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3 Benefits Of Futures Spread Trading

Futures spread trading is a unique discipline that offers many benefits to practitioners. Featuring reduced margin requirements, extensive strategic applications, and limited exposure to systemic risk, spread trading is viewed by many traders as a premier financial strategy.

Limited Systemic Risk Exposure

Aside from being a catch-all term, risk comes in a variety of forms. Financial, currency, and commodity risks are several that are common in the futures market. However, systemic risk—the danger of a market-wide or sectoral meltdown—is the type that most concerns traders and investors. In futures, systemic risk is the possibility of an asset class experiencing a crash in pricing.

Those involved in futures spread trading can largely avoid systemic risk by simultaneously buying and selling related contracts. A spread consists of two offsetting positions, known as legs, that mitigate exposure to either the bullish or bearish side of the market.

The mechanics of a spread are very different from those of outright futures. In the case of outrights, rising and falling prices directly impact P&L and boost risk exposure. For spreads, a position’s upside and downside risks are essentially covered. Therein lies the crux of spread trading: Dramatic spikes or plunges in asset pricing have a negligible impact on the spread’s aggregate value. What really matters is the pricing of each leg relative to the other.

Strategic Alternatives

In practice, traders may use different futures spread trading strategies to produce consistent returns. However, all of these strategies fall into one of these categories:

  • Intramarket: Also known as calendar spreads, intramarket spreads involve the buying and selling of the same contract with different months. For instance, if you bought one lot of January 2020 WTI crude oil and sold one lot of March 2020 WTI, you would be executing an intramarket WTI spread trade. Intramarket spreads are regularly used by long-term traders to manage futures contract rollover and extend their investment horizon.
  • Intermarket: Intermarket spreads are executed by buying and selling two different-but-related products with the same expiration dates. A common example of an intermarket spread trade is to buy December corn and sell December wheat. This wheat/corn spread offers producers insulation from erratic commodity prices and gives speculators an opportunity to profit from market variations.
  • Commodity: Commodity spreads are executed by buying contracts that pertain to the processing and manufacturing of raw materials. To execute, a trader buys the underlying commodity contract and sells the manufactured product. As an example, assume that Erin the energy trader buys one contract of January 2020 WTI crude oil while simultaneously selling one contract of January 2020 RBOB gasoline. Erin will profit from the trade if the two legs of the spread converge (rising WTI and falling RBOB prices).

Countless intramarket, intermarket, and commodity spread strategies exist, and they offer interested parties many opportunities. For those seeking trading/investment alternatives, few instruments match the versatility of spreads.

Reduced Margin Requirements

Due to the limited risk exposure, futures spread trading furnishes participants with vastly reduced margin requirements. Trading futures outright can be capital intensive; spreads are typically offered at a fraction of the financial commitment.

To illustrate this point, let’s examine the margin requirements for a CL Light Sweet Crude Oil intramarket futures spread:

  • Spread: For the December 2019/January 2020 listing, maintenance margin requirements are $350.
  • Outrights: To execute each leg of the December 2019/January 2020 spread using outrights, the maintenance margins of each leg are $4,350 and $4,200. A total of $8,550 is needed to execute the trade.

In the example above, the diminished margin requirements of the spread are a direct reflection of the much smaller risk exposure. This is a big advantage to the trader because opening new positions in the market requires only a minimal capital outlay.

Adding Futures Spread Trading to Your Financial Plan

For more than 20 years, the team at Daniels Trading has specialized in helping individuals achieve their financial goals via standard futures, options, and futures spread trading. To learn whether spreads are right for you, take advantage of Daniels Trading’s second-to-none service suite and schedule your free, no-obligation consultation today.

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Contact Daniels Trading

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Risk Disclosure

This material is conveyed as a solicitation for entering into a derivatives transaction.

This material has been prepared by a Daniels Trading broker who provides research market commentary and trade recommendations as part of his or her solicitation for accounts and solicitation for trades; however, Daniels Trading does not maintain a research department as defined in CFTC Rule 1.71. Daniels Trading, its principals, brokers and employees may trade in derivatives for their own accounts or for the accounts of others. Due to various factors (such as risk tolerance, margin requirements, trading objectives, short term vs. long term strategies, technical vs. fundamental market analysis, and other factors) such trading may result in the initiation or liquidation of positions that are different from or contrary to the opinions and recommendations contained therein.

Past performance is not necessarily indicative of future performance. The risk of loss in trading futures contracts or commodity options can be substantial, and therefore investors should understand the risks involved in taking leveraged positions and must assume responsibility for the risks associated with such investments and for their results.

Trade recommendations and profit/loss calculations may not include commissions and fees. Please consult your broker for details based on your trading arrangement and commission setup.

You should carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. You should read the “risk disclosure” webpage accessed at at the bottom of the homepage. Daniels Trading is not affiliated with nor does it endorse any third-party trading system, newsletter or other similar service. Daniels Trading does not guarantee or verify any performance claims made by such systems or service.

About Daniels Trading

Daniels Trading is an independent futures brokerage firm located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading is built on a culture of trust committed to the firm’s mission of Independence, Objectivity and Reliability.

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