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Trading Across Futures
Months and Markets
Introduction to
Spread Trading
Important Information About
Trading Futures and
Options on Futures
This communication is intended as a solicitation. Futures trading involves the substantial risk of loss
and is not suitable for all investors. Trading advice is based on information taken from trades and
statistical services and other sources which RJ OBrien believes are reliable. We do not guarantee
that such information is accurate or complete and it should be relied upon as such. Trading advice
refects our good faith judgment at a specifc time and is subject to change without notice. There
is no guarantee that the advice we give will result in proftable trades. All trading decisions will be
made by the account holder. Past performance is not necessarily indicative of future trading results.
When analyzing option strategies, it is important to take into account the commission and
fees associated with making a trade. Similar to trading futures, each contract executed
in an option strategy is charged commission and fees. Commissions and fees from
brokerage frms can be up to $99 per round turn with the vast majority of people paying
signifcantly less. Your actual charges may vary based on the service level you choose.
The two primary factors investors tend to overlook when trading options include:
Each contract traded is charged a commission. This is ofen misinterpreted as
each spread or strategy that is charged a commission. If you trade one bull call
spread, your account would be charged for 2 contracts rather than 1 spread.
Customers ofen try to sell or collect premium on options that are far out of the
money with the belief that they are collecting easy money. The further away an
option strike price is from the current market price, the lower the value of the option.
Make sure that you are not paying more in commission and fees than what you are
collecting. Keep in mind that until an option expires, you do hold risk in the positions.
Is the net premium collected afer paying commission and fees worth the risk?
Table of Contents
Getting Started ........................................................................................................................ 4
What Is Spread Trading? .......................................................................................................... 5
How Spreads are Quoted .................................................................................................... 5
Why Trade Spreads .................................................................................................................. 6
Calculating Spread Profts and Losses ..................................................................................... 8
How Spread Trades Make Money ......................................................................................... 9
How Spread Trades Lose Money ........................................................................................ 10
Types of Spreads ................................................................................................................... 11
Intramarket ..................................................................................................................... 11
Intercrop ......................................................................................................................... 11
Intermarket ..................................................................................................................... 11
Intercommodity .............................................................................................................. 12
Spread Margins ................................................................................................................ 12
Charting Spreads ................................................................................................................... 13
To Spread or Not to Spread? .................................................................................................. 16
Additional Resources ............................................................................................................ 17
4
RJO Futures, the premier brokerage frm
for futures traders, has specialized in
serving futures traders for more than 100
years. Everyone on our team is devoted
to providing the service you need to
become a successful futures trader.
Please feel free to contact us to answer
any questions you have about trading
spreads. Any of our experienced team
can explain the principles and strategies
in this guide, and help you understand
if trading spreads is right for you.
This guide explains the basics of
trading spreads. Youll learn:
What defnes a spread trade
How spreads are quoted
Four types of spreads
How spread profts and
losses are calculated
Pros and cons of using spreads
The Basics
A spread trader always wants the long side of
the spread to increase in value relative to the
short side. This means the spreader wants
the diference between the spread to become
more positive over time. For example, assume
the spead trader is buying March wheat while
selling May wheat. If the May wheat is at a
higher price, the spread diferential will be a
negative number, as you subtract the price
of the sell side from the price of the buy side.
Therefore, in this case, the spreader wants his
position to narrow toward zero and then
widen to positive territory, to be successful.
The easiest spreads to follow are those that
have the same tick value - soybean spreads,
corn spreads, cattle spreads. Tracking
a spread with diferent values per price
trick - heating oil vs. crude or British pound
vs. Japanese yen is viable, but trickier.
Trading spreadssimultaneously taking opposite positions in the same or related
marketsis a great way to participate in futures trading as it generally carries less
risk and lower margin requirements than outright positions.
Getting Started
5
Trading a spread means you are taking opposite positions in two diferent contracts
with the expectation that the relationship between the two contracts changes in
your favor.
