What is it?
Spread trading represents a simultaneous purchase and sale of equal number of related futures contracts. Opposite transactions on spread positions reduce risks better than keeping purchase or sale transactions alone.
Mail point of spread trading is a simultaneous keeping of short and long position on different futures for related commodity. For example, a trader obtains wheat purchase contract with 6 months' period. Movement of relative prices in those contracts constitute profit of a trader. Therefore, spread position is far less risky than a straight futures position because relative prices of spreads are more sustainable as compared to absolute price of futures.
Types of spread:
Intramarket spreads are calendar spreads. Under this type of transaction you buy and sell contracts for the same asset but date of delivery is different.
For example, you buy January futures for delivery of wheat and sell March wheat futures at the same time.
Inter–Exchange spreads are formed in the process of trading with futures contracts of different exchanges, but with related commodity. For example, purchase of Light Sweet futures on NYMEX and sale of corresponding futures on ICE.
Intermarket spreads mean trades with futures on various commodities with the same and delivery month. For example, purchase of Oat September futures and sale of Wheat September futures.
Spread trading answers purposes of position traders as well as of those avoiding risks of price movement.
Advantages of spread trading
- Low margin requirements
- Low risk
- No dependence on real-time data
- Small time spending you don't need to keep eye on positions all day long
- High return in relation to invested margin
Spread trading with Broco
- Account from $2000;
- $6.25 commission for transaction;
- $25 monthly fee;
Markets for trading with spreads:
- Grain: Wheat (Incl. Kansas , Minneapolis), Corn, Soybeans, Soybean Meal, Soybean Oil, Rice, Oats.
- Meat: Feeder Cattle, Live Cattle, Lean Hogs, Frozen Pork.
- Soft: Coffee, Cocoa, Sugar, Orange Juice, Cotton.
- Energy: Crude Oil, Natural Gas, Gasoline RBOB, Brent Crude Oil, WTI.
Example of spread trading
- Choosing commodity
- Let's assume that there are two futures for interrelated commodity X and Y. (Wheat–Corn). X and Y contracts with 6-months' delivery are sold for 1$ per unit.
- Let's assume that a trader sells one X contract and buys Y contract. Position on spread is purposed to annul price risk. Losses caused by price downfall for Y good will be offset by short on X good. For example, X price falls down to to 0.80$ per unit whereas Y price is as low as 0.75$ per unit.
- Since downfall on X good was more significant than for Y, profit from short X position exceeded loss on long Y position. Absolute variations of price were offset, and what mattered is just the difference between the cost of X and Y. Net profit in the amount of $0,05 is equal to value of spread's variation from 0 to $0.05.