Spread Trading Strategies

[spd]

Quote from londonkid:

Could you add a bit more colour to the bottom chart which charts 4 instruments, could you explain what you see and where they may be opps?

Thanks again. Good trading.

London

That bottom chart looks pretty messy, but in the interest of conversation I'll tell you what I see.

At a quick glance they all appear to be pretty well correlated, Im not sure which line is what, but there is all kinds of convergence and divergence going on.

Maybe they are spreading the ES-6C vs RBOB-Copper? There are bunches of possibilities.

Probably should start modeling these instruments and try and figure out how to become a mini-spread professor, even still who knows what the hell they are doing; thats whats so cool about spreads, can look at the same data as others and come up with all kinds of different ideas.

 

[ExchangeBonds]

Quote from bone:

You can indeed customize the CTS charting studies - I have a few clients who have modified CTS to use my proprietary study which I designed for spreads. What you need to realize is that the CBOT Exchange Interest Rate Spreads do in fact always reset to zero every day. It is an idiosyncracy from the floor broker days, as they always quoted the yield curve for clients and to other floor traders as net change for the day. You will notice upon closer inspection that the 360 minute NoB chart is not the ICS chart. But if you take that 360 minute NoB chart and make the intervals the same as the ICS chart, the curve shape for a particular day in isolation will look identical but the scaling will be different.

The real point I am trying to make is that you cannot use the CBOT exchange spread charts for Treasuries ( ICS ) for long term charting. You have to use a charting package sythetic combination, like the 360 minute NoB chart I had posted. This is a quirk applicable only to the CBOT Interest Rates.

I have used CTS in the past and I personally think that it is OK. I have lots of clients who use CTS. The primary reason I use TT Pro for myself is that I trade multiple accounts.

Yea, when I said customizable, I meant the chart itself and not the studies. I actually just emailed them about it, and they said they are working on a spreader and customizable charts but don't know when it would come out. The treasury curve has interested me, but I use CTS for now and like we both said, the native charts for those spreads are useless.

 

[bone]

Quote from sentrix:

Hi bone,

could you provide some information about the complex spreads like butterfly, condor etc? I've been trading futures spread so far and I am searching for another alternative ways how to develop this strategy. I was unable to find any relevant info on this.

Sentrix

There does not seem to be alot of published information on the art outside the options realm.

I like to use butterflies and condors to get different curve shapes, sometimes to build my own product that seems to trend and "behave" better, or to even supress volatility ( especially useful in the energy complex ).

Point is, spread trading is a much larger universe than the front six months of pair combinations - how boring, and they all typically look pretty much the same. It will amaze you how adjusting leg duration and getting creative will alter the shape of a spread combination curve.

Spread traders can make their own markets if they choose to - that is one of the very appealing aspects to it. I personally think it to be an edge. It allows me to be very selective about my entries in terms of risk-reward skew.

I personally hate the idea of being shackled to one market and trying to force trades to make money when in your own heart you know it is not there. By definition, scalping pretty much demands your allegiance to a singular market and all of it foibles. I think that is why many spread traders believe they are more consistent in terms of performance over the long term.

 

[sentrix]

Thanks for the reply. I completely agree, that changing just one leg of the spread has a vast influence on the spread curve. I also try to accustomize the contract months to get the best RRR.
Just one more question: Do you use Standard deviation by setting your entry and exit points? If yes, can you please explain a little bit how do you do that?

Sentrix

 

[bone]

Quote from sentrix:

Do you use Standard deviation by setting your entry and exit points? Sentrix

I used to use standard deviations extensively - and of course, I faded them. Worked from the late 1990's until about 2006-ish. Since that time, fading markets is an invitation to donate capital to other market participants. Now, I use a model working in multiple timeframes that is built to enter on freshly confirmed trend developments. 'Nuff said. I do use technical analysis for spread trade entry, with the big caveat that the studies were developed to work with spread trades. They do behave a bit differently than flat price markets.

 

[bone]

As you might suspect, the Comex High Grade Copper Future and the stock Rio Tinto have about a 94 % positive correlation daily close-on-close over the past two years. When we construct a spread, we find that the volatility weighting is significantly less than the currency adjustment - so we blend the two. Remember, we are trying to avoid the delta directionality risk of one of its' flat price components ( in other words, the spread just following either HG or RIO ).

When we look at the relationships intraday, we can see that there isn't much cointegration - the end-of-day settlement positive correlation we originally tested for indeed holds up intraday.

 

[bone]

One minute bar overlays - Rio Tinto is the orange bars last priced at 45.59, and the Comex Copper front month future is the plum bars last priced at 338.

 

[sentrix]

Just one more question. Which trading software do you use to display your spread charts?

 

[spd]

Quote from bone:

When we construct a spread, we find that the volatility weighting is significantly less than the currency adjustment - so we blend the two.

Would you be so generous to share how you come about your blended ratio when you come across discrepancies such as above?

Just a simple average of the two? I 'spose you could come up with something that'll work okay with some plain ol guess work/trial and error? I guess what Im asking is how precises do you need to be to smooth things out to your liking? Seems like spreading stocks against futures offers some cool flexibility, being able to add shares in odd lots to get where you want to be instead of being stuck with a hard ratio of futures:futures.

 

[bone]

Quote from spd:

Would you be so generous to share how you come about your blended ratio when you come across discrepancies such as above?

Just a simple average of the two?

In this case, I did indeed simply average the 20 day historical volatility ( of the futures contract and the stock basket at the same time stamp ) of the spread differential against the currency value of the futures contract versus the comparable value of the stock basket spread differentials ( again at the same time stamp ).

Typically, you would test each and take the hedge which gives you the least tail risk. In this case, a simple average gave the least tail risk when I ran this particular pair.