Stock Market Analysis

There are two types of spreads using futures contracts.

Intra-commodity spreads

This is where you buy one delivery month and sell another in the same commodity (e.g. simultaneously buy August Soybeans and sell November Soybeans). These are also called

“calendar” or “time” spreads for obvious reasons.

Inter-market spreads

There are also inter-commodity spreads where you buy one commodity and sell a related commodity (e.g. buy December Live Cattle, sell December Lean Hogs).

Sometimes it is easy to confuse the terms inter and intra. Don’t worry about this so much. It’s more important that you know the basic idea. Both types of spreads simply try to make money from the change in relative prices of the contract.

At this stage, all you need to understand is the concept of going long one contract and

short another simultaneously. There is really not a lot to it. A spread trade is all about

making money from the relative change in prices.

Spread charts

If you are reading up on spread trading elsewhere, you’ll need to understand how spread charts are displayed.

Generally speaking you will calculate the spread as the bought(long) side minus the

sold(short) side. Some books on spread trading will show the near contract month minus the distant month for intra-market spreads, but this is a little confusing.

For this lesson, we’ll stick with ‘bought less sold’. This is also the way we display things on the eSignal charts shown throughout.

Examples of futures spreads

Wheat

This is an intra-market spread. This chart shows the difference between March and July

Wheat as traded on CBOT.

Source: eSignal - www.esignal.com

As you can see, the period leading up to October it was very quiet. Then it just exploded! Spreads don’t normally behave this dramatically, but occasionally they do. Not good if you are on the wrong side of it, but great if you are.

Live Cattle versus Lean Hogs

Here is another example. This one is a spread between two meats futures contracts: Live Cattle and Lean Hogs, both traded on the CME. This is an inter-market spread. As you can see this one has moved around quite a bit too.

Source: eSignal - www.esignal.com

Equity spreads

The spreads shown above are calculated by taking one price away from another. For most spreads, this is the logical way to do it – as well as the way brokers will accept orders.

What if however, you were looking to trade two related markets that have different contract sizes? In this case, taking one price away from the other does not make sense.

This is where you can calculate an equity spread. This calculation takes contract size into account. Consider gold versus silver. This is an actively traded spread market, but the COMEX futures contracts are based on different amounts of the underlying metal.

Gold is based on a 100 ounce contract whereas silver is based on a 5000 ounce contract. Calculating the equity spread will effectively give you a dollar value of the spread, or as it is called as “equity spread”.