CME - Why Smart Money Trades Spreads

[bone]

DRW is all about spread trading, too. What do you know about them?

I never placed much stock in prop firms that had everyone trading the same markets and essentially doing the same things. And predictably most of them are gone.

I urge my clients to swing trade exchange supported spreads, since the margins are so favorable. And with a universe of tens of thousands of spread combinations on all electronic markets - there’s always opportunity.

From my experience, clients who swing trade spreads spend far less on commissions than they did when they were day trading outrights.

Interesting - but don't you feel the CME's vested interest is in the extra commissions? Or are you trading exchange-traded spreads?

I recently witnessed the rise and fall of a prop firm. Don't want to say who/where - but spreads was the game and what struck me during the setup phase was the firms focus on generating fees.

The firm could make money overall without the traders making money. A lot of guys were squeezing a living despite commissions and a number were seeing commissions wipe them out.

This was all interest rates at a time that interest rates were at historical lows. For some reason, they stuck with the same markets and a lot of firms (including this startup) didn't survive.

So - I'd be interested to hear how the trader at home would
- get over the commission hurdle
- decide when a particular market had run its course from a spread-perspective and find better markets

It's not my arena - but I am always interested to hear from people on a different side of the game. Not quite ready to take CME's word on it, though - but I do think the retail side needs to hear more about spreading than always be obsessed with outrights.

 

[misterkel]

Spread trading is fun. It's important to note I've found generally that trading further back month spreads is more profitable. The only reason I survived the oil plunge was I was way out on the curve.

I focus mainly on seasonality. It's been fairly profitable to me, and after losing a chunk of my account to the oil dips (I still lost I just didn't get destroyed) I am slowly but surely pulling myself out of the hole again. I probably won't trade oil again for a while though. The trick really is to have good data and historical research. Without it, spread trading is basically just margin reducing an outright position. I generally sit on my position for months (currently I'm in a natural gas spread that I'll take off some time in late July). It's not really for the spastic daytrader.

I've been looking to do spread trading in the conventional markets. I've done it in Crypto and it's pretty low Risk, plus setups come fairly frequently.
I want to learn the ropes in conventional markets. Do you have any resources to point me to?

thx

 

[misterkel]

https://www.seasonalgo.com/
What do people think about spread trading software - like this one?

 

[bone]

Seasonals are about ten percent of the spread trading universe. It’s a very limited perspective on what is possible and available.

https://www.seasonalgo.com/
What do people think about spread trading software - like this one?

 

[gaussian]

Seasonals are about ten percent of the spread trading universe. It’s a very limited perspective on what is possible and available.

https://www.seasonalgo.com/
What do people think about spread trading software - like this one?

You're the master @bone. I agree with bone in the sense the universe is limited. However for a small account it's probably all you can do. If you're super well capitalized I'd imagine you have an opportunity to essentially play market maker. I'm not even sure what kind of startup capital you'd need for that - 250k+? Unless you're talking about using spreads to reduce margin on directional bets.

 

[misterkel]

Seasonals are about ten percent of the spread trading universe. It’s a very limited perspective on what is possible and available.

Is there a book on the methods?
I've looked, but I've never found one.

 

[bone]

I’ve had hundreds of clients start with very modest accounts - $20K ish, and clearing a top tier Chicago FCM that knows who to correctly margin spreads.

There are a myriad of reasons for spread differentials to converge or diverge - supply versus demand rebalancing, commercial order flows creating forward curve dislocations, institutional portfolio rotation, producer hedging, industrial user hedging...

To say that order flows are entirely predictable based on something as nebulous as “seasonality” is a dangerous oversimplification IMO.

You can model spread differentials by price and you can take trade entries using your price based model and you can be quite successful at it. In that sense - you’re really not concerned about what’s driving the market.

If you are an expert at all things Cotton - by all means specialize in Cotton. If you are an expert in short term interest rates - by all means specialize in SOFR and Eurodollars and T-Bills.

But that shouldn’t stop you from modeling price and spread trading.

You're the master @bone. I agree with bone in the sense the universe is limited. However for a small account it's probably all you can do. If you're super well capitalized I'd imagine you have an opportunity to essentially play market maker. I'm not even sure what kind of startup capital you'd need for that - 250k+? Unless you're talking about using spreads to reduce margin on directional bets.

 

[bone]

Is there a book on the methods?
I've looked, but I've never found one.

There is precious little on modern methods for spread trading futures. I don’t consider seasonality to be ‘modern’.

Let me add some color.

I do very well modeling and trading intra markets exchange spreads in the Coffee, Sugar, and Cocoa markets. Been really consistent for me since I included them in my universe several years ago. And I know **very little** about those products. I model the price differentials, use my proprietary indicator package and rules set, then take my entry and set my stop-loss and profit targets. Just like I do for Eurodollars and Crude Oil and a hundred other instruments with exchange recognized and supported spreads.

 

[ironchef]

Good primer from the CME on spread trading futures. footnote: I am personally not a big fan of spreading WTI versus Brent - the positive correlation has come way off the past several years and the cointegration tendencies have gone up (not good). But for the most part these are good, solid introductory concepts.

The intra market complex spreads [for example, CL Dec 20-Mar21-Jun21, 1-2-1 Butterfly] {NG Jan21-Feb21-Mar21-Apr21 Condor} are the types of trade constructs where my own clients spend most of their time.

I have found that the CME Education Section has some of the best publicly available materials I have personally seen on spread trading. And it's free.

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-i.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-ii.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-iii.html

https://www.cmegroup.com/education/articles-and-reports/why-smart-money-trades-spreads-part-iv.html

Statistical arbitrage?

 

[bone]

That’s not what the CME piece or even myself are advocating per se.

Pure Stat Arb would require extremely high correlations and automation. And as you can imagine - those are quite competitive and populated trades. Would require something along the lines of a prime brokerage omnibus account typically.

Statistical arbitrage?