People have varying levels of experience with spreads, so I'll try to keep it simple. For the beginner, more information about spreads is available on the web, and Stephen Reverre's "The Complete Arbitrage Deskbook" is a notable book on the subject.
I trade the S&P/DJIA spread using the S&P emini futures contract on CME/Globex and the Mini Dow ($5 multiplier) futures contract on CBOT/ace. For stock traders, the SPY and DIA stocks can be done instead, which I have done in the past. For now, I will be focusing only on the futures, but may include stocks at some point.
I'll get into more details about the spread in the coming days. Know that, in my system, BUYING THE SPREAD refers to the simultaneous BUY of an S&P emini contract, and SELL of a DJIA contract.
I will also give a price for the spread. This is computed by:
(Emini S&P conract price * 9.5) - (DJIA contract price)
A couple important points.. First, the number of contracts can be increased, for instance buying and selling 5 contracts of each at a time, but liquidity may become an issue on the DJIA - and that brings me to the second point..
There is risk in this type of trading, but it is more execution risk than market direction risk. The proper way to trade this is to buy and sell the corresponding contracts simultaneously, so you have no market direction risk. Of course, some may buy one side and only buy the other side if the first position moves against them.
This is a variation that may be used, I have done this at times in the past - but I won't get into it here, as it kind of defeats the purpose of spread trading by risking directional moves.
Also, remember execution risk is your primary challenge in this trading. It is better if you are fast on the trigger. Better also if you trade both positions in a basket trade if your software allows.
You need LOW commissions. I wouldn't pay more that $3 per side/per contract. Interactive Brokers ($2.40/side) and I believe Advanced Futures are below this level.
I'll get into more information in the coming days. I will post trades here on ET for a few days, after that I will do so on MSN Messenger only. The holding period may be a few days (even more sometimes), especially in slow market periods. Considering this holiday week, maybe not so much action this week.
Best Wishes!
