447 tHe COnCepts And MeCHAniCs OF spreAd trAding spread is equal to 200 points, a long October/short december spread initiated at October 100 points under might be termed a limited-risk spread. However, the same long October/short december cotton spread would not be termed limited risk if, for example, October were at a 300-point pre- mium. nevertheless, it should be noted that even in this latter case, the maximum risk would still be defined—namely, 500 points—and in this respect the spread would still differ from spreads involving the selling of the nearby contract, or spreads in markets that do not fulfill the limited-risk specifica- tions detailed above. the best way to understand why it is unlikely for the premium of a distant month to exceed car- rying costs is to assume the existence of a situation where this is indeed the case. in such an instance, a trader who bought a nearby month and sold a more distant month would have an opportunity for speculative gain and, at worst, would have the option of taking delivery, storing, and redelivering at a likely profit (since we assumed a situation in which the premium of the distant month exceeded carrying charges). sounds too good to be true? Of course, and for this reason differences beyond full carry are quite rare unless there are technical problems in the delivery process. in fact, it is usually unlikely for a spread difference to even approach full carry since, as it does, the opportunity exists for a speculative trade that has very limited risk but, theoretically, no limit on upside potential. in other words, as spreads approach full carry, some traders will initiate long nearby/short forward spreads with the idea that there is always the possibility of gain, but, at worst, the loss will be minimal. For this reason, spreads will usually never reach full carry. At a surface glance, limited-risk spreads seem to be highly attractive trades, and indeed they often are. However, it should be emphasized that just because a spread is relatively near full carry does not neces- sarily mean it is an attractive trade. V ery often, such spreads will move still closer to full carry, resulting in a loss, or trade sluggishly in a narrow range, tying up capital that could be used elsewhere. How- ever, if the trader has reason to believe the nearby month should gain on the distant, the fact that the spread has a limited risk (the difference between full carry and the current spread differential) makes the trade particularly attractive. the components of carrying costs include interest, storage, insurance, and commission. W e will not digress into the area of calculating carrying charges. ( such information can be obtained either through the exchanges themselves or through commodity brokers or analysts specializing in the given commodity.) However, we would emphasize that the various components of carrying charges are variable rather than fixed, and consequently carrying charges can fluctuate quite widely over time. interest costs are usually the main component of carrying charges and are dependent on interest rates and price levels, both of which are sometimes highly volatile. it is critical to keep changes in carrying costs in mind when making historical comparisons. Can a trader ever lose more money in a limited-risk spread than the amount implied by the differ- ence between full carry and the spread differential at which the trade was initiated? the answer is that although such an occurrence is unlikely, it is possible. For one thing, as we indicated above, carrying charges are variable, and it is possible for the theoretical maximum loss of a spread trade to increase as a result of fluctuations in carrying costs. For example, a trader might enter a long October/short december cotton spread at 100 points October under, at a time when full carry approximates 200 points—implying a maximum risk of 100 points. However, in ensuing months, it is possible higher