|
|
Mortgages
Home > Finance
> Mortgages
|
The options market is a speculator's paradise.
Buying and selling options contracts requires a knowledge
of how they work and what gives them value.
During the Great Housing Bubble, residential mortgages took
on the characteristics of options contracts.
This was not by design. The practices of lenders created
this problem, and in the end, it cost lenders and investors
a great deal of money. |
An option contract provides the contract holder the option to force
the contract writer to either buy or sell a particular asset at
a given price. A typical option contract has an expiration date,
and if the contract holder does not exercise his contract rights
by a given date, he loses his contractual right to do so. An option
giving the holder the right to buy is a "call" option,
and the option giving the holder the right to sell is a "put"
option. Writers of option contracts are typically obtain a price
premium for taking on the risk that prices may move against their
position and the contract holder may exercise his right. The holder
of an options contract willingly pays this premium to limit his
losses to the premium paid if the investment does not go as planned.
Most options expire worthless.
Mortgages took on the characteristics of options contracts in the
Great Housing Bubble. Speculators utilized 100% financing and Option
ARMs with low teaser rates to minimize the acquisition and holding
costs of a particular property. The small amount they were paying
was the "call premium" they were providing the lender.
If prices went up, the speculator got to keep all the gains from
appreciation, and if prices went down, the speculator could simply
walk away from the mortgage and only lose the cost of the payments
made, particularly when this debt was a non-recourse, purchase-money
mortgage.
Another method speculators and
homeowners alike used was the "put" option refinance.
Late in the bubble when prices were near their peak, many
homeowners refinanced their properties and took out 100% of
the equity in their homes.
In the process, they were buying a "put" from
the lender: if prices went down (which they did,) they already
had the sales proceeds as if they had actually sold the property
at the peak; if prices went up, they got to keep those profits
as well.
The only price for this "put" option was the small
increase in monthly payments they had to make on the large
sum they refinanced. |
|
In fact, on a relative cost basis, the premium charged to these
speculators and homeowners was a small fraction of the premiums
similar options cost on stocks.
Of course, mortgages are not option contracts, and lenders did
not view themselves as selling option premiums to profit from the
premium payments; however, speculators certainly did view mortgages
in this manner and treated them accordingly. The "put"
and "call" option features of mortgages during the bubble
are the direct result of 100% financing. Speculators and homeowners
have too little to lose to behave responsibly when 100% financing
is available. Without increasing the cost to speculators through
downpayments or a loan-to-value limit on refinances, speculators
are going to utilize these mortgage products in ways they were not
intended. There are many expensive lessons learned by lenders concerning
100% financing during the Great Housing Bubble.
Article Source:- Link
Building
|
|
