Things To Know About Spread Pricing
Simply put, spreads are priced as the difference between the two contracts you are looking to trade.
For example, the September crude oil contract (front month) is trading at $48.70 and the December crude oil contract (deferred month) is trading at $49.11. The spread price would be…
$48.70 - $49.11= -$.41
Now if you trade options, you should realize that this does not represent a $.41 credit or debit, but rather a discount or a premium.
When pricing futures spreads, you always take the front month and subtract out the deferred month.
- If the front number is trading lower than the deferred month (like our example above), the spread will be quoted as a negative number
- If the front month is trading higher than the deferred month, the spread will be quoted as a positive number
Futures Spread Tick Values
Generally, the tick values for spreads as the same as they are for individual contracts. There are a couple caveats (i.e. when rolling E-mini S&P contracts or NOB spreads, the tick values may be less - to help minimize the cost of rolling positions), but for the most part, the tick values are the same.
Seasonality In Futures Spreads
Because many of the commodity markets have seasonal periods of supply and demand, some prices are higher during the summer (things like gasoline, crude oil), while others have a higher demand in winter (things like natural gas, heating oil, and coffee).
Then there are other products like any of the grains (corn, soybeans, or wheat) that have seasonality in fall because of the harvest, which can lead to lower prices at that time of year.
Benefits Of Spread Trading
The main reason to trade spreads as opposed to outright futures is that it limits your exposure to systemic risk (outside factors that can impact commodity prices).
Let’s look at an example of how create a spread trade can limit exposure from market fluctuations that are a product of the systemic risk.
If you were to buy a crude oil future (/CL), you had to put up cash (as margin) to attain that position. Because the /CL contract is priced in US dollars, you’re not just long /CL, you’re technically short the USD. Technically, you would have a CL/USD cross position.
By trading a long /CL contract with a short /CL contract (thus creating a futures spread), you are effectively hedging out the USD. Let’s take this a little further…
If Greece were to default on their bonds (therefore sending Europe into a tailspin), the USD would go up materially. This rise of the USD would put pressure on crude oil, driving the price of /CL down. If you were long /CL, there is no hedge against this systemic risk.
To offset this risk, you could have created a spread with /CL using a deferred month contract, or, created a spread using another market.
Strategies: Futures Spreads
Products Discussed In This Episode: N/A
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