What Is Spread Trading?
No longer are you concerned about how
much either contract might move up or
down on a daily basis, like you would if
you were trading futures. Now you are
concerned about how much those contracts
move in relation to one another.
Spread trades usuallybut not alwaysinvolve
less risk than an outright futures position
because they involve at least one long and
one short position in related markets. This
means that if the general market advances
or declines, one of the futures contracts
in the spread is likely to show a proft.
The most common type of spread is an
intramarket spread, which involves buying
and selling two diferent delivery months in
the same marketsuch as buying July wheat
and selling December wheat. If you take
on this spread, you are not concerned with
the absolute price level of soybeans, but in
the relative performance of July wheat vs.
December wheat. If July wheat increases in
value relative to December wheat, the spread
position will show a gain because you are long
July. However, if the July contract decreases
in value relative to the December contract,
then this position will result in a loss.
How Spreads are Quoted
Spreads are quoted as a single price, always
subtracting the back month from the front
month. In typically normal carrying charge
markets, this creates a spread quote that is
a negative number. For example, assume
that July wheat is trading at $7.05 per bu.
and December wheat is trading at $7.50. The
spread price between them would be -45
cents, or 45 cents, premium December.
Now lets say you go long the spread, meaning
youre long the front month and short the
back month. If the July contract increases
by 50 cents and the December contract
rises just 35 cents, the spread would have
narrowed to -30 cents, thus showing a gain
of 15 cents for the position. Even though
both contracts rose in price, the one you
were long rallied more than the one you were
short, so your long spread showed a gain.
6
1. Lower risk
2. Attractive margin requirements
3. More predictable
Remember, though, that futures markets are
about risk and reward. In trading spreads,
the reduced risk, lower margin and increased
predictability come at a cost. Spreads are
not as volatile as outright futures, so their
opportunities for proft are more limited
than just a single, directional futures
position. In addition, you pay commissions
and fees on each leg of the spread.
1. Lower risk
Generally, spreads are less risky than outright
futures positions because spreads have both a
long and a short position in a related market,
so one side tends to proft at the expense
of the other. Because prices of two diferent
futures contracts can exhibit a strong tendency
to move up or down together, spread trading
ofers protection against losses that arise
from unexpected or extreme price volatility
as both contracts might react similarly.
Of course, not all spreads have lower risk
than outright futures positions. For example,
in the grain markets, a couple of types of
spreads can be treacherous. One is a spread
between crop years, e.g., July-December corn
or July-November soybeans. Because the
fundamentals underlying each month are
diferent, there is potential for each contract
to move the limit in opposite directions,
resulting in twice the exposure vs. a single
futures position. Similarly, a spread between
two grain markets, e.g. Wheat-Corn, is a
seasonal trade in which the two markets
can react very diferently to market news.
2. Attractive margin requirements
Spread margins tend to be lower than those for
outright futures positions. Thats because the
relationship in price between the two contracts
is less volatile than the absolute price level.
For example, spread margin requirements may
be as little as 10% of the margin requirement
for an outright position. Please check with
your RJO Futures broker for information
about current spread margin requirements
in the markets you would like to trade.
Because less capital is required to trade
spreads, traders are able to increase their
portfolio diversity and enter a larger variety of
Why take two positions instead of one based on your market outlook? Heres the
reasons many futures traders like trading spreads:
Why Trade Spreads
SPREAD MARGINS TYPICALLY ARE MUCH LOWER
THAN OUTRIGHT FUTURES MARGINS.
7
positions. Also, spreads allow traders to risk a
smaller percentage of their capital on any one
trade, enabling lower capitalized traders to
practice conservative money management.
Like any other margin requirement,
spread margin minimum levels are set by
the exchanges, although your brokerage
frm can set them higher. Just like any
other futures margin, spread margins
are subject to change without notice.
3. More predictable
Many spread traders believe that spread
price movement is more predictable than
the movement of absolute futures prices.
