Spread Trading Strategies

[wlnd]

How can I explain spread trading to my grandma?

I am retail trading indices futures / fx outright based on the usual technical patterns. I am exploring the feasibility of spread trading & have thus far found that the lower margin is the main draw

On agriculture spreads, where liquidity is, if I am competing against big sharks, with real-time satellite imaging on weather trends, physical holdings of the actual goods & hence ability to manipulate calendar spreads- what edge is there to be had from a "everything can be implied from the last price" style of spread trading? models based on price alone, without an insider knowledge of driving fundamentals, strike me as the "dead mean reversion" game

Is it then better for me to remain trading outrights based on classic technical patterns? I do not see a slightly improved edge trading spreads based on technicals, apart from a low overnight margin

 

[JackRab]

How can I explain spread trading to my grandma?

Don't bother... 98% of people don't understand anything beyond merely buy-and-hold.

I always lose people when I say I trade derivatives like futures and options. In response they usually say something like "Oh, so you're a broker?" Or... "Ah, you invest for other people?".

Sometimes I make the mistake of saying "I'm a trader" and they misinterpret that as "I'm a tradie"... and in Australia a 'tradie' is a tradesman like an electrician (sparky) or carpenter (chippy)... so I get requests to do their bathroom etc...

It used to be worse, when I was a market maker... they always wanted to know more about marketing. F%$king grade A annoying....

Nowadays I try to gauge their level of intellect before answering. If they look like idiots, I say I'm in finance. If they look like they have a bit of a brain, I tell them I trade on the stock market. If they ask more about it then I dive into derivatives... which usually backfires and I go back to me trading on the stock market.... usually means people think I'm a broker...

I'm thinking of just ignoring people when they ask what I do.... play deaf or something... Should work well with your Grandma... "Eh?"... "sorry what?"...
"did you say something?"... just nod...

 

[maxinger]

How can I explain spread trading to my grandma?

I am retail trading indices futures / fx outright based on the usual technical patterns. I am exploring the feasibility of spread trading & have thus far found that the lower margin is the main draw

On agriculture spreads, where liquidity is, if I am competing against big sharks, with real-time satellite imaging on weather trends, physical holdings of the actual goods & hence ability to manipulate calendar spreads- what edge is there to be had from a "everything can be implied from the last price" style of spread trading? models based on price alone, without an insider knowledge of driving fundamentals, strike me as the "dead mean reversion" game

Is it then better for me to remain trading outrights based on classic technical patterns? I do not see a slightly improved edge trading spreads based on technicals, apart from a low overnight margin

I have been day trading futures outrights for years too.
We might not feel comfortable or competent with spreading.


The way I see, spreaders are actually swing traders. They hold position for weeks or even months.
They also look at chart. They either expect spread to continue with its trend, or they expect mean reversal.
They look at fundamentals too like weather .... then take position.
They might not feel comfortable or competent with day trading.

 

[wlnd]

...play deaf or something... Should work well with your Grandma... "Eh?"... "sorry what?"...
"did you say something?"... just nod...

haha an entertaining read. this point on explaining to pple must really be a 'omg' for you

seriously, how would you explain spread trading, in simple words? I have found that the best explanations are simple. and I am struggling to find a simple explanation for trading spreads. this makes me wonder if there really is an edge here

- tough to compete with physical holders who can manipulate calendar spreads
- tough to compete with deep pockets who have real-time satellite imaging, predicting weather trends

where else is there an edge to be had? if I trade seasonality (edge has been eroded) based upon pure price charts, I might as well trade both legs outright?

I have been day trading futures outrights for years too.
We might not feel comfortable or competent with spreading

Thanks for sharing maxinger! we might as well be trading price structures outright, on both legs, instead of spreading. the only advantage seems to be lowered margins

or am I missing something obvious :')

 

[maxinger]

haha an entertaining read. this point on explaining to pple must really be a 'omg' for you

seriously, how would you explain spread trading, in simple words? I have found that the best explanations are simple. and I am struggling to find a simple explanation for trading spreads. this makes me wonder if there really is an edge here

- tough to compete with physical holders who can manipulate calendar spreads
- tough to compete with deep pockets who have real-time satellite imaging, predicting weather trends

where else is there an edge to be had? if I trade seasonality (edge has been eroded) based upon pure price charts, I might as well trade both legs outright?




Thanks for sharing maxinger! we might as well be trading price structures outright, on both legs, instead of spreading. the only advantage seems to be lowered margins

or am I missing something obvious :')

outright traders and spread traders look at trend.
Both trade based on trend continuation, or trend reversal.

both look at charts.
for outright, y axis has just one trading instrument.
for spread, y axis has 2 or 4 instruments (where u plus here or minus there).

outright traders could be scalper, day trader
spreaders - only swing trader.

both also look at fundamentals, news ....

outright traders - trade small quantity. margin needed higher.
spreaders - trade huge quantity because spread movement is much reduced.


so we should choose what we are comfortable with.

