Spread Trading

vanilla2 · May 28, 2003

you guys got me interested in learning more about spread trading as well. revisiting what my finance text from college had to say about futures, it was almost all focused on spreads. last night i took a look at ESH03, and charted it's spread to ESM03 in TS just to see what it looks like, and it appears they float in about a +8 to -8 point range. I like the idea of hedging, and filtering out the lighting stops in ES.

In your opinion is the ES far month contract too illiquid to spread against? It appears to meet the volume criteria discussed earlier in this thread, but looks extremely thin. Further, do you think there is any merit in this spread at all?

bone · May 28, 2003

Sure... if you have market-making capability. I make markets in back months all the time. Just try to be aware of carry and optionality for the back months. For example, for the past several weeks, the interest rate calendar spreads were getting weaker due to the risk premium on the Sep and Dec contracts. Since the interest rates have gotten a little weaker since late last week, the calendar spread has reversed a little of that loss.

No, this is not seasonality. Go away, Goldmember.

Backwardation · May 28, 2003

I don't know much about spreading but since there are some experienced people here, I thought I'd ask. Is there any way to spread a pit traded contract against an electronic contract? Has anyone done this on a week or longer time frame? For example, spreading 5 eminis against one big contract or the pit traded euro contract against globex?

Hi riskreward,

What you describe in your post is not spreading. Spreading focuses on the differential of price between instruments and one's belief that the the differential will get larger or smaller over some time period (days, weeks, months). If you Spread 5 eminis es against one big S & P you would be flat by the end of the day when the exchange marks to market because the contracts are fungible on a 5:1 basis. Intraday, people do Arb the contracts to take advantage of small price differentials.

Backwardation

-ooO-(GoldTrade · May 28, 2003

bone >>So shut up and learn,

What exactly are you preaching bone?

bone >> Why are you pushing seasonals so hard as the ultimate spread?

I like the habit of having winning trades in my portfolio. Traders returning to the game after blowing out should know that there is a less-riskier way to stay in the game.

bone >>You sound like a boiler-room scambo website.

The web sites I visit generally donât have any sound. What side of the web are you using?

-ooO-(GoldTrader)-Ooo- is not selling anything, are you happy with your long distance service?

Perhaps it is your perception bone. Are you still hearing voices?

bone >>If anyone had bothered to follow the MCRI "seasonal" recommendations

I do not have access to âMCRI "seasonal" recommendations,â I trade spreads. Some of those got stopped out too.

bone >>on CBOT T-Bonds .. they would have gotten crushed. Completely.

That does not mean it was not the seasonal window. It just implies that this year prices did not advance as expected as they passed through the seasonal window. Traders would have been protected by MCRIâs stop. Could work next year.

bone >>Remember the Wall Street Journal article on Jake Bernstein's seasonal spread strategies?

No, I think I was at the beach that day. Wasnât that the day of the shark sighting? I know people pick on Jake allot. Feeble minds ridicule genius. Jake found a way to tap wealth from the market for the little guy. The establishment is not too happy about it.

bone >>Didn't work out so well at all.

Happens.

bone >>You call yourself a spread trader ... and don't know what DV01 is?

Never heard of it. Is it some kind of âSkull and cross bones?â Code.

bone >>Beginners shouldn't weight spreads?

Beginners can reduce risk by having professional research filter their spreads. If a weight spread comes up it should be considered. They can also pass on it. There are plenty of Calendars out there.

bone >>Encouraging people to do dangerous things with THEIR money - not yours.

What dangerous things?

Do you mean like driving in front of a semi on the freeway, in your Caddy, in the rain.

Or doing four wheel drifts on Pacific Coast highway in your Porsche?

What do you know about risk?

bone >>Unless instruments have identical volatility and valuation characteristics, you must weight them appropriately.

Is that a problem with Calendars?

bone >> Sure, many seasonals don't require weighting because they are usually identical contracts with different delivery months.

One more way to reduce risk to the new trader.

bone >>Maybe these would be better for new spread traders. Maybe that is part of their allure for you.

