What Exactly Are Futures Spreads

08/05/2014 6:00 am EST

Focus: COMMODITIES

Ilan Levy-Mayer of CannonTrading.com defines the different types of futures spreads and illustrates how and when to use each of them to minimize risk when trading commodities.

Corn is one of nature's greatest creations. You can make all sorts of delicious foods from the vegetable. It feeds many different types of animals. It is the base to many different popular types of liquor. Corn also can be an alternative fuel source. Not only are the corn's uses wondrous, it is also a very durable plant. It can take almost any type of weather pattern and still grow. Corn is also popular amongst investors, most notably commodity traders. Although a very good sturdy plant, investing in corn is a risky investment. Actually, commodity investing is a risky strategy, but rewarding if you can invest the right way.

To invest in a commodity you have to minimize your risk. Commodities traders will use a strategy known as a futures spread. Future spreads lower the amount of risk because the trader is hedging two commodities contracts and the result is the spread between the prices of the two contracts.

There are several types of futures spreads that traders can take advantage of.

Calendar Spreads

Calendar spreads are also known as Intra-market spreads. The practice lets the trader take on a short contract and a long contract, both based on specific months of the year. An example would be that the trader buys a contract for soybeans in May, and sells another contract for soybeans in November. To get your results, you would simply subtract the November price of soybeans from the May price, and then you get your spread.

Inter-Market Spreads

Inter-market spreading is the practice of buying a short contract of one commodity and buying the long contract of a different commodity. An example of an inter-market spread; you purchase a short contract of corn and at the same time purchase a long contract of wheat. The difference in the prices of the two will give you the spread.

Inter-Exchange Spreads

An Inter-exchange spread is the practice of taking one commodity and spreading their contracts on two different exchanges. An example would be a trader who takes a short contract of wheat on an exchange in Chicago and a long contract of wheat on an exchange in Kansas City. The difference would give you the spread.

Bull Spreads

To be a bull in the market place means that you see a long-term price increase ahead. A bull futures spread consists of taking a long position in a nearby—or front month—and simultaneously taking a short position on a deferred or farther out month.

Bear Spreads

To be a bear in the market place means that you see a long-term price decrease ahead. A bear futures spread consists of taking a short position in a nearby—or front month—and simultaneously taking a long position on a deferred or farther out month.

By Ilan Levy-Mayer of CannonTrading.com

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