All you need to know about futures spread trading
So, you are interested in futures spread trading. You want to know more about this trading option. This article will answer all your queries.
What is Futures Spread?
It is an arbitrage technique that enables traders to take two positions on products to make profits. In the futures spread trading, you will have to complete the unit trade using both the positions that include buy and sell.
What exactly it is?
It is a type of strategy designed to help traders to make profits by using derivatives on the principal investments. The key objective of this trading is to use both positions to make profits from the inconsistent or changing market conditions. Traders can make profits from the difference in the price change between the two positions. You can take futures spread if you find that you can make more profits from the price volatility.
As stated earlier, futures spread means taking two positions at a time. However, there will be different expiration dates so that you can make profits from the price change. The two positions will be traded at a time just like a unit and each position will be considered to be the leg of the trade.
There are different types of future spreads. The most common type is the calendar spreads. In this trade, you will have to take two positions according to the price speculation. The investors’ position will depend on the market condition.
Spread trading futures example
For example, if a trader feels that the price will go up, he can take the long term sell position and short term buy position. When the price will go down, the trader can take short term sell position and long term buy position. The key benefit is two positions. It ensures guaranteed profits.Of course trader need to do spread trading strategy calculation and calculate risk reward for both positions.
It is a bit riskier to take only a single leg option. You can make profits from this position only when you hold an underlying product and choose the option to sell that product at a much higher price any time in the future. When you will choose the buy position, then the risk of the price decline will be more. You cannot make profits from your investment in adverse conditions.
The term “futures spread training” is a staple among many professional traders. If you do any form of trading, however, most experts agree that it should be a part of everyone’s trading strategy. In this article, we will go over exactly why that is and help you get a good grasp of the latter as part of your trading arsenal.
To understand how futures spread can augment your trading strategy, it would be best to jump into its’ different forms. Only then can you glean valuable insights on how you can use it to augment your trading.
How to Trade Futures Spreads
It is important to understand each type of futures spread before trading. See list :
Inter-Commodity Futures spread
Simply put, Inter-Commodity Futures Spreads (ICFS) is a type of Futures contract that is divided among different, but related markets. One good example of this is the markets of Gold vs. Silver.
Spread trading futures example – Inter-Commodity Futures spread
Let us say that one trader believes that there will be a higher demand for Gold in the market for precious metals compared to Silver. The trader then proceeds to buy more Gold and sell Silver without having to worry about the fluctuations in price between the two. This is typical example for commodity futures spread trading.
In the example cited above, a trader using ICFS wants to see the value of Gold appreciate over the price of Silver. If the precious metals market sells off, the trader expects that Gold will retain its’ value better than Silver. Likewise, in a booming market, a trader expects Gold to increase farther than Silver.
Intra-Commodity Calendar Spread
In an Intra-Commodity Calendar Spread (ICCS), Futures contracts are allocated in just one market but spread between different months. For example, June Gold vs. December Gold.
ICCS trading intends to submit a long position for one futures contract while shorting the other. In the same example, a trader might be looking to play a short position for Gold in June and shift to a long position come December.
Bull Futures Spread – bull spread futures
A trader than engages in a Bull Futures Spread is said to be playing a long position on the same market for the next month and a short one for the protracted month. For example, let us say it’s April of 2019. You buy Gold in June intending to sell it come August 2019, June is closer to April compared to August.
It is essential to regard that the near months tend to fluctuate farther than faster compared to the back months hence the term “Bull Futures Spread”. Granted that Gold is in a bull market, the price is expected to increase more quickly during the closer month as opposed to the deferred one. In this case, a trader who is bullish on Gold would buy more during the nearest month and sell during the deferred month. Such a trader is counting on the possibility that the price of Gold will move quicker and faster during the closer month as opposed to the deferred one.
Of course, the price disparity between the closer and deferred months is not always accurate. That said, this is how these trades often turn out when on a bullish market with spreads turning to the trader’s favor.
Bear Futures Spread
A Bear Futures Spread is the polar opposite of the Bull Futures Spread. This means that a trader plays a short position (sells) during the near month and switches to a long position (buys) on the deferred month. The idea is for traders to profit from the spread as prices dwindle during a bear market.
Bitcoin Futures
Bitcoin futures entered the trading industry in December 2017. These products also offer ample opportunity to the traders to make money from the futures spread and price volatility. If you believe that the price will increase over time, then you can consider buying a contract for one month out and sell a contract two months out at a higher price to make profits. Traders will have the option to buy in the one month contract and sell in two months contracts. They can make benefits from the price change.
Futures Spread Trading Margins
Futures Spread Trading Margins is when traders reduce their margins for trades that make up a portion of a spread. Let us say that the margin for one contract of Gold is $4050. However, if you have both short and long positions for the said commodity during the same year, then the margin could be as low as $400.
Exchanges decrease the margins to account for lower volatility compared to the actual contracts. In effect, a Futures spread stalls the market for traders enabling them to react faster to significant events such as sudden interest rates, market crash, an outbreak of war, and the like. Whatever the case, Futures Spread Trading Margins enable traders to hedge their risks as the effects of external factors are spread evenly among their contracts.
Futures Spread Pricing
As the name implies, Futures spreads pricing revolve around the price difference between the two contracts. If one troy of Gold is equal to $1600 in May, and come August is trading at $1620, then the spread price is -$20. Conversely, if May was trading at $1620 and August is at $1600, then the spread price is $20.
Futures Spread Quotes
A trader engaging in what’s known as Futures Spread Quotes takes the price for the near month and deducts it with the price for the deferred month. Not surprisingly, if the near month is trading lower than the deferred month (i.e., June vs. August, for example), then the spread will have a negative value. Conversely, if the near month is trading higher than the deferred month, then the spread value will be a positive one.
Futures Spread Tick Values
Futures Spread Tick Values refer to the incremental increase or decrease in value for both spreads and individual contracts. Let us say that that spread for June Gold and August Gold is -$100 and the spread moves to -$110, then that is a $10 move.
$10 in Gold is $500 for all months in a $50,000 Gold contract because the tick value is both similar in spreads and individual markets.
Con-tango market
A contango market simply refers to the “regular” market wherein the value of a commodity tends to be higher during the deferred months compared to the near month.
Backwardation
A market that is said to be in backwardation is the polar opposite to that of a Contango market. Hence they are also aptly called an “inverse” market wherein markets are trading higher during the near month and lower towards the deferred month. The latter usually occurs during a bull market as demand rapidly overtakes the available supply.
Seasonal Futures Spreads
Many markets like wheat, cooking oil, and natural gas are subject to seasonal fluctuations in supply and demand. Some commodities experience high demand during the winter (i.e., natural gas) while others tend to peak during the summer (i.e., gasoline).
A seasoned trader is one that knows how to take advantage of any disparity in supply and demand. In the process, they take into account the past performance of spreads across several years to glean patterns that will help them weigh their risks and increase the probability of trading success.
Final Tip
Futures spread trading is completely risk-free in virtual cash with $100, 000. If you want to try your trading skill and make money from the futures spread, you can use the Free Stock Stimulator. You will have to submit the trade in a virtual environment before risking your hard-earned money. It is suggested to practice the trading strategies to perform better in the real market.
