Futures Trading - Spreads
Futures Trading - Spreads
Futures spread trading, where a single position in the market consists of the simultaneous purchase of one futures contract and sale of a related futures contract as a unit, is a method I have noticed to be underrepresented among retail traders. This is surprising since large speculators and commercial firms who regularly employ spreads are among the most invested and sophisticated players in futures trading.
Many traders looking for a strategy focus on straightforward directional trading, but spread trading is a fundamental and essential part of the commodities futures markets. Though spread trading can be challenging to figure out, there are some important reasons why spread trading should be considered when looking for an approach to trading futures.
Firstly, many futures contracts can be extremely volatile, not just during their U.S. daytime trading hours but also during nighttime hours, and trading volume can be greatly reduced. Certain types of spreads can greatly reduce volatility risk for futures trading positions and be a viable substitute for placing stop orders. In this case, a spread would enable traders to withstand the “surprises” that often appear when they rise to a new day.
Secondly, due to the lower volatility, the exchanges set margin requirements for many futures spreads can be much less than an outright futures position. For example, the current initial margin requirement for July soybeans is $4,590. The current total initial margin requirement for the July soybean / November soybean spread mentioned above is $2,700.
Those qualities by themselves don’t very strongly suggest futures spread trading is worth pursuing. But, consider this: large speculators and commercial firms who regularly employ spreads are often employing spreads based on market conditions and events that recur at periodic intervals. The most obvious of these intervals is the cycle of weather from warm to cold and back to warm. For agricultural and energy futures markets, weather – more accurately the seasons – can have an important effect on price movement. Enormous supplies of soybeans, once harvested, dwindle throughout the year. The same goes for futures trading in agricultural commodities such as wheat, corn, sugar, and cotton.
Seasons and weather changes affect energy prices as well. Demand for heating oil typically rises as cold weather approaches but subsides as refiners meet the anticipated demand. Memorial Day typically marks the beginning of the “driving season” in the United States and similarly, a vast number of the rest of the world’s population prepares to “go on holiday.” As a result, gas consumption rises.
Seasons and weather changes aren’t the only cycles affecting futures trading. Cycles in the financial arena can affect related futures markets. For example, a nation’s fiscal year and tax due date may often be at variance with others who are important trading partners. That can influence currency flows and the forces on interest rate-sensitive instruments.
All these forces, though not 100% predictable, give rise to recurring price phenomena and reveal an established tendency for prices to move in the same direction at a similar time every year. Spread trades can take advantage of these types of cycles. For example, market-driven U.S. interest rates historically exhibit a strong tendency to reach a seasonal high around April/May, presumably when monetary liquidity is tightest after the massive transfer of financial assets from out of the private sector and into the public sector, in the form of income tax payments due April 15.
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Disclaimer - Trading Futures, Options on Futures, and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. Past performance is not indicative of future results. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. Opinions, market data, and recommendations are subject to change at any time.