Sure it is! Winning is about finishing in front. New Traders can be winners trading Seasonal Calendar Spreads.

bone >>But seasonals are maybe 10% of the spreading possibilities,

Its not how many there are, it is how many do you need?

bone >and your ignorance about intermarket spreads

I sure am not learning much from you. Did anyone who read this learn anything helpful about trading Seasonal spreads from bone?

Look, I trade cross-markets and across continents spreads every year. But I donât advise new traders who should be getting use to winning in them.

riskreward · May 28, 2003

I'm not going to ask somebody to define these for me as that would probably be lazy. (But if somebody wants to that'd be great). Can somebody recommend a decent Finance textbook on this stuff? I mean straight textbook not a trading book. I'll look through the exchange websites as well but maybe a good old college text will be complementary.

vanilla2 · May 28, 2003

Riskreward,

I'm not sure if this is what you're interested in, but the text I was referring to is "Contemporary Investments, Security and Portfolio Analysis" by Douglas Heath and Janis K. Zaima. There are only about 10 pages or so regarding spreads but I was surprised at the attention they gave this in relation to other futures material.

Another good text I have is "Options, Futures and Other Derivatives" by John C. Hull. This is an excellent text all around recommended by an energy options trader at the investment bank I used to do IT for. It's coverage of futures spreads is minimal, but there is quite a lot of material devoted to options spreading.

Definitely do not pick these up without looking at them first, and I must disclaim that I know nothing about spreads beyond the discussion here, and someone else here can probably give far better recommendations.

nitro · May 29, 2003

DV01 is the dollar value of a basis point. The standard formula for deriving DV01s is (assuming a 1 bp change):

(((0.01 * duration) * full price)) * 0.01) = DV01

Or stated another way for "bonds":

DV01 = Value Change / Yield Change (bps)

For example:

Suppose you hold $50 million par of the JPM 6 1/4s of February 2011. As "Initial Market Conditions" below shows, this bond is currently priced at 110.258 to yield 4.69%. At this yield, the bond has a 6.33-year modified duration and a full price of $55,215,991.

Initial Market Conditions:

Corporate Bond (JPM 6 1/4% of February 2011)
Quoted Price: 110.258
Yield: 4.69%
Modified Duration: 6.33
Full Price: 110.432
DV01 ($50 million par) $34,951.72

CBOT 10-Year Agency Note Futures
Price: 113-07 (113.2188)
DV01: $66.90

(((0.01 * 6.33) * 55,215,991)) * 0.01) = 34,951.72

The CBOT 10-year agency note futures contract, in contrast, has a $66.90 DV01. To define the size of the hedge position, simply divide the DV01 of the position being hedged by the futures DV01. In this case, you can see that a futures hedge position of 522 futures contracts should essentially protect the value of this $50 million contribution.

34,951.72/66.90 = 522.4472, round to 522

In effect, DV01 gives you the correct ratio to use for each instrument when hedging contracts against each other.

There are some very creative uses of this kind of ratio calculation in correlated "markets" and I have used them to great success in the past.

nitro

-ooO-(GoldTrade · May 29, 2003

Textbooks!

pretzel · May 29, 2003

nitro

Wow, this is something new. I dont think this is covered in the Joe Ross or Courtney Smith books.

Where can I get more info on this?

pretzel

Quote from nitro:

DV01 is the dollar value of a basis point. The standard formula for deriving DV01s is (assuming a 1 bp change):

(((0.01 * duration) * full price)) * 0.01) = DV01

Or stated another way for "bonds":

DV01 = Value Change / Yield Change (bps)

For example:

In effect, DV01 gives you the correct ratio to use for each instrument when hedging contracts against each other.

There are some very creative uses of this kind of ratio calculation in correlated "markets" and I have used them to great success in the past.

nitro

bone · May 30, 2003

How 'bout it. I used to spread for years down on the floor of the CBOT, and nobody EVER heard of Joe Ross, Courtney Smith, or Ooo Goldtrade. Imagine that. Neither had any of the big commercial customers.

I've seen these books, read Goldtrade's silly posts, and I'm not impressed.