Once reserved only for institutional traders, spreads are gaining popularity among retail participants around the globe. Reduced margin requirements, limited risk exposure, and diverse strategic alternatives have made spreads an ideal destination for legions of active futures traders.
The first step in learning how to trade futures spreads is to address their three fundamental classifications: intramarket, intermarket, and commodity product. In order to execute each type of spread, it’s necessary to simultaneously buy and sell futures contracts in the same or similar markets. To execute each type, assume that Sam the spread trader takes the following measures:
Though spread strategies vary greatly, almost all fall within these three categories. If you were to sign up for a weekend seminar titled How to Trade Futures Spreads, these terms would be covered on day one.
One of the premier advantages of trading outright futures and futures spreads is the abundance of strategic possibilities at your disposal. In many ways, the trader’s imagination is the only limit.
However, there are spread strategies that have stood the test of time. Here is an example that people who know how to trade futures spreads have historically found useful.
One way that risk-averse traders use spreads to secure market share is through the gold bull spread. This strategy is an intramarket spread, meaning that offsetting positions will be taken in the same contract with different expiration months.
Any trades are educational examples only. They do not include commissions and fees.
The objective of the gold bull spread is to benefit from rising prices in the short term. To accomplish this goal, Sam the spread trader executes the strategy per the following:
Gold bull spreads are often applied in anticipation of forthcoming risk. If the capital markets become suddenly turbulent, the long gold position will very likely appreciate faster than the short. The result is a net gain from the difference in contract values.
Any thesis on how to trade futures spreads had better address the topic of risk. Perhaps the largest benefit to spreads over outrights is the limited risk exposure. Holding both long and short positions in the market protects against disaster, greatly limiting downside exposure.
Regardless of strategy, every trade comes with a degree of risk. In the gold bull spread above, Sam is opening conflicting positions in the same market. How could a loss possibly be sustained? Here’s how:
The beauty of spreads is that their application is not limited to one asset class. No matter whether your expertise is in commodities, bonds, or equities indices, spreads offer countless strategic possibilities.
Of course, before you can profit from the inherent opportunity, it’s necessary to learn the basics of how to trade futures spreads. For more information, contact one of our industry professionals today.