Spread Futures Trading Strategy

In commodities, a spread is the distance between the value of two separate contracts.

Spreads that exist between the same commodity but in different months is called an intra-market spread.

Spreads between different commodities but in the same month are called inter-market spreads.

It’s assumed that spread traders trade spreads that are somewhat correlated (or negatively correlated) to a certain degree. 

For instance, when the S&P 500 goes up, the Russell 2000 tends to go up as well.

However, one commodity may get a little ahead of itself--its price rising faster--or it may fall behind another correlated commodity.

In such cases, the “spread” widens, and one strategy that spread traders implement is to take advantage of “imbalances” in correlation, often going long one contract and short the other, anticipating that the spread will return to its average correlation.

Let’s use a bunch of examples for spread trading:

1. Long the e-mini Nasdaq futures and short the E-Mini S&P futures. 

In this example the trader may want to capitalize on the fact in the short term there is technical divergence between the two contracts whether for technical or fundamental reasons. 

The fundamental trader may see more flow into the technology sector represented by the Nasdaq index, and the technical trader may base it on the divergence that exists between the charts. This is an example of inter-market spread on futures. 

2. Long the gold futures and short the silver futures. 

Although both futures commodities are correlated to a certain degree, you may see higher flow into the gold market versus the silver market. This is also an inter-market spread.
 

 3. Short the June crude oil futures and long October crude oil futures. 

 

 Because the crude oil market is deliverable, there could be divergence based on the supply and demand changes in different periods as dictated by things such as travel for example. This is an example of an intra-market spread.

  Note: whatever method you use to trade--whether trading a spread or trading an “outright” position-- keep in mind that one method is not better than another and that one (particularly spreads) may not “safer” than an outright position. 

Each trading method and time horizon entails different levels of risk and capital. 

Typically, anything that is beyond day trading would require higher levels of capital as longer term strategies can be extremely volatile, and the fluctuations in your account may reflect that.