The Rise Of The Real Estate Mortgage Walkers

In those situations, for the long straddle to make money, the asset price has to move far enough into the money to cover the straddle’s cost. So if a straddle costs $10, the asset price has to move $10 into the money to break even (rise above the zero line of the y-axis on the chart above). Every penny further into the money is profit.

However, in the case of the options acquired by homeowners with “zero down” mortgages, the straddle was essentially free. In other words, homeowners get the profit if prices rise and they get to stick someone else with the asset if prices fall. Prices have fallen. Hence, the title of this article.

See below for more of my comments, plus the article that inspired this posting.

My thoughts on this Wall Street Journal article are as follows:

When you give someone a “zero down” mortgage you have given them a free ATM (at the money) call and a free ATM put. ATM means the option’s strike price equals the asset’s current market price.

The call remains valid as long as the homeowner makes the schedule payments.

The homeowner makes the scheduled payments as long as the asset price is rising.

When the asset price rises, the value the put approaches zero and the value of the call increases exponentially. The put is “out of the money” and the call is “in the money.”

To realize the value of the call, the homeowner sells the house, repays the debt and pockets the difference. Everybody’s happy.

However if the value of the asset falls, the value of the call approaches zero and the value of the put increases exponentially.

To realize the value of the put, the homeowner stops making scheduled payments and “puts” the house to the lender (i.e., sends in the keys or waits until foreclosure). The put’s value equals the amount it is in the money (strike price minus the current market price), less transaction costs.

It’s funny and sad that lenders and investors (sucker institutions) didn’t realize, or more likely didn’t care, that the house of cards they built would topple if asset prices fell. The real problem is the perverse incentive system and corruption in all part of the food chain.

Source: By chrisco.wordpress.com/