First, spreads are much less sensitive to
sudden market shocks. Second, commercial
users of the markets pay great attention
to spreads and take positions to keep
them generally within historical ranges.
Also, trading spreads makes it is easier to
take advantage of longer-term price moves
because the lower volatility makes it easier
to ride out corrections within major trends,
instead of being shaken out of a position.
EACH SIDE OF A SPREAD IS A LEG. YOU CAN ALSO
LEG INTO OR LEG OUT OF A SPREAD POSITION.
ADDITIONAL RESOURCES
Click for your RJO Futures guide, Introduction
to Options Trading for more detailed
examination of options trading.
Or, call 800-441-1616 to request your free copy.
8
Calculating Spread Profts and Losses
If market prices move as expected (meaning
the long position gains in value relative to
the short position), you will proft from the
change in the relationship between the prices.
When you are trading spreads, you will
proft from the position if any of the
following fve situations occur:
1. The long contract rises in price, while
the short contract decreases.
2. The long contract rises in price,
more than the short contract.
3. The long contract rises in price, and the
short contract stays at the same price.
4. The long contract stays at the same price,
while the short contracts price declines.
5. The long contract declines in price,
less than the short contract.
Obviously, the converse is also true. When
the purchased contract (long) underperforms
the sold contract (short), you will have a
loss on the position. Here are the situations
when your spread position will lose money:
1. The long contract falls in price,
while the short contract rises.
2. The long contract falls in price,
more than the short contract.
3. The long contract falls in price, and the
short contract stays at the same price.
4. The long contract stays at the same
price, while the short contract rises.
5. The long contract rises in price,
less than the short contract.
8
No matter the level of absolute prices, in a spread trade you buy the contract
you consider cheap and sell the contract you consider expensive.
BULL SPREAD = LONG THE FRONT MONTH
BEAR SPREAD = SHORT THE FRONT MONTH
9
How Spread Trades Make Money
To understand how the math works in
trading spreads, take a look at the following
examples between the July and December
wheat contracts at the Chicago Board
of Trade. These examples show how the
markets would have to move to generate
profts for the spread trade. (These fgures
are exclusive of commissions and fees.*)
SPREAD NARROWS/STRENGTHENS
+SPREAD QUOTE GETS
LARGER, E.G. +10 FROM +5
-SPREAD QUOTE GETS
SMALLER, E.G. -10 FROM -15
FAVORS BULL SPREADS
Ex. 1 - Long Gains more than Short Loses
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 710 785 -75
Change +10 -5 +5
P&L $500 -$250 +$250
Ex. 2 - Long Gains and Short Gains
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 710 775 -65
Change +10 +5 +15
P&L $500 $250 +$750
Ex. 3 - Long Gains and Short Flat
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 710 780 -70
Change +10 0 +10
P&L $500 $0 +$500
Ex. 4 - Long Flat and Short Gains
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 700 775 -75
Change 0 +5 +5
P&L $0 +$250 $250
Ex. 5 - Long Loses less than Short Gains
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 695 770 -75
Change -5 +10 +5
P&L -$250 $500 $250
*Commissions and fees from brokerage frm can be up to $99 per round turn with the vast majority of people paying signifcantly less. Your actual charges may vary
based on the service level you choose. See disclaimer on inside cover for detailed discussion.
