Perhaps the single largest benefit of trading futures is the diversity of opportunities. Market participants are furnished with access to a wide variety of products and leverage, opening the door to countless trading possibilities. In essence, the only thing limiting opportunity is the trader’s imagination.
One way that industry professionals engage the markets is via futures spread trading. While not suitable for everyone, spreads are frequently executed by traders and investors interested in executing any number of arbitrage strategies.
What Is a Futures Spread?
At first, the concept of a spread appears somewhat daunting. It involves multiple moving parts and a number of strategic considerations. However, after a bit of study, the mystery surrounding futures spread trading quickly dissipates.
A futures spread is a type of trade where two positions are opened simultaneously at market. Each position is taken in opposition of the other, with one being a buy and the other a sell. The orders are referred to as legs, with both legs making up the completed unit.
In practice, there are three basic types of futures spreads:
- Intermarket: An intermarket spread involves taking offsetting positions in different, but related, products. For instance, let’s say that Chris the ag speculator believes that the corn and soybean markets are going to be volatile following an exceptionally strong El Niño cycle. To execute the intermarket spread, Chris chooses to buy corn and sell beans to pursue profit from the action.
- Calendar: Calendar spreads involve taking opposing positions in the same market using different contract months. Once again, let’s assume that Chris ag trader is fascinated by activity in the grain and oilseed markets. To gain exposure, Chris puts on a calendar spread through buying July corn while selling the December corn contract.
- Commodity product: Commodity product spreads address the relationship between raw materials and finished goods. To trade a commodity product spread, a trader takes offsetting positions in both the commodity and product contracts. Crude oil/gasoline and Soybean/soybean oil plays are two common types of commodity product spreads.
As in most forms of active trading, a trader attempts to profit from either a long or short side bias toward a given market(s). Futures spread trading is no different in this regard. The evolving relationship between contracts typically favors a particular side of the market. In the case of calendar spreads, there are two basic postures a trader can assume:
- Bull spread: A bull spread occurs when a trader buys the front-month contract while selling the deferred-month in the same market. If prices go up, the gains from the front-month long exceed the losses of the deferred-month short.
- Bear spread: The bear spread works in an opposite fashion. A short position is taken in the front-month contract, while a long is opened in the deferred-month.
In practice, futures spread trading furnishes participants with several advantages. Due to the covered nature of open positions and limited volatilities, margin requirements are typically much lower than those of outrights.
In addition, spreads are priced in a user-friendly format. Tick values are equal to that of the underlying futures product(s) and are represented as being the difference between the two contracts. For instance, if July corn is trading at 446’4 and December corn is trading at 459’4, the July/December spread is priced at -13. If reversed, the July/December spread price would be +13.
Getting Started in Futures Spread Trading
A common misconception regarding futures spread trading is that it’s only for institutional investors. This simply is not the case. Retail traders of all types can benefit from spread trading. In fact, the limited margin requirements and ease of execution make spreads attractive to a broad spectrum of retail traders.
For more information on spreads, check out the online educational portal at Daniels Trading. Featuring trading guides, webinars, and resources direct from the Chicago Mercantile Exchange (CME), it’s a great place to boost your spread IQ.