48 lines
3.8 KiB
Plaintext
48 lines
3.8 KiB
Plaintext
445
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tHe COnCepts And MeCHAniCs OF spreAd trAding
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shifts.) As a consequence of the intrinsic nature of this commodity, different months in live cattle are,
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in a sense, different commodities. June live cattle is a very different commodity from december live
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cattle. the price of each will be dependent on the market’s perception of the supply-demand picture
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that it expects to prevail at each given time period. it is not unusual for a key cattle on feed report to
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carry bullish implications for near months and bearish connotations for distant months, or vice versa.
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in such a case, the futures market can often react by moving in opposite directions for the near and
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distant contracts. the key point is that in a bullish (bearish) situation, the market will sometimes view
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the near-term supply/demand balance as being more bullish (bearish) and sometimes it will view the
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distant situation as being more bullish (bearish). A similar behavioral pattern prevails in hogs.
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thus,
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the general rule would not apply in these types of markets.
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in these markets, rather than being concerned about the overall price direction, the spread trader
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is primarily concerned with how he thinks the market will perceive the fundamental situation in dif-
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ferent time periods. For example, at a given point in time, June cattle and
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december cattle may be
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trading at approximately equal levels. if the trader believes that marketings will become heavy in the
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months preceding the June expiration, placing pressure on that contract, and further believes the
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market psychology will view the situation as temporary, expecting prices to improve toward year-
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end, he would initiate a long
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december/short June cattle spread. note that if he is correct in the
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development of near-term pressure but the market expects even more pronounced weakness as time
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goes on, the trade will not work even if his expectations for improved prices toward year-end also
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prove accurate. One must always remember that a spread’s life span is limited to the expiration of the
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nearer month, and substantiation of the spread idea after that point will be of no benefit to the trader.
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thus, the trader is critically concerned, not only with the fundamentals themselves, but also with the
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market’s perception of the fundamentals, which may or may not be the same.
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■ Spread Rather Than Outright—An Example
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Frequently, the volatility of a given market may be so extreme that even a one-contract position may
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represent excessive risk for some traders.
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in such instances, spreads offer the trader an alternative
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approach to the market. For example, in early 2014, coffee futures surged dramatically, gaining more
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than 75 percent from late January to early March, with average daily price volatility more than tri-
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pling during that period.
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prices swung wildly for the next several months—pushing to a higher high
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in April, giving back more than half of the rally in the sell-off to the July low , and then rallying to yet
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another new high in October (see Figure 30.1). At that juncture, assume a low-risk trader believed
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that prevailing nearest futures prices near $2.22 in mid-October 2014 were unsustainable, but based
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on the market’s volatility (which was still around three times what it had been early in the year) and his
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money management rules felt he could not assume the risk of an outright position.
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such a trader could
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instead have entered a bear spread (e.g., short July 2015 coffee/long december 2015 coffee) and
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profited handsomely from the subsequent price slide. Figure 30.1 illustrates the close correspondence
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between the spread and the market.
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the fact that an outright position would have garnered a much
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larger profit is an irrelevant consideration, since the trader’s risk limitations would have prevented him
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from participating in the bear move altogether had his market view been confined to outright trades. |