Eurodollars to hedge my mortgage?

[eric3]

I am a Forex guy wondering if you money market guys can help me figure out how to hedge the adjustable rate mortgage on my house (I assume with Eurodollar futures or maybe options)

Mortgage Balance $1,000,000
Current Rate 5%
Rate will adjust in April 2010 to 1 year Libor +2.75%. Currently 1 year Libor is about 1.86%??
Adjusts each year thereafter.

I would be happy to lock in at something close to current rates , but am unable to refi since the spread between conforming and Jumbo Mortgage rates in the US has widened so much. I would have to refi at roughly 7%.

So my initial thought was I need to sell 1 March 2010 Eurodollar future (98.60 and $1M value) and possibly "lock in" at a rate of 4.15% (1.4 plus 2.75) but
1) the math doesn't work out
2) Only helps me for the first adjustment

Point 1) When I do the math, it indicates that I actually need 4 Euro$ futures to properly hedge a $1M mortgage, and I assume this has to do with it being a 3 month rate but I don't quite get how or why? Can someone explain simply or at least confirm that I do need 4?

Point 2) It appears that this would not work like I think of a typical hedge where I could just roll it over after expiration and be hedged for the next year and so on. It seems those 4 contracts need to be liquidated upon the first rate adjustment to properly complete the hedge. And if I simply put 4 new ones on in March 2010, I am then locking in for the next year from that point rather from the today's rate. So it seems I need to sell 4 contracts for March 2010, and 4 more for March 2011, and so on for as many years as I'd like to hedge.

Does that seem correct? I do realize that there will always be a small spread between the 3 month Libor that the future is based on and the 1 yr Libor my mortgage is based on; and that will change my end result slightly but I can accept that.

Any other tips as to how I might accomplish this better? Possibly using options? Since there are caps on how much the rate can adjust each year, I may be able to sell options against my hedge for a little extra cash.

Thanks for your time and advice,
Eric

 

[eric3]

More ...

Well now I don't know if this whole idea is way off or if I just have my head in a knot but I am looking at the prices of the different contracts and not sure how this would work.
Rough prices
March 2009 99.04
March 2010 98.60 selling 4
March 2011 97.66 selling 4
March 2012 97.27 selling 4

If I just say, "Assume Libor rates stay the exact same for a year", then would the March 2010 contract be trading 99.04 in a year? If so, I would lose $4000 on my hedge but not gain on the mortgage reset since rates stayed exactly the same....and obviously more so over the longer periods.

This is confusing me. Does this mean I would sell 12 of the March 2010's, then liquidate 4 after 1 year and roll 8, then liquidate 4 more after 2 years and roll the last 4 and then liquidate the last 4 to complete my 3 year hedge? Using my theoretical of rates staying the same, I would be rolling them over at 99.04 each year and it would appear the hedge would then work?

 

[readyaimfire]

Hi Eric,

To do this hedge you should really employ a professional investment company/qualified and experienced advisor.

Eurodollars are the best way to hedge against rate moves on your ARM as they are quoted on an index basis,100 minus the LIBOR and as LIBOR is most likely the base rate used for your ARM you can hedge with some degree of accuracy.

LIBOR is influenced by the Fed Funds rate,but LIBOR can differ based on how the ECB views its lending risks over and above its knowledge of what the Fed are doing.LIBOR rate changes can differ from Fed rate decisions so though there is a strong correlation in short-term rates,it won't always be perfect.

OK,now why you would need 4 contracts:

A one percent increase in interest rates on a $250,000 mortgage would yield an increase of $2,500.A Eurodollar point is valued at $2,500 (100 ticks x $25 per tick = $2,500) therefore for every $250,000 of your mortgage an opposing hedge of 1 lot locks you in.A $1m mortgage would thus require 4 lots.

There are however definite risks attached and everyone has different tolerance levels.While in essence the hedge is quite simple if you're not absolutely confident that the hedge you are putting on is accurate,I'd reiterate that you speak to someone qualified to take care of it for you,in relation to how badly it could go wrong,they should be able to take care of matters fairly easily and explain all the potential risk involved.

Best of Luck

 

[emma1234]

Guys i am looking for a professional, qualified and experienced advisor for my mortgage loan. So that i can use their help.

 

[jobysid]

Eric,

As you found out, it simply doesn't work. While the normal futures are hedge mechanisms which is independent of the time (though there are expiry dates, it is just for the execution of the contract and you can do rollovers by paying few extra spreads). But interest rate futures are designed to limit the damage just for a fixed time period (ie contract cycle duration/year.. or for example for a one percentage increase in interest rates for a quarterly cyle future, you are compensated for .25 percentage). Once the future cycle period is over, a new contract at that point is hedging the then interet rates and not the interest rate at the beginning of the mortgage. If you want to hedge for 15 years, probably you have to start buying contracts with monthly/quarterly expiration for all the cycles till the end of 15 years which is quite difficult to due to the extra permiums you will be paying, low liquidity and due to the high margins you will have to maintain...

I am also looking for a product to hedge my mortgage other than by using fixed rate interest rates.. If you ever come to know about a better option, please post it here..

Thank you

 

[awoodj]

Did anyone come up with a way of doing this?

 

[Martinghoul]

There's no way to do it, unless your bank offers you a product for this, smth akin to mtge insurance. It's not cheap normally. All other methods imply rolling costs etc.

 

[mikmo]

Eric you need to get a swap contract. Your lender can almost certainly do this.

A platform is unlikely to offer it as the potential mtm you could build would be a massive credit risk.

A creditless way to do it would be to buy a cap on all or a portion of the notional which most banks could probably sell you. If you'd like help give me a PM and I could maybe sell you a cap and if not will happily give you a steer as to what you should looking to pay so you don't get legged over.