Use futures to hedge your equity

The most complicated strategy to protect a home’s value involves hedging against a decline in the owner’s equity by selling a futures contract pegged to one of the S&P CoreLogic Case-Shiller Home Price Indices. There are indexes in this group that track prices in each of 10 major U.S. markets, and one that tracks prices in all 10 markets.

The hedge, which can only partially offset any loss of equity, works like this: The homeowner sells a futures contract that sets a target value at a set point in the future for one of the home-price indexes, above the current value. The contract has a duration of one to three years.

When the contract is settled at its expiration, if the home-price index has fallen or hasn’t risen to the target level, the homeowner receives a payment based on the difference between the target value and the actual index value. That payment partially offsets any loss of value in the home. If the index moves higher than the target value, the homeowner pays—which takes a bite out of any increase in the property’s value.

One uncertainty with this strategy is how closely an individual home’s value will track the selected hedge index, especially if the home isn’t in one of the 10 markets the indexes cover. If the index rises above the target but the value of the home falls, the owner has to pay the contract’s buyer while also losing equity. “Each user has to decide, ‘Is my house going to move with the index?’ ” says

John Dolan,

an independent market maker for index futures.

Other considerations include the cost of setting up the hedge, as well as the cash required by the exchange to cover potential losses in the contract, and an additional amount required to open an account with a futures broker.

For one home-price futures contract, the broker’s fees would total about $24, says

Joe Fallico,

principal futures broker for Insignia Futures & Options Inc. in Schaumberg, Ill. The minimum cash the exchange requires to be set aside to cover the contract would be less than $3,000, but Mr. Fallico would want investors to put more in their account.

“Technically, an individual investor could come in with as little as $2,640, but I would require them to have $4,000 to $5,000 for the account,” Mr. Fallico says. That’s because if the value of the contract drops, the investor is required to put up additional money or liquidate the position.

Christopher Ritter,

a retired trader of government securities at a regional bank, has been taking out hedges since 2014 on the one-bedroom condominium he and his wife own in the Cleveland Park area of Washington, D.C. He thinks his apartment unit would sell now for slightly more than $500,000, He has used both the Washington, D.C., home-price index and the 10-city index in his hedges. “It’s worked very well, but less well over the last two years” as the value of units in multifamily buildings has languished a bit, he says.

Several times since he started using hedges the index has moved higher than the target level in his contract. That meant that his property’s value increased more than he expected but also that he had to hand over an average of $3,000 to $3,500 per contract at settlement time. “You have to be ready to pay,” he says.

Since 2014, Mr. Ritter estimates the value of his home has risen 18%. After deducting the losses on his hedges, he calculates his net gain at 8%. “Essentially, our return on the property was reduced by 10 percentage points over the seven years to reduce our downside exposure by about 36%,” he says. With his current contract, “I wouldn’t be surprised if the hedge costs us a little, but I look at it as insurance, and it certainly has been very low-cost insurance,” he says.

Buy home-builder shares

A simpler hedge involves home-builder stocks.

Kurt Fillmore

of Wealth Trac Financial LLC in Bingham Farms, Mich., says one of his clients had a home that had appreciated considerably, but the client wasn’t planning to move for a year or two. As a hedge, Mr. Fillmore purchased a put option on behalf of the client to sell shares of home-builder stocks at a fixed price in the future, assuming that if property values fell, so would the value of those shares.

If that happened, Mr. Fillmore’s client could buy the shares at the market price and sell them at the higher price set in the option, earning a profit that would help offset the loss of equity in his home. Instead, when it came time for the client to sell the home, the shares’ prices had moved up, so the client ended up eating the $1,000 cost of the put option. But that was much less than the increase in the value of the client’s home, Mr. Fillmore says.

“It essentially was insurance against a drop in home values,” Mr. Fillmore says. “There’s not going to be a direct connection between the share prices and the value of the house, but you still get some protection on the downside of dropping home values. And it’s much simpler than a lot of the alternatives, especially having to physically sell your house.”

Put your equity in the broader market

Stocks can offer another, much riskier, way to offset potential losses in home equity, by using that equity to make money in the market. As a rule, financial advisers are loath to have clients risk their home equity on Wall Street, but in some instances it can make sense, says

J.P. Maroney,

chief executive of Harbor City Capital Corp. in Melbourne, Fla.

“If you’ve got confidence that your investment will produce a rate of return greater than the cost of your money, and you can tolerate the risk,” he says, “it can be a very good strategy for someone if they have got a lot of equity that isn’t being utilized.”

With rates on home-equity loans averaging 4.6%, a homeowner would need to not only produce a higher return on stocks, but also factor in the cost of the loan and ensure that they have the cash flow to cover the monthly payment without needing to take money out of the market. They would also need to be investing for the long term to ride out the ups and downs of stocks. Of course, as recent months have shown, the downs can be dramatic, and it could take so long for the market to recover that the homeowner would need to move before selling the stocks would net enough money to fully repay the home-equity loan.

Another risk is that if home values decline, the homeowner could owe more on the loan than the property is worth. If the home was sold for less than the loan value, the homeowner would need cash to settle the home loan.

“There’s plenty of calculations that have to be done before you pull the trigger,” Mr. Maroney says.

Use home equity to pay down debt

A simpler way to profit from home equity is to use it to create savings by borrowing against it and using the money to pay off higher-rate debt, such as credit-card balances.

At the end of April, the average credit-card interest rate was 16.36%, according to CreditCards.com—11.76 percentage points higher than the current average interest rate of 4.6% on a home-equity loan. For someone paying off a $5,000 balance over a five-year period, the monthly payment would drop from $122 on a credit card to $93 on the home-equity loan, meaning the homeowner would save $1,740 in interest over the five years, minus loan costs.

The risk with this approach is if the homeowner doesn’t address the issues that created that credit-card debt in the first place, and continues to accumulate debt. If that happens, the homeowner is putting the home at risk by making it harder to pay the equity loan, as well as any mortgage.

That’s why many financial advisers tell clients to simply keep paying down their mortgage to build more equity while safely keeping a roof over their head.

Mr. O’Connor is a writer in metropolitan Detroit. He can be reached at reports@wsj.com.