trading strategies involving options and futures

What is Commodity Spread Trading?

Spread trading involves taking opposite positions in the same or related markets. A bedspread trader ever wants the long pull of the spread to increase in esteem relative to the short side. This means the spreading trader wants the difference between the spread to become more positive concluded time. Whenever a facing pages is quoted, it's ever a single price. You would never get over a quote with the 2 individualistic prices. The price is patterned by subtracting the gage month from the foremost month. For a more in-profundity explanation, please confabulate our Introduction to Spreadhead Trading Thomas Nelson Page.

Good Spreads Can Offer Lour Risk

Commodity futures spreads are a lower take chances approach to trading trade good futures that give notice be utilized by traders of all levels of experience. Commodity futures spreads are inferior sensitive to market moves than a pure good emerging position, and bathroom provide a more conservativist addition to an existing futures trading portfolio.

We are releas to delve in point into trade good futures spreads and explain a compass of key commodity spread trading strategies that traders can utilize to effectively trade the trade good forward market.

Good Spread Strategies

What is Contango?

A market is regarded as being in Contango when the value of the brash contract is higher than its cash price Oregon the price of a cut expiring in an earlier calendar month is lower than the monetary value of a contract expiring in a latter calendar month (yielding in an up sloping curve). In such conditions the marketplace is said to be 'normal'.

What is Backwardation?

A market is in backwardation when the value of the forward contract is lower than its cash price surgery the price of a contract expiring in an earlier calendar month is high than the price of a contract expiring in a latter month (generating an inverted gradual curve). In such conditions the market is said to beryllium 'turned'. This typically happens in bull markets, and when there are shortages of the commodity and/or increased demand. This is because the nigher months are up for delivery earlier spell prices are high because of demand supply imbalances, with the expectation that these conditions will simpleness nigher to the last mentioned delivery months.

Corn Contract Example of Backwardation

For example, let us say in February 2022, a March 2022 corn contract is priced higher than a December contract. This is because settlements in Marching music will need to be done from existing stockpiles (which may be relatively humbled), with nobelium new corn coming into the grocery store; while for the December settlement, there will be fresh planting, with the expectation of suitable weather conditions and/or increased area low polish, leading to lower prices.

Figure Generator: The Handbook of Commodity Investing – Frank Fabozzi

Bull Futures Spread

In good futures contracts, near months react more quickly and by a big quantum than farther months, in a bull grocery store therefore, the prices of nearer month contracts will rise quicker and further than a latter month contract. In such markets, a bull futures counterpane is a vernacular strategy on the job by traders. Hither a trader would seem to grease one's palms a nearer coming contract and sell one and only further out, in the same market.

Warming Oil Contract Illustration of a Bull Banquet

For instance, assume a trader has the panoram that due to expected wintertime storms, the cost of heating oildannbsp;for Jan volition be higher than the price of the forward Whitethorn cut. The trader will and so consider the advantages of buying Heating Oil January and selling the Warming Oil May contract.

Expect Futures Spread

Founded once more on the premise that nearer contracts react quicker and further than later contracts, in a bear out market value of nearer calendar month contracts will fall faster and past a larger amount than those further proscribed. In that scenario a digest futures spread strategy would be utilized by selling a nearer futures constrict and buying cardinal farther out, in the same market.

Soja Contract Example of a Bull Spread

For example, assume a trader has the view that an growth in supply of Soybean is prospective to come into the market in September, putting forc on the cost of the upcoming calendar month futures contract. The monger can then sell the Soybean September contract and buy the Soya bean December contract to create the spread.

Futures Spreads and Seasonality

Many commodities run to be cyclical, significant there are expected periods in the year where the commodity is expected to trade higher, and times that the same commodity ordinarily trades lower.

Let's take grains American Samoa an deterrent example. When the crop is most conquerable – i.e. when IT is planted in the spring – the price tends to Be high than at the harvest in the autumn. Similarly, commodities such as Heating Anele operating room Gas are usually higher during the winter months delinquent to high necessitate. These seasonal changes are expected and usually priced in the approaching contract. Thus, a trader may engage a bull futures spreadhead during a seasonal phase angle when prices are insurrection and may use a bear futures spread when prices are declining due to seasonality.

A trader lav flavor to profit from this seasonality, both past trading an actualized futures contract, operating theatre utilizing a futures spread trading strategy. However, unexpected brave conditions, much every bit a drought can regard the prices of grains and a warm winter, may drive the prices of heating oil lower than expected. In much conditions, trading the actual sign on is riskier, not just because of higher margin requirements but as wel because the position is essentially unhedged, which Crataegus laevigata conduct to high losses and expected margin calls. Risks may therefore be better managed by trading a futures spread instead of an actual contract.

This is on-key for other events such as a menace of war, political upheaval or earthquakes. Arsenic in the seasonal examples, if the trader is in a futures spread, then both sides would be expected to rise or fall in a similar manner, leaving the banquet position adequately qualified.

Understanding Spread Trading Margins

One of the biggest advantages of commodity futures spread trading is the lower leeway requirements to enter and keep in a position. The price of a spread position is the difference in prices between the near-term contract and the latter contract, with the margin requirements being 5 to 10% of the condense price. For example, if Butt 2022 corn costs $700 a bushel and May 2022 costs $650 and then the circularize is priced at $50 with around $5 to $10 being the tolerance required, while the actual contract itself would have mandatory a margin of anywhere between $30 to $70.

What is an Intercommodity Cattle ranch?

An intercommodity bedspread is another type of commodity futures spread in which the trader goes long happening one commodity (along which he or she is bullish) and drawers another (happening which atomic number 2 or she is pessimistic). The trader's returns are and so the difference in the prices of these two commodities. This type of a strategy would allow the monger to hedge their risks while reducing margin requirements simultaneously.

Futures spread trading strategies are not hugely popular amongst retail traders. However, as we have seen above, they bash have several advantages over trading the underlying/actual contracts and are susceptible to both fundamental and technical analysis. They can also constitute very useful for traders with prison term constraints and small accounts.