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Reap the Benefits of Spread Trading

by | Tips & Strategies

The sayings go, “you can’t teach an old dog new tricks” and “if it isn’t broken don’t fix it”. We get it – we will leave the old dogs alone. Then again, how come no one ever talks about teaching new dogs old tricks? There is a trading style, as old as the exchanges themselves, that is constantly ignored by many who try to master the markets – spread trading.

Spread trading has been around for as long as there have been more than one market; and for those who don’t like to see big swings in their accounts from massive daily market moves due to recessions, QE hype and all types of headline risk, it might be a style worth exploring.

In the trading world, the word “spread” is tossed around frequently. Essentially, it is defined as the difference between two prices. Many refer to the spread as the bid/ask on a contract or option, some refer to spreads when talking about the differences between 2 option prices, and even more will talk about a spread being the difference between two futures contracts. Whatever the reference, it is important to understand that when trading the futures spreads you will end up with one of the following positions:

  • Intra-market Spread: Long Dec Corn, Short July Corn
  • Inter-market Spread: Long Dec Corn, Short Nov Soybeans
  • Inter-exchange Spread: Long KC Wheat, Short Chicago Wheat

When spread trading, it is paramount to get into these spreads simultaneously. Effective spread traders will use spread order entry tools from either the platform or the floor to enter positions. Keep in mind that we are trying to make a profit only from the price movement between the two contracts being spread. It makes no difference whether soybeans go to zero or to infinity – all I care about is how that would affect the difference between the two prices of the different soybean contracts and whether I would be long and short. This takes a lot of the “outside market” pressure we hear so much about out of play.

Here are other key benefits of market spreading:

  • Spreads, especially intra-market spreads, have lower margins. A corn contract has an initial margin of $2362 while the spreads in the same crop have an initial margin of $1013.
  • Because of that lower margin, the rate of return on an investment might be higher. This is from posting a lower margin for hopefully the same returns.
  • In my opinion, seasonality plays tend to be more consistent with spreads rather than outright positions because they shield a lot of outside market exposure.
  • Spreads reduce some of the currency risk. Essentially, every outright trade one enters is a spread trade. If you buy Corn, you are long Corn against the US Dollar. The dollar falling or rising has just as much an affect with the underlying corn price as the cash market corn does. Spreading eliminates this because you are long and short instruments that are both priced in dollars.

These are just a few benefits. To learn more information on spread trading and how you can diversify using them, contact a Daniels Trading broker. Even old dogs might find that switching to spread trades is a trick worth learning, especially in these choppy markets.

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About John Payne

John Payne is a Senior Futures & Options Broker and Market Strategist with Daniels Trading. He is the publisher of the grain focused newsletter called This Week in Grain, along with being a co-editor of Andy Daniels’s newsletter, Grain Analyst. He has been working as a series 3 registered broker since 2008.

John graduated from the University of Iowa with a degree in economics. After school, John embarked on a 4 year career with the United States Navy. It was during two tours in Iraq and the Persian Gulf where John realized how important commodities are to the survival of society as we know it. It was this understanding that brought about John’s curiosity in commodities. Upon his honorable discharge in 2007, John’s intense interest in the world of commodities inspired him to move to Chicago and pursue his passion in a career in the futures arena.

After a three year position with a managed futures firm specialized in livestock trading, he was given the opportunity to join the team at Daniels Trading. Being in the business and seeing how other IB’s operated, it was the integrity and straightforward approach of the Daniels management team and brokers that attracted him to make the move. Since joining Daniels, John has broadened his fundamental and technical analysis of the markets even further. John has been writing his newsletter This Week in Grain under the Daniels banner since 2011.

Working in high pressure industries like the military and capital markets, John has learned the value of preparation in times of stress. He believes that instilling within his clients the value of a good plan and a cool head for dealing with the day to day swings of commodity markets. He treats every client as a teammate, understanding that his job is to help clients achieve their goals, whatever they may be.

John is a proud supporter of the Iraq and Afghanistan Veterans of America, the Veterans of Foreign Wars and the National Corn Growers Association. When he is not working, he enjoys athletics of all kinds and spending time with his wife and their two kids.

John’s commentary is featured in the following publications:

* All Ag Radio – Sirius Channel 80
* AM 880 KRVN – Lexington, Nebraska
* RFD TV
* Wall Street Journal
* Barron’s
* China News Daily (English version)

Risk Disclosure

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the "risk disclosure" webpage accessed at www.DanielsTrading.com at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.