41 lines
3.0 KiB
Plaintext
41 lines
3.0 KiB
Plaintext
440
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A Complete Guide to the Futures mArket
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■ Spreads—Definition and Basic Concepts
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A spread trade involves the simultaneous purchase of one futures contract against the sale of another
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futures contract either in the same market or in a related market. normally, the spread trader will
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initiate a position when he considers the price difference between two futures contracts to be out of
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line rather than when he believes the absolute price level to be too high or too low .
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in essence, the
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spread trader is more concerned with the difference between prices than the direction of price. For
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example, if a trader buys October cattle and sells February cattle, it would not make any difference to
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him whether October rose by 500 points and February by only 400 points or October fell by 400 and
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February fell by 500.
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in either case, October would have gained 100 points relative to February, and
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the trader’s profit would be completely independent of the overall market direction.
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However, this is not to say the spread trader will initiate a trade without having some definitive
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bias as to the future outright market direction. in fact, very often the direction of the market will
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determine the movement of the spread. in some instances, however, a spread trader may enter a posi-
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tion when he has absolutely no bias regarding future market direction but views a given price differ-
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ence as being so extreme that he believes the trade will work, or at worst allow only a modest loss,
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regardless of market direction. W e will elaborate on the questions of when and how market direction
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will affect spreads in later sections.
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■ Why Trade Spreads?
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the following are some advantages to not exclusively restricting one’s trading to outright positions:
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1. In highly volatile markets, the minimum outright commitment of one contract
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may offer excessive risk to small traders.
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in such markets, one-day price swings in excess
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of $1,500 per contract are not uncommon, and holding a one-contract position may well be
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overtrading for many traders.
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ironically, it is usually these highly volatile markets that provide
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the best potential trading opportunities. spreads offer a great flexibility in reducing risk to
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a desirable and manageable level, since a spread trade usually presents only a fraction of the
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risk involved in an outright position.
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1 For example, assume a given spread is judged to involve
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approximately one-fifth the risk of an outright position. in such a case, traders for whom a one-
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contract outright position involves excessive risk may instead choose to initiate a one-, two-,
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three-, or four-contract spread position, depending on their desired risk level and objectives.
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2. there are times when spreads may offer better reward/risk ratios than outright
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positions. Of course, the determination of a reward/risk ratio is a subjective matter. never-
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theless, given a trader’s market bias, in a given situation spreads may sometimes offer a better
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means of approaching the market.
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1 For some markets, reduced-size contracts are available on one or more exchanges. |