43 lines
3.1 KiB
Plaintext
43 lines
3.1 KiB
Plaintext
443
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tHe COnCepts And MeCHAniCs OF spreAd trAding
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■ The General Rule
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For many commodities, the intramarket spread can often, but not always, be used as a proxy for an
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outright long or short position. As a general rule, near months will gain ground relative to distant
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months in a bull market and lose ground in a bear market.
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the reason for this behavior is that a bull
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market usually reflects a current tight supply situation and often will place a premium on more imme-
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diately available supplies.
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in a bear market, however, supplies are usually burdensome, and distant
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months will have more value because they implicitly reflect the cost involved in storing the com-
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modity for a period of time.
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thus, if a trader expects a major bull move, he can often buy a nearby
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month and sell a more distant month. if he is correct in his analysis of the market and a bull move
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does materialize, the nearby contract will likely gain on the distant contract, resulting in a success-
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ful trade.
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it is critical to keep in mind that this general rule is just that, and is meant only as a rough
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guideline. there are a number of commodities for which this rule does not apply, and even in those
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commodities where it does apply, there are important exceptions. W e will elaborate on the question
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of applicability in the next section.
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At this point the question might legitimately be posed, “
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if the success of a given spread trade is
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contingent upon forecasting the direction of the market, wouldn’t the trader be better off with an
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outright position?” Admittedly, the potential of an outright position will almost invariably be consid-
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erably greater. But the point to be kept in mind is that an outright position also entails a correspond-
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ingly greater risk.
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sometimes the outright position will offer a better reward/risk ratio; at other
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times the spread will offer a more attractive trade. A determination of which is the better approach
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will depend upon absolute price levels, prevailing price differences, and the trader’s subjective views
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of the risk and potential involved in each approach.
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■ The General Rule—Applicability and Nonapplicability
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Commodities to Which the General rule Can Be applied
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Commodities to which the general rule applies with some regularity include corn, wheat, oats,
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soybeans, soybean meal, soybean oil, lumber, sugar, cocoa, cotton, orange juice, copper, and heating
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oil. (
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the general rule will also usually apply to interest rate markets.) Although the general rule will
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usually hold in these markets, there are still important exceptions, some of which include:
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1. At a given point in time the premium of a nearby month may already be excessively wide, and
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consequently a general price rise in the market may fail to widen the spread further.
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2. s ince higher prices also increase carrying costs (see section entitled “the Limited-risk spread”),
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it is theoretically possible for a price increase to widen the discount of nearby months in a
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surplus market. Although such a spread response to higher prices is atypical, its probability of
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occurrence will increase in a high-interest-rate environment. |