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commodity spreads - buying from outright future contracts or is it a specific market?
I started to trade spreads. I was always thinking, that when I trade a spread, I buy one leg in one market and the second leg in another market from outright future contracts. I asked my broker and he told me that spreads are specific market and that I am trading only with other spread traders. In the trading platform I have also a DOM and I can put Stop, Limit etc orders on the spread.
This made me suspicious. Is this normal or some kind of scam?
Thanks guys
Can you help answer these questions from other members on NexusFi?
@durri: This is an interesting question. Although I am not trading spreads, I will try to answer.
Traditional Way of Establishing a Spread
You can always create a spread by buying a first leg in one market and then selling a second leg in a related market. The result is a spread. If you are doing this, you have an increased risk of slippage, because the second market may move, after you have established the first leg and prior to your entering the second leg.
Enhanced Way of Trading Spreads
The traditional way of trading spreads does not allow you to enter any position at a defined cost. There is always a risk of slippage, as you cannot enter the two legs simultaneously.
In order to allow traders to enter and exit spreads at limit prices without the legging risk (but with no guarantee for a fill, of course) some exchanges have introduced futures spreads that can be directly traded. If you buy the spread (that is buying leg 1 and selling leg 2 simultaneously) you spread buy order will
- either be crossed with a spread sell order (the other trader sellls the spread that you are buying)
- or be simulatenously crossed with an outright sell order for leg 1 and an outright buy order for leg 2 such that you obtain the specified limit price (you spread order is matched with two outright futures orders)
The prerequisite for crossing a spread buy order with two outright futures orders is that the matching engine of the exchange is able to handle this case. If the matching engine handles this case, it will typically follow time price priority. Your limit spread order will only be executed if it simulaneously matches the best ask for leg 1 and the best bid for leg 2 and also has time priority versus the limit orders sitting on the other side of the outright futures order books.
Futures Time Spreads (Calendar Spreads) at EUREX
"Time spreads combine two different maturities for futures on the same underlying. At any time, three time spreads are supported for products subject to price/time matching:
•
first month/second month (for example March/June)
•
second month/third month (for example June/September)
•
first month/third month (for example March/September)
For pro rata matched futures products, all spreads between each pair of consecutive maturity months are supported.
The purchase of a combination means you buy the first (nearer to expiration) leg and sell the later leg, with the price limit reflecting the net price of the purchase and sale. For example, "Buy 5 MAR/JUN FDAX spreads at -25" represents an order to buy 5 March contracts and simultaneously sell 5 June contracts of the DAX® Futures. The prices of the purchase and the sale are individually unspecified, but the net of the price on the buy trade must be no greater than the price of the sell trade minus 25 points. The trader is not concerned with the price level of the contracts, but with the relationship between the two prices. If the order is filled, the trader is long the combination, i.e. he is long the nearby contract, but short the later contract.
Futures time spread combinations are fully integrated with the order books for the individual legs. Orders will automatically be matched against either the outright order books for the individual legs (sometimes called an 'implied-in' price) or the separate combination order book, depending on which book will yield the better price. For time spreads, it is possible to enter prices with an increment smaller than the tick size for single leg orders in the same product.
If the order is not immediately executed or cancelled, it enters the combination order book. Due to the integration of the combination book and the books for the individual legs, the open combination order will generate a synthetic price in the later leg. The counterparties for the two legs may not be the same. Individual legs are treated as separate trades for position and transaction management purposes, although they are related to each other through their single order number. If the conditions of the order book change, the synthetic prices will change accordingly"
Futures Interproduct Spreads at EUREX
"The Eurex® system also supports inter-product spreads (IPSs) for futures. The buyer of an inter-product spread buys the first and sells the second component similar to the time spread, but the components refer to different underlyings, usually with the same expiration month. Inter-product spreads are treated as separate products in the Eurex® system. Matched orders in interproduct Spread products are posted to the two separate product legs. As with time spreads, a buy of an inter-product spread product results in a long position in one product and short position of another product. The Eurex® system does not directly permit negative pricing for inter-product spread orders; instead, an offset price is applied. At present, interproduct spreads are not set up for trading."
Bid/Ask Spread for Futures Spreads
If you want to enter a spread traditionally, you will usually suffer from twice the spread, as you have to pay the spread on each side of the leg. Below is a snapshot of a futures time spread built from the front and the second month contract for CL.
If you wish to purchase the spread you would have to buy the front month at a price of 94.52 and sell the back month at 94.81, which will result in a credit of - 0.29 points. If you sell the spread you would have to pay 94.83 - 94.50 = 0.33 points.
By directly entering the calendar spread, you benefit from a reduced bid/ask spread, as you can enter long at a credit of 0.30 points and sell short at a debit of 0.31 points.
Trading of futures spreads is very easy and it have a lot of advantage unlike trading futures outright. Some spreads are directly quoted by exchange (this is what your broker told you) but you can open spread by legs (Buy / sell each leg separately) this is called like leging - but I don't recommend this for beginner. For example Joe Ross describing how to trade outright futures and spreads use as hedge, when news report are expected - this example of legging.
As begginer try to trade intracommodity spreads (in grains intracrop spreads). Last year grains have a lot of volatility so I would avoid them.
Thank you guys, didnt know that there are also spreads directly quoted by exchange. Great explanation Fat Tails, many thanks )
@Kurtas:
This is exactly what I am trying to trade - intracommodity spreads. I have also read some of Joe Ross books. What would you suggest to trade for a beginner? Only intracommodity intracrop grains?
I also read books from Joe Ross and I mean that opinions in this books are little - but It's my personal opinion. Joe recommending trade a grains for beginners but today is this markets so much volatile that is a better obchodovat another markets. Later, I will post soybeans spread what I trade last summer and you will see how it could be dangerous
Allways browse how spread reacted in history, don't let loss be bigger than average worst result for 15y for example.
I could recomend energies, some meats at this time. Specialy natural gas isn't so much volatile. But with strict SL you could trade all markets without problem
As you can see BUY this spread around July and sell it at october looked as great trade. 5y, 10y, 15y, 20y, 30y patters showed bull ride. Backtest was great only one loss from 1993.
I started buy -50 close all at -85 - thank god it went -150
At next picture you can see range where spread moved in last 20y. It's range cca +30 / -15. Bolded black line is spread ZSH13-ZSX12 - last summer. It was crazy - a lot of people still bought this spread (including me) because they hoped that it can't go lower - it went. I personaly started buy -50 (I didn't have margin earlier) but all time low was -15 so a lot of my friends had positions from -20.
I can recommend a few if you tell me whether you need charts or not.
Matt
Trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. You may lose more than your initial investment. All posts are opinions and do not claim to be facts. Please conduct your own due diligence. Use only Risk capital when trading Futures.
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I use IB as broker, but all analysis I do in www.seasonalgo.com - there is a lot of trading tips, backtesting, historical charts etc. You can try their demo - in demo you will get all functions but it's limited only for corn future contracts. It is sufficient for start.
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