The Best Futures Trading Strategies: Spread Trading
Understanding Futures Spread Trading
An arbitrage futures trading strategy known as a futures spread allows a trader to take advantage of price differences by taking two positions on a commodity. The trader completes a unit deal in a futures spread, holding both a long and short position.
ESSENTIAL NOTES
- Using a futures spread, an arbitrage strategy, a trader can profit from a price difference by taking opposing positions on a commodity.
- Using futures contracts in several but closely related commodities with the same contract month, an inter-commodity spread is possible.
- Using contracts of the same commodity, an intra-commodity calendar spread looks for differences between several months or strikes.
Futures Spread: How It Works
A kind of method a trader can employ to use derivatives on an underlying investment to try and make money is a futures spread. Making money off of changes in the price differential between two positions is the goal. When a trader believes there is a chance to profit from price volatility, they might try to take a futures spread on the asset.
To profit from a price shift in a futures spread, two bets must be opened concurrently with separate expiration dates. Each side is regarded as a leg of the unit trade, and the two positions are traded simultaneously as a unit.
Futures Spread Types
Inter-Commodity Futures Spread
The term “inter-commodity futures spread” refers to a futures spread with the same contract month between two distinct but linked commodities. For instance, a trader who is more confident in the wheat market than the corn market would purchase wheat futures and sell corn futures at the same time. If the price of wheat rises relative to the price of maize, the trader benefits.
Intra-Commodity Calendar Spread
This is a futures spread in which the purchase and sell legs are spaced out over several months inside the same commodity market. For example, a trader may purchase a wheat futures contract in March and sell one in September and vice versa.
Futures Spread Trading Margins
Because there is less market turbulence when trading futures spreads, margins are lower than when trading a single contract. Theoretically, both the buy and sell contracts are equally impacted by an external market event, say a terrorist attack or unexpected change in interest rates, so that the profit on one leg balances the loss on the other.
Exchanges are able to lower spread trade margins by using futures spreads as an efficient hedge against systematic risk. For instance, a single corn contract on the Chicago Mercantile Exchange (CME) requires $2,700 in initial margin in addition to $1,000 in maintenance margin for the same crop year futures spread.
An Illustration of a Bull Futures Spread
Assume a trader is Bullish on wheat in December. With a spread of 11’0 between the two months (526’6 – 537’6 = -11’0), he purchases one contract of March wheat for 526’6 and sells another of September wheat at 537’6.
Because front months tend to do better than the postponed ones, the trader purchases wheat in March and sells it in September. He made the right move on the market, and by March, the difference between the two months had shrunk to -8’0, resulting in a 3’0 (-11 + -8) profit for him. In the spread transaction, he gains $150 because one contract is for the delivery of 5,000 bushels of wheat (3 cents x 5,000).
