Futures Spread

Futures Spread

A futures spread is an arbitrage technique in which a trader takes two positions on a commodity to capitalize on a discrepancy in price. For instance, a trader could buy a March wheat futures contract and sell a September wheat futures contract. Alternatively, the trader could sell a March wheat futures contract and buy a September wheat futures contract. For example, a trader who is more bullish on the wheat market than the corn market would buy wheat futures and simultaneously sell corn futures. **Intra-Commodity Calendar Spread:*This is a futures spread in the same commodity market, with the buy and sell legs spread between different months.

A futures spread is an arbitrage technique in which a trader takes offsetting positions on a commodity in order to capitalize on a discrepancy in price.

What Is a Futures Spread?

A futures spread is an arbitrage technique in which a trader takes two positions on a commodity to capitalize on a discrepancy in price. In a futures spread, the trader completes a unit trade, with both a long and short position.

A futures spread is an arbitrage technique in which a trader takes offsetting positions on a commodity in order to capitalize on a discrepancy in price.
An inter-commodity spread utilizes futures contracts in different, but closely related commodities with the same contract month.
An intra-commodity calendar spread uses contracts of the same commodity, looking for discrepancies between different months or strikes.

Understanding a Futures Spread

A futures spread is one type of strategy a trader can use to seek out profit through the use of derivatives on an underlying investment. The goal is to profit from the change in the price difference between two positions. A trader may seek to take a futures spread on an asset when they feel there's a potential to gain from price volatility.

A futures spread requires taking two positions simultaneously with different expiration dates to benefit from the price change. The two positions are traded simultaneously as a unit, with each side considered to be a leg of the unit trade.

Types of Futures Spreads

Inter-Commodity Futures Spread: This is a futures spread between two different, but related commodities with the same contract month. For example, a trader who is more bullish on the wheat market than the corn market would buy wheat futures and simultaneously sell corn futures. The trader profits if the price or wheat appreciates over the price of corn.

Intra-Commodity Calendar Spread: This is a futures spread in the same commodity market, with the buy and sell legs spread between different months. For instance, a trader could buy a March wheat futures contract and sell a September wheat futures contract. Alternatively, the trader could sell a March wheat futures contract and buy a September wheat futures contract.

Bitcoin Futures Spread Trading

Bitcoin futures began trading in December 2017. These futures products offer an opportunity for a futures spread to benefit from price volatility. A trader who believes a price will go up over time can take a buy contract one month out and a sell contract two months out at a higher price. They exercise their option to buy in the one-month contract and then sell in the two-month contract, benefiting from the differential.

Futures Spread Trading Margins

Margins are lower for futures spreads than for trading a single contract due to reduced volatility. If an external market event occurs, such as a surprise interest rate movement or terrorist attack, both the buy and sell contracts, in theory, should be affected equally — e.g., the gain on one leg offsets the loss on the other.

A futures spread effectively provides a hedge against systematic risk, allowing exchanges to reduce the margins for spread trading. For example, the Chicago Mercantile Exchange (CME) has a $1,000 margin requirement for one contract of corn, whereas it has a $140 margin requirement for the same crop year futures spread.

Practical Example of a Bull Futures Spread

Suppose it’s December, and David is bullish on wheat. He buys one contract of March wheat at 526’6 and sells one contract of September wheat at 537’6, with a spread of 11’0 between the two months (526’6 – 537’6 = -11’0).

David buys March wheat and sells September wheat because front months typically outperform deferred months. David called the market correctly and, by March, the spread between the two months has narrowed to -8’0, meaning he has made profit of 3’0 (-11 + -8). Since one contract is for delivery of 5,000 bushels of wheat, David makes a profit of $150 on the spread trade (3 cents x 5,000).

Related terms:

Bitcoin

Bitcoin is a digital or virtual currency created in 2009 that uses peer-to-peer technology to facilitate instant payments. read more

Calendar Spread

A calendar spread is a low-risk, directionally neutral options strategy that profits from the passage of time and/or an increase in implied volatility.  read more

Chicago Mercantile Exchange (CME)

The Chicago Mercantile Exchange or CME is a futures exchange which trades in interest rates, currencies, indices, metals, and agricultural products. read more

Deferred Month

In the commodities futures market, the deferred month futures contract is the contract whose expiration date is farthest in the future. read more

Derivative

A derivative is a securitized contract whose value is dependent upon one or more underlying assets. Its price is determined by fluctuations in that asset. read more

Expiration Date

The expiration date is the date after which a consumable product like food or medicine should not be used because it may be spoiled, or ineffective. read more

Front Month

Front month, also called "near" or "spot" month, refers to the nearest expiration date for a futures or options contract. read more

Futures Contract

A futures contract is a standardized agreement to buy or sell the underlying commodity or other asset at a specific price at a future date. read more

Futures Exchange

A futures exchange is a central marketplace, physical or electronic, where futures contracts and options on futures contracts are traded.  read more

Horizontal Spread

Horizontal spread is a simultaneous long and short derivative position on the same underlying asset and strike price but with a different expiration. read more

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