SpreadProfessor Clients - Thanks !
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TTT !
Fine Print: "Generally Speaking"
Definitely. Inter-market Spreads have more co-integration issues from a statistical standpoint, and from a capitalization standpoint the SPAN margin credits are typically less generous. I tell my clients that I personally will not consider an inter-market spread with less than a 93 percent positive statistical correlation over the past 2 years ( OTR ).
Another consideration is execution - with inter-market spreads, you will either have to leg them manually or use some sort of spread execution software tool. I cover this topic with my clients. The main theme here is to not get "cute".
If you understand the risks and have modeled the trade correctly, I have had some clients do very well with inter-market spreads. I also have some clients with some ridiculously good performance metrics who don't bother with them - they're quite happy with the intra-commodity spread opportunities. It seems that some clients have a greater attraction to them than other clients. YMMV
I find the inter-market spreads are more intuitive with regard to modeling, but the logistical aspects (hedge ratios, margin, execution) are more difficult. Those logistical factors are simpler with intra-commodity spreads. But with intras, you are essentially trading the convexity/concavity of the forward curve for a single instrument. I have a harder time with modeling the curve and having confidence in the predictive value of technical indicators for points along the curve which make up a calendar or fly spread.
I have many clients making a living doing just what you described. It's their niche, they have confidence and a comfort zone with the trade, and they do not spoil the family recipe as it goes.
Now... wink - wink... I also have some clients who play intra-market spread combinations to great effect further out in the curve.
The spec and immediate demand order flows are greatly diminished - and they model smoother. The trick is to find combinations with worthy liquidity.That's why I have my clients go through hell and build, literally, hundreds if not thousands of spread combinations. They need to learn how to build their own markets.
As an aside, I've always been amused by traders who "race" the order book. Never understood it. Of course those stacked bids and offers that move in lock step with the best bid/offers are a ruse. From my experience, FWIW, "real" money isn't going to care about stacking an order book away from the best price - they're going to hit bids and lift offers that appear in their price range of interest. They're also going to iceberg orders.
http://www.justice.gov/sites/defaul...ments/2015/04/21/sarao_criminal_complaint.pdf
http://www.justice.gov/sites/defaul...ments/2015/04/21/sarao_criminal_complaint.pdf
I stumbled across this thread by accident, and looking at the subject line I realised I'm kind of trespassing, but its an interesting subject.
I don't trade spreads any more (though I do have some relative value signals in my univariate system), but I used to, mainly in fixed income futures (both intra market in STIR, and inter market in both bonds and rates) and also swaps. I thought I'd just add my view.
I see spread trading as sitting on a continoum between pure relative value and pure directional trading.
On the one side you've got adjacent intra market spreads. Strong relationships. Very high correlation. Very low natural risk. Lots of leverage needed. Negative skew type returns, higher Sharpe, more tail risk. Divergences from the mean probably last for less time, so you have shorter holding periods and probably higher trading costs.
Looking more like directional risk you've got inter market spreads. Of course there is a spectrum here as well. The crack spread is stronger than the inter market spreads in bonds, bonds stronger than equities. Weaker relationships. Lower correlation. Less leverage needed. Less like negative skew, lower Sharpe, protracted drawdowns rather than tail risk when divergences happen. Divergences are longer, probably lower trading costs.
The inter market spread relationships are sometimes less obvious. So in bonds for example yields across countries show some weak cointegration; the futures prices don't. Wackier and perhaps non linear hedge ratios are the name of the game. Wheras a 1:1 spread in STIR is naturally a yield differential (although you might want to vol adjust especially if you're at the front of the curve).
Not saying one extreme or the other is better, but clearly its horses for courses (or you could do both).
Best of luck to you and your clients.
I don't trade spreads any more (though I do have some relative value signals in my univariate system), but I used to, mainly in fixed income futures (both intra market in STIR, and inter market in both bonds and rates) and also swaps. I thought I'd just add my view.
I see spread trading as sitting on a continoum between pure relative value and pure directional trading.
On the one side you've got adjacent intra market spreads. Strong relationships. Very high correlation. Very low natural risk. Lots of leverage needed. Negative skew type returns, higher Sharpe, more tail risk. Divergences from the mean probably last for less time, so you have shorter holding periods and probably higher trading costs.
Looking more like directional risk you've got inter market spreads. Of course there is a spectrum here as well. The crack spread is stronger than the inter market spreads in bonds, bonds stronger than equities. Weaker relationships. Lower correlation. Less leverage needed. Less like negative skew, lower Sharpe, protracted drawdowns rather than tail risk when divergences happen. Divergences are longer, probably lower trading costs.
The inter market spread relationships are sometimes less obvious. So in bonds for example yields across countries show some weak cointegration; the futures prices don't. Wackier and perhaps non linear hedge ratios are the name of the game. Wheras a 1:1 spread in STIR is naturally a yield differential (although you might want to vol adjust especially if you're at the front of the curve).
Not saying one extreme or the other is better, but clearly its horses for courses (or you could do both).
Best of luck to you and your clients.