50 Shades of Spreading

For many popular spreads, the exchange will make available a ‘spread market’ – or exchange traded spread. So instead of transacting twice to get into a spread, there is a specific ladder you would use to transact only once to enter a spread position.

For example, this image shows the Au 3yrs, the 10yrs and the exchange spread market. The thing to note with this spread is a transaction of 1 lot in the spread puts you in the market at a ratio determined by the exchange. Right now the ratio is 10:32. This means if you were to buy one lot in the spread market, you would be buying 10 10yrs and selling 32 3yrs. The 10:32 ratio is the hedge ratio as determined by the exchange and does change from time to time. Most exchange traded spread ratios are 1:1, but this one isn’t.

This next image shows Natural Gas – both outrights and the spread.

The CME offer a huge range of exchange traded spreads that include both calendar and inter-market spreads. In fact calendar spreads are available in almost every liquid futures contract on the exchange.

Examples of inter-market spreads include:

  • The Crack: Crude Oil versus Heating Oil versus Gasoline
  • The Crush: Soybeans versus Soybean Oil versus Soybean Meal
  • Cattle: Live Cattle versus Feeder Cattle
  • Meats: Cattle versus Hogs

For settlement purposes, transacting in any of these spreads gives you positions in the underlying markets. For example if you bought an exchange spread in August-September Natural Gas, your account shows a long position in August and a short position in September.

Are you Buying the Spread or Selling the Spread?

The general convention in quoting spreads is to have the near contract minus the far.  That applies to both calendar spreads (near expiry minus far expiry) and yield curve spreads (shorter maturity minus longer maturity).

When you are buying the spread, you are then buying the near and selling the far. This would leave you ‘long the spread’. When selling the spread, you are selling the near and buying the far.

There are exceptions to this rule, but it stands most of the time.

Summary

If you are looking at a new market to spread, always check the exchange site to see if a spread is available. If there is a spread, and there is liquidity, then it’s an easier trade than legging the outrights.

For markets where there is no exchange spread available, platforms such as CQG and XTrader have modules whereby you can create a synthetic spread. The modules normally cost extra as it’s an advanced feature, but it’s there…