10
How Spread Trades Lose Money
To understand how the math works in
trading spreads, take a look at the following
examples between the July and December
wheat contracts at the Chicago Board
of Trade. These examples show how the
spread trade would lose money based on
market price moves. (These fgures are
exclusive of commissions and fees.*)
SPREAD WIDENS/WEAKENS
+SPREAD QUOTE GETS
SMALLER, E.G. +5 FROM +10
-SPREAD QUOTE GETS
BIGGER, E.G. -15 FROM -10
FAVORS BEAR SPREADS
Ex. 1 - Long Loses more than Short Gains
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 690 775 -85
Change -10 +5 -5
P&L -$500 $250 -$250
Ex. 2 - Long Loses and Short Loses
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 690 785 -95
Change -10 -5 -15
P&L -$500 -$250 -$750
Ex. 3 - Long Loses and Short Flat
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 690 780 -90
Change -10 0 -10
P&L -$500 $0 -$500
Ex. 4 - Long Flat and Short Loses
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 700 785 -85
Change 0 -5 -5
P&L $0 -$250 -$250
Ex. 5 - Long Gains less than Short Loses
Long Jul Short Dec
Spread
Jul - Dec
Day 1 700 780 -80
Day 2 705 790 -85
Change +5 -10 -5
P&L $250 -$500 -$250
*Commissions and fees from brokerage frm can be up to $99 per round turn with the vast majority of people paying signifcantly less. Your actual charges may vary
based on the service level you choose. See disclaimer on inside cover for detailed discussion.
11
Types of Spreads
More advanced spread traders may be
interested in three-way spreads, such as the
crack spread among crude oil, heating oil
and gasoline, or the crush spread among
soybeans, soybean oil and soybean meal.
Please discuss these advanced spread
trades with your RJO Futures broker.
Intramarket
The most common spread is the intramarket
spread, also known as the delivery spread. An
intramarket spread position attempts to take
advantage of the price diference between
two delivery months of a single futures market
when you perceive the diference to be
abnormal. In the grain markets, these spreads
are between months in a single crop year.
Popular intramarket spreads include:
December-May corn
December-May wheat
April-June live cattle
Intercrop
An intercrop spread is refects the underlying
fundamentals of two diferent crop years.
For example, in corn, July is in the old-crop
year (corn harvested the previous fall), while
December is in the new-crop year (corn
harvested in the current-year fall). These
spreads are riskier than intramarket spreads
because of the two legs of the spread are
reacting to market fundamentals of two
crop years, which can be quite divergent.
Popular intercrop spreads include:
July-December corn
July-November soybeans
May-July wheat
Intermarket
The wheat market provides the most
popular intermarket spreads because three
diferent wheat contracts represent three
diferent varieties of the cropall of which
are grown in diferent parts of the country.
You can choose to spread sof red winter
wheat at the CBOT, hard red winter wheat at
the Kansas City Board of Trade or hard red
spring wheat at the Minneapolis Exchange.
There are four basic types of spreadsintramarket, intercrop, intermarket and
intercommodity. Each of these spreads involves buying one contract and selling
another.
12
Popular intermarket spreads include:
December Chicago wheat -
December Kansas City wheat
July Minneapolis wheat -
July Chicago wheat
May Minneapolis wheat - May
Kansas City wheat
Intercommodity
In an intercommodity spread, you trade
two diferent, but related markets. Be
aware that only a few of the combinations
of intercommodity spreads are exchange-
recognized and receive reduced spread
margin requirements. If the markets
are not somewhat related, then you
are taking two outright positions,
not a single spread position.
Popular intercommodity spreads include:
Corn-Wheat
Soybeans-Soybean meal
Soybeans-Soybean oil
Live cattle-Lean hogs
Live cattle-Feeder cattle
Crude oil-Gasoline
Heating oil-Gasoline
Gold-Platinum
10-year T-notes--30-year T-bonds
10-year T-notes--5-year T-notes
Euro-British pound
Canadian dollar-Australian dollar
Japanese yen-British pound
Euro-Swiss franc
Spread margins
Margin requirements refect the risk and
volatility in the underlying market or
market relationship. Although spreads
typically exhibit less volatility and less
risk than an outright futures position,
it is possible for any spread to have a
higher margin requirement than the sum
of its components. Please check with
your RJO Futures broker before placing
a spread trade so you are up-to-date
with current margin requirements.
Intramarket spreads usually are the
least risky, thus they typically have
the lowest margin requirements.
Intermarket spreads usually carry the next
highest risk. The most common intermarket
spread is in the wheat market, which has
three varieties trading on three exchanges.