 

[AlexxS]

outright traders and spread traders look at trend.
Both trade based on trend continuation, or trend reversal.

both look at charts.
for outright, y axis has just one trading instrument.
for spread, y axis has 2 or 4 instruments (where u plus here or minus there).

outright traders could be scalper, day trader
spreaders - only swing trader.

both also look at fundamentals, news ....

outright traders - trade small quantity. margin needed higher.
spreaders - trade huge quantity because spread movement is much reduced.


so we should choose what we are comfortable with.

I'm pretty new to spreading so my opinion should not have much weight, but to me it seems that the biggest advantage of spreads is that you can basically construct your own market, i.e. something that moves in a (more or less) predictable pattern.

 

[maxinger]

I'm pretty new to spreading so my opinion should not have much weight, but to me it seems that the biggest advantage of spreads is that you can basically construct your own market, i.e. something that moves in a (more or less) predictable pattern.

spread doesn't mean it will move in predictable pattern.


for outright, we look for pattern (be it continuation or reversal pattern).
similarly for spread trader, they look for pattern (be it continuation or reversal pattern).
most spreaders focus on reversal pattern ie when price hit the ceiling, they look to short and vice versa.

for outright day trader, we have to concentrate for say 3 hrs per trading session.

spread traders are swing traders. they can do their analysis anytime they want.
after they have opened a position, they don't have to monitor intensively. just monitor once a day should suffice.

 

[bone]

This is a repeat from another post of mine, but maybe it will add some color.

There are plenty of proprietary futures traders in Chicago, NYC, London, Sydney, Singapore who day trade inter and intra market spreads (for stupid size typically), but they have the significant advantage of Member Clearing rates and just a few cents in brokerage (GCM) commissions. At retail clearing rates day trading spreads other than the more volatile ones would not make much sense. But swing trading futures spreads on retail clearing/commission rates makes plenty of sense. For me personally, my trade holding time frame is entirely dependent upon a particular spread's volatility. I could hold a Eurodollar Butterfly for six months, and an ICE GasOil/Brent Crack for two days.

Keep in mind that there are literally thousands of regulated electronic exchange recognized potential spread combinations. It can be a very appealing proposition for the type of person who might not necessarily want to follow the herd. Spread strategies can have quite a bit of dimensionality to them, and typically appeal to creative thinkers.

Yes, the price movement and volatility - particularly for exchange supported intra market spreads, will be much better behaved than the analog outright prompt futures month contract. This is especially true for intra market spreads if you stay away from the first three months in the curve where spec order flows dominate the volume.

So yes, depending upon the individual it might make sense to consider the possibility of levering a more tamed price action versus the idea of trading smaller size with outright futures contracts in a much more volatile and choppy price action scenario.

If you can manage to query some proprietary firm futures traders in Chicago, NYC, London, Sydney, Singapore I think you'll find that the majority of the big earners are indeed employing some type of spread trade strategy. Nearly all of them will carry a core position overnight and massively day trade around it during peak market hours.

 

[sle]

I'm pretty new to spreading so my opinion should not have much weight, but to me it seems that the biggest advantage of spreads is that you can basically construct your own market, i.e. something that moves in a (more or less) predictable pattern.

I think the statement is more like "a properly constructed spread is stationary, while stand-alone asset price series usually are not". That transformation comes with good and bad, obviously.

 

[bone]

I personally would not use the term "stationary" (in the quite literal sense synonymous with the word 'static' for example) to describe a properly constructed spread position.

What the trader is trying to model and ultimately capture in a proper spread trade is either the convergence or divergence between at least two highly correlated products (both statistically and fundamentally correlated). Inter market spreads are highly correlated positions using different instruments - like Crude Oil versus Gasoline or Soybeans versus Soy Meal. Intra market spreads utilize the same product but different expiries - like a 1-2-1 Eurodollar butterfly using Dec17, Jun18, Dec18.

Baskets are another widely used strategy. Entire strips of futures contracts or swaps are played against each other. In the equity space, Equity Index futures and ETFs are ideal for this. Let's say, for example, that you thought Chipotle and Yum Brands would significantly outperform other restaurant stocks, and you didn't want your premise to get blown apart by the broader market - one answer you might consider would be to construct a hedged spread position where you were long YUM + CMG and simultaneously short a restaurant heavy ETF like the Consumer Discret Sel Sect SPDR ETF. ( I'm no equity expert, but I am trying to describe a generalized scenario )

Spread trading is the basis for most all arbitrage. Physical Gold vs Comex GC. Cash Treasury Bonds vs CBOT futures. OTC 2 year Plain Vanilla Swaps versus Dec '19 Eurodollars. Exelon electrical generation versus PJM-W ICE swaps. Memphis Cash Cotton versus ICE Cotton futures. That kind of thing.

The basis for almost all Statistical Arbitrage is the high speed capture of spread differentials utilizing automation and ridiculously expensive ECN networks.

The spread differential narrows or widens. The point is to model that differential in the abstract and make a projection about it's future behavior. Some experienced spread traders might opine that this differential behaves in a smoother and more reliable fashion than the directional movements of a singular outright product. Another feature of spread trades is that they are usually, but not always, fairly well insulated from the turbulence of broader market moves.

I'm using some very generalized examples many of which I haven't traded in a while and a couple not at all - but hopefully it adds some color to the discourse.