Chapter 8: Spreads

Overview

• Focus on futures spreads: buying one futures contract and selling another.
• Different types of spreads and how to identify them.
• Importance of understanding bullish/bearish positions, spread widening/narrowing, and calculating profit or loss.

Types of Spreads

1. Intramarket or Interdelivery Month Spread

• Definition: Buy and sell the same commodity on the same exchange but different delivery months.
  • Example: Buy March wheat, sell July wheat on CME.
• Important to determine bullish/bearish outlook, and whether the spread should widen or narrow.

2. Intermarket Spread

• Definition: Buying and selling the same commodity on different exchanges.
  • Example: Buy gold on COMEX, sell on ICE.
• Often used for arbitrage when slight price discrepancies exist.

3. Intercommodity Spread

• Definition: Trading relationship between different commodities.
  • Example: Buy corn, sell wheat.
• Based on perceived value between related commodities.

4. Commodity Product Spread

• Definition: Spread between a raw product and the processed product.
  • Crush Spread (e.g., soybeans): Long raw product (soybeans), short processed (soybean oil/meal).
  • Crack Spread (e.g., crude oil): Long crude oil, short gasoline/heating oil.
• Reverse spread involves opposite positions.

Yield Curve and Treasury Spreads

• T-Note vs. T-Bond Spreads
  • Related to changes in interest rates and yield curve shape.
  • If yield curve flattens: Expectation of short-term rates rising compared to long-term rates.
  • Strategic positions: Short T-note (if short-term rates rise), Long T-bond (if long-term rates rise).

Determining Bullish/Bearish Positions

• Generally determined by the near month position.
  • Exceptions: Foreign currencies and stock index futures (determined by deferred month).

Spread Widening/Narrowing

• Determine by the more expensive leg of the spread.
  • Buyer: Wants spread to widen.
  • Seller: Wants spread to narrow.
• Trick: Match the number of letters (buyer - widen, seller - narrow).

Examples and Calculations

• Intramarket Spread Example:

  • Short March corn at $3.19, Buy July at $3.23.
  • Determine bullish/bearish and whether to widen/narrow.

• Profit/Loss Calculation:

  • Example: Long July soybeans at $38.50, Short December at $52.50.
  • Offset at different prices to calculate spread widening/narrowing.

Activities and Practice

• Create custom exams focusing on spreads for practice.
• Types of questions include identifying spreads, determining bullish/bearish sentiment, and profit/loss calculations.

Next Steps

• Focus will shift to hedging in the upcoming sections.
• Important topics include long and short hedges and calculating effective selling price or cost after a hedge.