Be sure to understand the diference that
deliverable grades, production areas and
varietal demand can have on prices.
Intercrop spreads can be riskier than an
intramarket spread and even an outright
futures position, particularly if the crop
sizes in the two years are widely divergent.
An example would be the July-November
soybean spread, with July in the old-crop
year and November in the new-crop year.
Intercommodity spreads almost always
require the highest spread margin. This type
of spread is the most volatilesometimes
more volatile than two outright positions
combinedbecause the same market factor
may afect one market more than the other.
Intramarket (Delivery)
Same market
Diferent months
Same exchange
August gold and April
gold at COMEX
Intermarket (Exchange)
Same market
Same month
Diferent exchange
March wheat at
CBOT and March
wheat at KCBT
Intercrop (Crop years)
Same market
Diferent crop year
Same exchange
November soybeans
2013 and November
soybeans 2014 at CBOT
Intercommodity (Market)
Diferent markets
Same month
June E-mini S&P
500 and June E-mini
Nasdaq-100 at CME
13
If youre used to trading futures with the aid of technical analysis tools, youll be
glad to know that those same tools are helpful in analyzing the charts of spread
trades.
Charting Spreads
For example, you can apply support/resistance,
trendlines and breakouts just as easily to
spread charts as you can outright price charts.
The biggest diference is that spread charts
usually are created on a close-only basis, rather
than the open, high, low, close bar charts
common in plotting futures price ranges. This
is done because the only price for the contracts
involved that can be stated as absolutely true
at the same time is the settlement price.
Close-only pricing can be both an advantage
and a disadvantage. It is advantageous because
there is little need to monitor spread changes
closely during the day. It is a disadvantage
because you have just a single price upon
which to evaluate your position on a daily basis.
ADDITIONAL RESOURCES
Click for your RJO Futures PRO demo! An exclusive and
sophisticated online trading platform like no other
with integrated tools to seamlessly trade and monitor
the markets. Test drive a demo today with a Free 100K
simulated account with real time data & execution.
Call 800-441-1616 to request your free demo.
14
Intercrop (Crop year) Spread - July/December Corn
Intramarket (Delivery) Spread - August/April Gold
15
Intercommodity (Commodity) Spread - June E-mini S&P 500 and June Nasdaq-100
Intermarket (Exchange) Spread - Chicago March Wheat/KC March Wheat
16
To Spread or Not to Spread?
What is my outlook for a change in the
price relationship between two contracts?
Do I want to minimize my
margin commitments?
Will I be happy with the likely lower
volatility, i.e., reduced risk and
reduced proft opportunity?
As youve learned in this guide, spreads usually
are less volatile than outright futures positions.
For many spread traders, that is a good thing.
They are not pursuing sudden, oversized
sudden gains, but simply a slow, steady way to
participate in the market. Indeed, with a spread,
you may be able to withstand an extreme
market movement that would have forced
you out of the market with an outright trade.
Trading spreads also is a good way to either
conserve the percentage of account funds
devoted to margin requirements or diversify
your positions across more markets. In either
case, you could be risking a smaller portion
of your account on any one position.
But spread trading does have its disadvantages.
The largest one is that commissions and
fees are charged for each leg of the spread,
so likely will be a higher percentage of your
positions gain or loss than if you were
trading a single outright futures contract.
In some cases, spread positions can involve
more risk than an outright futures position, as it
is possible for any type of spread for each leg to
show a loss simultaneously. Also, some spreads
may involve deferred contracts, which may be
less liquid than the nearer months typically
traded when taking an outright position.
Spread trading has many benefts, as well
as some drawbacks. Because spread trading
is of the beaten path for most traders, it
may be an excellent arena if you are willing
to study and practically implement your
knowledge about how prices related to
one another, with less competition.
Whether you decide to trade spreads may depend on your answers to
several questions:
17
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Additional Resources
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