22 lines
1.8 KiB
Plaintext
22 lines
1.8 KiB
Plaintext
459
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INTERCOMMODITY SPREADS: DETERMINING CONTRACT RATIOS
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In the preceding example, because wheat is a larger contract than corn (in dollar-value terms),
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a long 1 wheat/short 1 corn spread would be biased in the direction of the general price trend of
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grains. For example, during November 2012–August 2013, a period of declining grain prices (see
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Figure 31.4 ), the equal contract spread seems to suggest that wheat prices weakened signifi cantly
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relative to corn prices (see Figure 31.1 ). In reality, as indicated by Figures 31.2 and 31.3 , the
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wheat/corn relationship during this period was best characterized by a trading range. T o illustrate
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the trading implications of the spread ratio, consider a long wheat/short corn spread initiated at the
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late-November 2012 relative high and liquidated at the August 2013 peak. This trade would have
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resulted in a near breakeven trade if the spread were implemented on an equal-dollar-value basis
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(see Figure 31.2 or 31.3 ), but a signifi cant loss if an equal contract criterion were used instead (see
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Figure 31.1 ).
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It should now be clear why the standard assumption of an equal contract position is usually valid
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for intramarket spreads. In these spreads, contract sizes are identical, while price levels are normally
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close. Thus, the equal-dollar-value approach suggests a contract ratio very close to 1:1.
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If, however, two contracts in an intramarket spread are trading at signifi cantly diff erent price
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levels, the argument for using the equal-dollar-value approach (as opposed to equal contract positions)
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would be analogous to the intercommodity and intermarket case. Wide price diff erences between
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contracts in an intramarket spread can occur in extreme bull markets that place a large premium on
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FIGURE /uni00A031.4 September 2013 Wheat and September 2013 Corn
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