Spread Trading

sledged said:
would like to do more analysis on pair trades in energy commodities. What are the biggest factors in analyzing a spread trade like this? Standard deviation and correlation are the two I would
Think are most important, correct ? Thanks.
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I have attached links to exchange settlement sheets for Crude Oil and Natural Gas:

https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_quotes_settlements_futures.html

https://www.cmegroup.com/trading/energy/natural-gas/natural-gas_quotes_settlements_futures.html

The prompt month is primarily speculative order flow. There is significant open interest in the dated months and for good reason. There is a great deal of commercial activity in the dated months and simple pairs are not the only game in town: there is significant opportunity in expressions like butterflies and condors that capture a greater section of the forward curve and the granularity within that cross-section. In other words, a Jun20-Dec20 pair will model and behave much differently than a Jun20-Sep20-Dec20 butterfly.

In other words, there is a hell of a lot more to spread trading than the front month roll and simple pairs.

I wish you good fortune !
 
Wheezooo said:
Personally, I never trusted those either.
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I think the safe thing to tell a newb like the OP is that if you stick to a spread combination that is recognized by the exchange and receives SPAN margin credits from the exchange, you don't really have to concern yourself with correlation.

The exchange is NOT going to give you a significant SPAN margin credit if there's not a very high correlation.

Eurodollar Intra Market Spreads Hedge Ratios and Margin Credits:
https://www.cmegroup.com/trading/in...ctor=INTEREST+RATES&exchange=CME&pageNumber=1

Eurodollar Inter Market Spreads Hedge Ratios and Margin Credits:
https://www.cmegroup.com/trading/in...ctor=INTEREST+RATES&exchange=CME&pageNumber=1
 
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bone said:
I think the safe thing to tell a newb like the OP is that if you stick to a spread combination that is recognized by the exchange and receives SPAN margin credits from the exchange, you don't really have to concern yourself with correlation.

The exchange is NOT going to give you a significant SPAN margin credit if there's not a very high correlation.

Eurodollar Intra Market Spreads:
https://www.cmegroup.com/trading/in...ctor=INTEREST+RATES&exchange=CME&pageNumber=1

Eurodollar Inter Market Spreads:
https://www.cmegroup.com/trading/in...ctor=INTEREST+RATES&exchange=CME&pageNumber=1
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I agree entirely.
 
bone said:
Look at all the fun you can have with Crude Oil and Natural Gas:

Crude Oil Intra Market Hedge Ratios and Margin Credits:

https://www.cmegroup.com/trading/en...CL&sector=CRUDE+OIL&exchange=NYM&pageNumber=1

Henry Hub Natural Gas Intra Market Hedge Ratios and Margin Credits:

https://www.cmegroup.com/trading/en...&sector=NATURAL+GAS&exchange=NYM&pageNumber=1
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With a gun to my head, I don't click on those links!!!! That's like dangling a rock in front of a recovered crackhead. Ego te absolvo... Ego te absolvo... ego te...
 
Wheezooo said:
With a gun to my head, I don't click on those links!!!! That's like dangling a rock in front of a recovered crackhead. Ego te absolvo... Ego te absolvo... ego te...
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Maybe you should click them, and embrace the SPAN margin credit crack.
 
bone said:
It's too bad that your sincere thread has been hijacked.

For intra market spreads (same commodity, different expiries), naturally correlation isn't a real issue. For inter market spreads that are recognized by exchanges for SPAN margin credits, (like Gasoline versus Crude or Two Year Notes versus dated Eurodollars) those are highly correlated - but other less obvious synthetic combinations can get exotic (like Transco Zone 6 Natural Gas versus TCO Appalachian Natural Gas, or French 10 Year Notes versus German Bunds) and will require analysis for correlation and cointegration.

If you stick to exchange-recognized spreads they will always be considerably less expensive to trade in terms of margin than outright futures.

I would suggest that you swing trade them and not day trade them.
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What are exchange-recognized spreads? Would that be trades like the NOB spread? Or the widow spread?

I've always been intrigued by commodity and financial future spread trading but never have put skin in the game. But I have a feeling there's a lot of potential with commodities and spreads.
 
Exchange supported spreads are a rather recent development as far as exchange products go - probably about a dozen years old. It’s fantastic in that futures clearing firm risk managers are going to be able to give you the substantial margin discount instantly, and you can properly trade the spread differential itself and avoid legging execution risk.

An exchange spread is where the exchange lists, quite literally, thousands of spread combinations and the exchange order matching engine internally executes all of the individual spread components (called legs) for the trader - which is huge because the trader avoids legging risk. And all the futures exchanges like CME, ICE, Euronext, etc. all have exchange supported spreads.

For example, in CME Globex, if I pull up a Dec20-Dec21 Natural Gas Spread, I would see a single price ladder: 0.027 Bid x 0.029 Offer as an example. So that’s the price differential (the spread) between those two futures contracts. Let’s say that you are working a 0.027 Bid for two contracts and you get hit - instantly in your filled order window you will see that you bought two Dec20 at 2.658 and sold two Dec21 at 2.631 as an example. Those fills were internally matched for you by the exchange.

And a week later, if you sold that spread at 0.060 you made 33 tics on the trade. And the margin required to hold that trade is a fraction of the margin required to hold 2 Jan20 NG futures contracts outright - which is fair because the spread differentials are almost always less volatile than a naked unhedged futures contract.

.sigma said:
What are exchange-recognized spreads? Would that be trades like the NOB spread? Or the widow spread?

I've always been intrigued by commodity and financial future spread trading but never have put skin in the game. But I have a feeling there's a lot of potential with commodities and spreads.
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Sigma, to add what bone said, spreads are also great in as far as you can create new spread positions by trading spread combinations. Suppose you're long H20/M20, if you were to buy M20/Z20, then you'd be long H20/Z20, get more exposure across the curve. Or you can reverse the position: adding a short H20/U20 to your long H20/H21, you'd be long the curve U20/H21, and so forth. Depending on the product in question, this can be Legoland. (Mind you, when it comes to calendar spreads, no all combinations may be supported as exchange traded spread, so you may be better off sticking with standard/popular spread combinations) Have a look at the CFTC's COT reports. They split out spread open interest, so you'll see which markets are predominantly spreaders' markets.
You'll notice that the wider the spread's legs are (within same product), the higher the margin requirement cet. par. as the correlation between both contracts is lower, another way to manage risk. If you venture into the back-months it's quite possible that there is less dynamic, so volatility and trends may be less pronounced. Simply run some correlation matrices. The lower the correlation between contracts (inter-contract spreads), the higher the margin requirements cet. par.
In short, you are absolutely right, there is plenty of potential and many opportunities in trading spreads!
 
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