Watch this RJOF Quick Tips: Introduction to Spread Trading video presented by our Senior Market Strategist, Phillip Streible to learn how spread trading can be another tool in your futures trading plan.
What is spread trading?
Spread trading involves taking opposite positions in the same or related markets. A spread trader always wants the long side of the spread to increase in value relative to the short side. This means the spread trader wants the difference between the spread to become more positive over time.
Whenever a spread is quoted, it’s always a single price. You would never get a quote with the two individual prices. The price is figured by subtracting the back month from the front month. Let’s say you bought a July wheat contract at $4.75 per bushel while selling a December wheat contract at $5.25 per bushel. The spread between them would be -50 or 50 cents to the December contract. If the value of July gains by 10 cents, your gain would be $500 in profit. In this case the spread would narrow. If the value of July loses 10 cents, your result would be a $500 loss. This would mean the spread widens.
One of the most common spreads is the intramarket spread. This is the buying and selling of two different delivery months in the same market. Let’s say you are buying one July wheat contract and selling one December wheat contract. If the July wheat increases in value relative to the December wheat, the position will show a gain because you are long July. Another outcome would be if July wheat decreases in value relative to the December contract, then this position will result in a loss.
Another type of spread is an intercrop spread. This is a spread that reflects the underlying fundamentals of two different crop years (i.e. July/December corn or July/November soybeans). There is also an intermarket spread is a spread that reflects a different variety of a commodity (i.e. December Chicago wheat and December Kansas City wheat). The intercommodity spread is another type which involves trading two different, yet related markets (i.e. corn and wheat, or gold and platinum).