Bet on inflation to beat the downturn The market climate has created just the right conditions to make a mint, says Katie Hope provider GFT launched a futures contract on UK consumer price inflation, offering a direct way to speculate on inflation rates. Starting off with a minimum bet size of £1 per basis point, investors can take a short to mid-term punt on the direction of inflation rates. Trades are settled based on the Office for National Statistics’ official monthly release on UK consumer price inflation, with revisions to previously released data disregarded.
Average Prices
Other providers offer similar bets on house prices. CFD or spread bet investors can take a punt on house prices, with providers typically using the Halifax House Price Index (a monthly indication of residential property prices considered the least subject to delays or distortions) as the basis.
Housing spread bets are priced according to what the average house price is expected to be at specified points in the future and most providers tend to offer spreads on the average house price for the UK as a whole, as well as for London.
One of the key attractions of such offerings, typically referred to as “special bets,” is that they offer an investor a potential chance to hedge their physical holding, such as the house they live in, or share portfolio, against current conditions. Summed up simply, if the physical asset that you own, such as your house, is falling in value, or your share portfolio is being hammered by rising inflation, you can try and make up, or at least break even, by taking out a short CFD position that house prices will fall or that inflation will fall.
In spite of the theory, however, it’s unlikely that you will be able to create a perfect hedge in this way. In the case of house prices, to create a true hedge your house would need to be of average price and move in line with the country’s average.
Many Variables
There are many variables, such as proximity to a good school, that affect how well your house holds its values. So the hedge can only be approximate rather than perfect.
Yet according to Tim Hughes, head of sales at IG Index, accessibility and the idea of getting your own back means betting on house prices remains popular. “Many clients sell £50-£200 a point knowing full well they are not fully hedged but will be in-pocket from the trade if prices do fall,” he says.
Unlike shares, there is no listed instrument for house prices or inflation rates. With no underlying physical market to trade, pricing for spreads is based on client views.
Good Opportunity
IG, for example, is quoting December at 164 mid-price. This represents an expected price of £164,000, an estimated nine per cent fall since June. As the market maker, the spreads are based on its clients’ views. In this case clients have sold the market quite aggressively. If the spread were too pessimistic, it would attract buyers and its price would rise. From the point of view of a potential hedger, a down bet on its December price is a bet that prices would fall further. If you do not agree the hedging opportunity may have been missed.
In spite of what may be perceived as disadvantages, for many investors the opportunity to switch from being a passive victim of the current economic conditions to being able to potentially use them to your advantage is too tempting to resist. It may indeed be grim out there, but for canny contract for difference investors, it could soon become a little bit less so.