crude down, crude spreads up

[dartheory]

I'm new to spread trading. I shorted RB, HO, and CL yesterday and have nice profits in them. I also sold some spreads on them. The RB spread was very profitable, (RB is the weakest of the three). HO was profitable and the CL spread was barely profitable (Crude is the strongest of the three)- it barely moved despite Crude dropping from 94 to about 93. I wanted to know if someone can explain why this is.

I sold the RBH3-RBJ3, HOG3-HOH3 spreads.

The Crude spread I sold was CLG3-CLZ3. But I looked at almost all the high volume, tight spread spreads and most of them are unchanged or up!

I decided to sell CLG3-CLZ3 as opposed to CLG3-CLH3, or CLH3-CLJ3 because from my observations it seemed like CLG3-CLH3 was not moving much whereas RBH3-RBJ3 and HOG3-HOH3 were.

Any advice/explanation here would be very useful. Thanks.

 

[bone]

1. The distilled products will frequently move at different rates than the crude oil due to refining capacity/constraints and seasonal demand. My advice would be to review the educational materials in the Nymex section on the CME website.

2. You are quite fortunate and a bit naive about the delta directionality ( risk ) you are taking on. When you have so many highly correlated products, I personally advise my own clients to choose just one trade entry - it is very ugly to get out of so many positions marking against you at the same time.

3. Spreads - even simple calendar pairs which include the front month, do not always exhibit the same directional tendency as the front month future. The other thing that you are not aware of is the G3 to H3 roll which is now in play. It is very difficult to account for a big commercial or fund rolling 50K Feb futures contracts forward.

 

[dartheory]

Thanks for your reply and pointing out the G3-H3 roll. That is something I didn't consider and I will look into it.

I'm assuming the G3-H3 roll would affect only those spreads involving G3 and H3. At one point Crude was down about 1% on Friday but if you had looked at all the spreads (not just those involving G3 and H3), most of them were unchanged at worst and most had moved up.

For Crude I found that the longer dated the deferred contract, the greater the spread had increased. That is the near month contract was being bought more than the deferred one. This is contrary to what I had read about how the spread should have changed given the drop in Crude yesterday. The HO and RB spreads did work as expected with near month contracts dropping more than further dated contracts.

While there are a ton of free material out there about calendar spreads, none of them address the issue of a contract dropping but bear calendar spreads simultaneously going up.

I'm probably going to buy some books on it to find some answers. If you have any recommendations that would be appreciated. I know you offer a spread training service, but I'm not ready to dive into spreads full bore yet. I'd like to figure out how they work and how I could have anticipated that the spread would not work.

 

[bone]

Quote from dartheory:

This is contrary to what I had read about how the spread should have changed given the drop in Crude yesterday. The HO and RB spreads did work as expected with near month contracts dropping more than further dated contracts.

... bear calendar spreads simultaneously going up.

... but I'm not ready to dive into spreads full bore yet. I'd like to figure out how they work and how I could have anticipated that the spread would not work.

When producing commercials want to roll short interest, they are going to buy the front month to second month calendar spread. So, if someone is short the front month flat price ( or strip ) CL contract and they need to continue that short exposure - the fastest, cheapest, most efficient way for them to day that is to buy the front calendar spread. It is not surprising to me at all that the front month calendar spread maintained some strength in the face of a flat price front month futures sell-off. You will see the same thing happen in other commodities as well.

The HO and RBOB contracts, by specification, roll later into the month than the CL contract.

I think your whole idea of what you have read and what you think is a "bear spread" is a bit naive and simplistic. Too bad you weren't around for some real contango and backwardation in the CL curve ! One thing that you can count on is that "generalizations" cannot be relied upon in live markets. One thing that is certain about markets is that they are always changing and always in a state of dynamic flux.

It seems to me that based upon your original post that you are very, very much involved with spreads and if your positions are live with real capital then you are into things "full bore". Again, there is more risk to your positions than you might realize. Learning on your own with live futures contracts can be a very expensive way to go about things - even with one lots. Look at the average daily trading ranges for those spreads you mentioned in your original post.

 

[dartheory]

Thanks again for the reply.

Your explanation about the G3-H3 roll makes sense.

But on Friday 1/11 when Crude dropped, almost all the crude calendar spreads went up. For example K3-J3, K3-M3, K3-Z3, Z3-Z4, etc.

Those later dated spreads shouldn't have anything to do with the G3-H3 roll. And the fact that all these spreads are moving up means nearer month contracts are being bought and/or deferred month contracts are being bought less. This may imply that traders are looking for Crude to continue moving up over the course of year.

I think the mistake I made was not studying the spread chart carefully enough. Clearly all the Crude calendar spreads have been in an uptrend since mid-to-late December. But from 1/4-1/9 most Crude spreads began declining. In particular I was looking at the G3-Z3 spread. Since the outright crude future contract looked like a sell on Friday, I decided to sell the G3-Z3 spread along with CL outright, expecting the decline from 1/4-1/9 to continue. But instead the spread increased while Crude decreased. Looking back the decline in the G3-Z3 spread between 1/4-1/9 looks like a pullback in a strong uptrend. After three days of declining, selling into the fourth day expecting a decline without any retrace is not very wise.

As you pointed out spreads won't always move in the same direction as the underlying instrument and I was relying on them too and shouldn't have.

I still think Crude is ripe for selling but this time around I'm going to try selling the Z3 contract and once I have a decent profit I will hedge by buying the H3 contract.