Futures Spreads Trading: An Overview
Futures spreads, which were previously solely available to institutional traders, are becoming more and more in demand with retail participants worldwide. This increase in popularity is due to their lower margin needs, minimal risk exposure, and variety of strategy options.
The Basics of Spread Trading
Understanding the three basic categories of futures spreads—intramarket, intermarket, and commodity products—is the first step in figuring out how to trade them. Each spread type requires concurrent purchases and sales of futures contracts in the same or comparable markets. The types of futures spread trading are as follows:
Intramarket: Purchasing and selling identical futures contracts with different expiration months.
Intermarket: Purchasing and selling various but connected futures contracts that have the same month of expiration.
Commodity Products: Purchasing and selling futures contracts of raw material processing. For instance, a trader may execute a “Soybean Crush” commodity product spread by purchasing soybean futures and selling soybean oil futures.
Despite the wide range of spread methods, nearly all of them fit into one of these three groups.
Futures Spreads Trading Strategy
The beauty of trading futures and futures spreads is the wealth of strategic options available to market players. The trader’s creativity is the only restriction. The following is one of the most popular futures spread trading strategies:
Gold Bull Spread
The gold bull spread is a strategy used by non-risk takers to protect market share. This is an intramarket spread, therefore, offsetting positions will be taken in the same contract with various expiration months.
The short-term goal of the gold bull spread is to profit from rising prices. It is executed in the following steps:
- At $1475.0, a trader purchases a single lot of 2019 CME December gold futures (GC).
- He sells one lot of 2020 CME February gold futures (GC) at $1485.0 at the same time.
- The trader reads knowledgeable blogs about bullion, keeps up with the news, and watches price movements.
- Finally, profit is made if the price of gold in December increases quicker than the price of gold in February.
Gold bull spreads are frequently used to predict impending risk. The long gold position will probably increase in value faster than the short position if the financial markets suddenly become unstable. The difference in contract values leads to a net gain.
Risk Behind Spread Trading
The reduced risk exposure of spreads over regular futures trading is arguably their biggest advantage. Having both long and short bets in the market reduces downside exposure and protects from financial catastrophes.
However, every deal has some level of risk, regardless of approach. The following are instances traders should look out for when trading futures spreads:
Global Event: A sudden burst of positive news may lower market perceptions of risk. As a result, the positions can lose value more quickly than the value of the deferred short gains.
Careless Leverage: Spreads naturally have much lower margin needs. However, extreme losses can occur when position sizes are too big. Traders risk a significant loss or drawdown if they wager a large amount on a gold bull spread and the trade doesn’t work out.
Bottom Line
Futures spreads are great because they may be used in a variety of asset classes. They provide a plethora of safe strategic opportunities regardless of your area of expertise, be it commodities, bonds, or equity indexes.