Q&A: Correlated Spreading

Q: Is it possible to trade a spread between Copper and the SPI?

A: It’s not a recognised ‘spread’ as such but these markets are correlated, so there should be spreading opportunities.

As a general rule, spreading opportunities exist in imperfectly correlated markets. You cannot spread a perfectly correlated market as that would mean the two markets move tick for tick and hence there is no opportunity. We need an imperfect correlation to spread. That said, the correlation still has to be strong enough to see a move in one market trigger a move in the other. There has to be some degree of reliability.

Australia is a big producer of copper, so yes a move in this market affects our stock market.

A strategy based on the assumption of a correlation is never going to work all the time. The easy part is this trade is to simply assume the correlation will be there. The tricky part is to list all the scenarios where that correlation might not be as strong or not hold at all. For example, there may be other news events, movement in the currency or other related markets moving in another direction.

If you work out when the correlation does not hold, you can make good spread trades with a decent strike rate.