Futures Spreads & Reduced Margins
One of the main draws traders have towards futures spreads is the reduced margins, but it is important to understand why the exchanges issue margin credit for spreads. The exchanges recognize margin for both flat priced futures and futures spreads should be proportionate to their risk and volatility. In this article, we will go over examples of reduced margins in Crude Oil spreads.
The Exchange Recognizes Margin Is proportionate to Risk and Volatility
The exchanges recognize margin should be proportionate to risk and volatility. As markets become more volatile, the margins increase. As the market becomes less volatile, margins decrease. Crude Oil is a perfect example of how futures spreads have lower volatility and lower margins when compared to the flat priced crude oil futures contracts.
December Crude Oil
Below is a chart of December 2013 Crude Oil. As of September 23, 2013, the margin on Dec Crude is $4325. On the chart below, December Crude has traded from an $86 low in April to a $110 high in August. That is a range of $24 per barrel. In June, the contract almost had a $4 intraday move. Taking all this into account, the exchange sets the margin at $4235 for this contract, which is equivalent to $4.235 per barrel in the Crude Oil contract.
December 2013 vs. January 2014 Crude Oil
Below is a chart of the Dec 13 vs. Jan 14 crude oil futures spread. As of September 23, 2013, the margin on this spread is $385. You read that correctly — almost a 92% margin reduction. Why does the exchange reduce the margin on this one month futures spread to nearly 1/10 of the flat priced futures contract? The exchange recognizes that as risk and volatility decrease so too should margin costs. The Z13/F14 spread traded a low of $0.20 in April and a high of $1.95 in August. The spread has had a $1.75 range over the past six months and the biggest intraday move it had was back in August for about 50 cents. The margin of $385 represents $0.385 per barrel in the Crude Oil contract.
December 2013 vs. February 2014 Crude Oil:
Below is a chart of the Dec 13 vs Feb 14 crude oil futures spread. As of September 23, 2013, the margin on this spread is $710. The Z13/G14 spread traded a low of $0.40 in April and a high of $3.50 August. The six month range on this spread is $3.10 and the largest intraday move was about $0.70 per barrel or $700 in the crude oil futures contract. The margin of $710 per spread is equivalent to $0.71 cents in the crude oil contract.
Notice how as the spread widens, the margins, trading range and volatility all increase. Dec vs Jan has lower margins and is less volatile than Dec vs Feb. As you will see in our last example, Dec vs March will have even larger margin requirements and volatility.
December 2013 vs. March 2014 Crude Oil:
Below is a chart of the Dec 13 vs March 14 crude oil futures spread. As of September 23, 2013, the margin on this spread is $1,705. The Z13/H14 spread traded a low of $0.50 in April and a high of $5.00 in August. The six month range for this spread is $4.50 and the largest intraday move was about $1.00 per barrel, which is worth $1000 in the crude oil futures contracts. The margin of $1705 is equivalent to $1.705 in the futures contract.
One of my favorite features of trading futures spreads is that you get to pick the volatility of the market. A trader may look at Dec Crude and think it is just too volatile to trade. If that trader understands spread trading, he can find a spread that fits his volatility and risk comfort levels. For some traders, they may like the one month spreads like Dec 13 vs Jan 14. For someone looking for more risk/reward, they may choose Dec vs March. Traders who are looking for even bigger moves may look at Dec 13 vs June 14 or Dec 13 vs Dec 14.
|Crude Oil Futures & Spread Margins|
|Crude Oil||Dec 13||$4,235||$3,850|
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