A spread is the simultaneous purchase and sale of the same or similar commodity
in the same or different contract months. Spread trading is usually considered to
be a lower risk strategy than an outright long or short futures position, and therefore
margin requirements are usually much less than an outright long or short futures.
For example, if the price trend of soybeans is currently up and you are in a soybean
spread, (short one month and long another) the gain on the long position would likely
offset the loss of the short position, and vice-versa. One side of the spread typically
hedges the other, therefore the lower margin requirements. Keep in mind that spreads
are not guaranteed to be less risky, there is risk of loss in all trading.
Just like with any commodity a spread can be bought and sold at "x" price, and it
can be charted just like any other market. What is being plotted?...simple...the
difference between two contracts. A typical spread chart looks like this:
You must be asking "How do I make money if I am long and short the same commodity?"
The answer is you are hoping to profit from the difference in the two contract months,
not from a trend higher or lower in any particular market. With a spread, you follow
the relationship, or difference between the contracts, without having to pick a
For example, if July Soybeans were trading at $5.10/bushel and November Soybeans
were at $5.35 the spread would be said to be at .25 to the November side. If you
entered a July/November bean spread (your broker would simultaneously buy a July
and sell a November contract) and soybeans rallied, what would happen? Well, let's
say July settled one day at $5.70 and November settled at $5.75, the spread would
now be .05. In this example July rallied 60 cents (you were long a July contract
so you made 60 cents on it) and November rallied 40 cents (you were short a November
contract and lost 40 cents on it), you would have a net gain of 20 cents on the
spread. Your broker could exit the spread and you would have made 20 cents/bushel
* 5000 bushels = $1,000. If you had entered the spread in the other direction you
would be losing $1,000.
The above example is known as an intra-commodity spread, buying one month and selling
another in the same commodity. An inter-commodity spread is buying a commodity month
in one market, and selling another related commodity in the same or similar month.
Some of the advantages of spreads are:
1. typically require smaller margin deposits
2. underlying market direction isn't important
3. seasonal patterns exist among spreads
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