Understanding Futures Spreads
Spreading involves buying one futures contract while selling another. A trading strategy is common across different asset classes and is considered less risky than outright futures. Two main benefits of spreading are:
- Lower risk
- Lower margin requirements
These aspects make it attractive for hedgers and speculators. By using spread trading, you can balance your portfolio more effectively and also potentially lower your trading costs.
Types of Spreads
Intramarket Spreads
Intramarket spreads, also known as calendar spreads, involve buying a futures contract in one month (e.g., March Contract) and selling the same contract in a different month (e.g., June Contract).
Example: You might buy the March 2024 Eurodollar futures contract and sell the June 2024 Eurodollar futures contract.
Traders focus on the changes in the relationship between the two contract months. The idea is to profit from these changes. One leg of the spread might show a loss, but ideally, the profit from the other leg should offset it. Calendar spreads are also popular among traders and used for rolling a futures position from one expiration month to the next one.
Intermarket Spreads
Intermarket spreads involve buying and selling two different but related futures contracts within the same month. This type of spread allows you to trade based on the relationship between the two products.
Example: The Gold-Silver Ratio spread (trading Gold and Silver futures). This spread helps you understand the global economic health, letting you trade based on the relationship between gold and silver prices.
Commodity Product Spreads
Commodity product spreads involve trading futures contracts related to a process or production cycle, such as different Soybean futures.
Spread Margins
When trading futures spreads, you experience lower margins compared to outright futures positions. This is because a spread trade can offset risks between two related commodities. For example, let’s look at the Soybean-Corn spread
- Soybean futures margin: $2,500
- Corn futures margin: $1,000
Instead of needing $3,500 to trade both outright, you might only need a lower initial margin due to a margin credit. This credit reflects the reduced risk of spreading the two contracts. This means you need less capital upfront, allowing for potential cost efficiencies while managing risk.
Conclusion
Spread strategies allow futures market participants to manage their position risk.
