Unlike other financial instruments, futures contracts allow traders to benefit from rising or falling asset prices. You’re not limited to the buy side of the market, which means that you can also generate profits from the sell side. By using bull spreads, bear spreads, and associated strategies, you can secure market share by being either net long or net short the market.
How Do Bull Spreads and Bear Spreads Work?
Futures spreads come in many shapes and sizes, each with a unique application. Bull and bear spreads are two of the most commonly implemented ones. Here’s a quick look at the functionality of these exciting trading strategies.
A bull spread is a trading strategy that aims to capitalize on rising asset prices. To execute a bull spread, the trader simultaneously buys a near-month contract and sells a deferred-month contract in the same product. If asset prices rise, the gains in the near month are likely to outweigh losses sustained in the deferred month.
To illustrate how a bull spread works, assume that Carey the corn trader is optimistic that the price of corn will increase going into the summer months. Carey decides to execute a bull spread in the hopes of securing market share from a short-term bump in pricing. Here’s what he does:
- In April, Carey buys 10 lots of CME June corn futures.
- At the same time, Carey sells 10 lots of CME September corn futures.
Should prices rise, gains from the June corn long position are highly likely to outweigh losses from the September short. If so, Carey will be able to tally profits as corn appreciates in value.
Contrary to bull spreads, bear spreads offer the trader the ability to profit from falling asset prices. To execute a bear spread, the trader sells a near-month futures contract and buys a deferred-month contract in the same market. By doing so, the trader realizes gains from a downtick in short-term pricing.
As an example, assume that Carey the corn trader doesn’t see much upside for this year’s harvest. To cash in on the opinion, Carey places a bear spread trade via the following steps:
- In April, Carey sells 10 lots of June CME corn futures.
- At the same time, Carey buys 10 lots of September CME corn futures.
If corn prices show weakness through the early planting season, Carey will be in a position to profit from gains made by the June short position. If not, the losses will be negligible; gains realized from the September long will largely mitigate the damage sustained by the June short.
Advantages of Trading Spreads
In addition to the advanced applications of both bull spreads and bear spreads, futures also offers traders a unique collection of advantages, including reduced margin requirements and limited risk exposure.
For instance, traders of the ever-popular E-mini S&P 500 are typically subject to $500 intraday and a $7,200 maintenance margin per contract. The intraday figures are modest, but traders who wish to hold a position through the daily or weekly close must commit significant capital.
However, E-mini S&P 500 spread traders enjoy an ultra-low margin structure. Depending on the duration of the spread, maintenance margins range from $1o0-$300. This is a major advantage to retail traders who are interested in holding open positions for days, weeks, or months.
Getting Started with Spreads
At first, the concept of spreads can be a bit intimidating. However, through a little due diligence, you can easily understand them, and they can become a valuable facet of your financial game plan.
To learn more about bull spreads, bear spreads, and all things futures, check out the online educational portal at Daniels Trading. Featuring a comprehensive collection of webinars, blogs, and timely market analysis, it’s a great tool for boosting your futures IQ.