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Basics of Futures Spread Trading
Futures Spread Trading has traditionally been known as a professional’s trading strategy. However, we feel it is a trading method that should be in everyone’s arsenal. Our goal here is to layout the basics of spreading so you will have a solid foundation of knowledge in this essential trading strategy.
Types of Commodity Futures Spreads
Inter-Commodity Futures Spread
Futures contracts that are spread between different markets are Inter-Commodity Futures Spreads. One example of this is Corn vs. Wheat. Let’s say the trader thinks that the Corn market is going to have higher demand than the Wheat market. The trade would buy Corn and sell Wheat. The trader does not care if the prices of Corn and Wheat go up or down; the trader only wants to see the price of Corn appreciate over the price of Wheat. If the grain markets sell off, the trader wants to see Corn hold its value better than Wheat. If the grain markets are bullish, the trader wants to see Corn advance farther than Wheat.
Intra-Commodity Calendar Spread
An Intra-Commodity Calendar Spread is a futures spread in the same market (i.e. Corn) and spread between different months (i.e. July Corn vs. December Corn). The trader will be long one futures contract and short another. In this example, the trade can either be long July Corn and short December Corn OR short July Corn and long December Corn. In order to be in an Intra-Commodity Calendar Spread, the trade must be long and short the same market (i.e. corn) but in different months (i.e. July vs. Dec).
Bull Futures Spread
A Bull Futures Spread is when the trader is long the near month and short the deferred month in the same market. Let’s say it is February of 2020. You buy May 2020 Corn and sell July 2020 corn. You are long the near month and short the deferred month (May is closer to us than July). It is important to note that the near months for futures contracts tend to move farther than faster than the back months. If corn is in a bull market, May (near month) should go up faster than July (deferred month). That is why this strategy is called a Bull Futures Spreads. Since the front months tend to outperform the deferred months, a trader who is bullish on corn would buy the near month, sell the deferred month, and would like for the near month to move faster and farther than the deferred months.
This relationship between the near and deferred months is not always true 100% of the time, but it is the majority of the time. That is why when you are long the near month and short the deferred, it is called a bull futures spread. The spread should go in your favor when prices are rising.
Bear Futures Spread
A Bear Futures Spread is when the trader is short the near month and long the deferred month. This is the opposite of our Bull Futures Spread. Again, let’s say it is February of 2020. You sell May 2020 Corn and buy July 2020 Corn. You are short the near month and long the deferred month. This is a bear spread because the near months ten to move faster and farther than the deferred months. If Corn is in a bear market, May (near month) should go down faster than July (deferred month). This is not always true 100% of the time, but it is the majority of the time. That is why when you are short the near month and long the deferred month, it is called a Bear Futures Spread. This spread should go in your favor when prices are declining.
Futures Spread Trading Margins
Margins for individual contracts may be reduced when they are part of a spread. The margin for a single contract of corn is $2025. However, if you are long and short in the same crop year, the margin is only $200. If you are long or short corn between different crops year (July vs. Dec) then the margin is $400. The crop year for corn is December through September.
Futures Spread Pricing
Spreads are priced as the difference between the two contracts. If May Corn is trading a 600’0 a bushel, and July is trading at 610’0 per bushel, the spread price is 600’0 May – 610’0 July = -10’0 . If May was trading at 620’0 and July was 610’0, the spread price is 620’0 May – 610’0 July = +10’0 .
Futures Spread Quotes
When pricing spreads, you always take the front month and subtract the deferred month. If the front month is trading lower than the deferred (like our first May vs. July example), the spread will be quoted as a negative number. If the front month is trading higher than the deferred month (like our second May vs. July example), the spread will be quoted as a positive number.
Futures Spread Tick Values
Tick Values are the same for spreads as they are for the individual contracts. If the spread between May Corn and July Corn is -10’0 cents, and the spread moves to -11’0 cents, that is a 1 cent move. 1 cent in corn is $50 for all months and spreads in the standard 5000 bushel contract. The tick values are the same for spreads as they are for their individual contracts.
A market is in Contango when the front months cost less than the deferred months. This is also known as a “normal” market. If a bushel of corn in May costs 600’0 and a bushel of corn in July is 610’0, that market is in Contango. In normal markets, the deferred month should cost a little more than the front month due to the cost of carry, which is made up of storage costs, insurance on stored commodity, and interest rates payments for the capital needed to own and store the commodity.
When markets are in Backwardation, the near months are trading higher than the deferred months. Markets in Backwardation are also called “inverted” markets. They are the opposite of Contango or “normal” markets. Backwardation typically occurs during bull markets. When there is a substantial supply issue or increase in demand, the front months of a commodity will start to go up faster than the back months. The front months are more sensitive to changes in supply and demand because the front months are the commodity months that are coming to the market for deliveries. If there are supply decreases or demand increases, it is easier for the market to account for these in the deferred months, especially in the next crop year, also known as the “new crop”.
For example, let’s say it is February of 2020 and there is a shortage of corn. The “old crop” months are March, May, July and September. The “new crop” starts in December. There is not much the market can do about the supply from March to September, when Corn is being planted, grown and harvested. The corn that is made available during these months is coming out of stocks and storage. However, the market does have some control over December and the months going into 2020, like using more farming acres for Corn.
New acres devoted for corn will help the new crop keep prices stabilized for the deferred months. The near months will still increase because corn can not be harvested until the fall, but the deferred months should be able to help with demand and will not go up as fast as the near months.
Futures Spreads and Seasonality
Many commodities markets have seasonal periods of supply and demand. Some commodities are in higher demand during the summer, like Gasoline and Crude Oil, while some have a higher demand in the winter, like Natural Gas, Heating Oil and Coffee. Commodities also may have seasonal periods of supply, like the grain markets. The Corn market has the greatest supply right after harvest in the fall, which can lead to lower prices during that time of year.
Traders will use spreads and try to take advantage of these seasonal supply and demand changes. They look at the performance of spreads over the year during specific time frames to estimate the risk, reward, and probability of success. If you would like to know more about Seasonal Futures Spread Trading please read my previous article, “Seasonal Futures Spread Trading”.
Finally, if you like this post, you may also like my other article, “The Wonderful World of Futures Spread Trading”.
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Wheat May ’20 (ZWK20)
Wheat Futures Market News and Commentary
The midday wheat market is mixed, with gains in the hard wheats. Chicago wheat is down with a 3/4 cent loss in May. May HRW wheat futures are 3 1/2 cents higher. Front month MPLS wheat futures are up by 5 1/2 cents. We’re now in the index fund roll period, moving May positions to July futures. The average WASDE report estimates for World wheat carryout are 287 MMT, which would be a slight dip from the March edition. Analysts estimate the U.S. wheat carryout at 947.4 mbu, which would be a 7.4 mbu increase over March. Export Sales estimates are to see 50,000 to 2000,000 MT of wheat bookings for the week ending April 02. Traders also estimate new crop wheat bookings at 150k to 350k MT. Turkey is tendering for 250,000 MT of wheat, closing 04/30. Japan issued their weekly MOA tender, seeking 128,760 MT of wheat from the U.S. and Australia. Estimates of French 2020 acreage are being revised downward, taking estimated production with them.
May 20 CBOT Wheat is at $5.48. Read more
grains Futures News
Jack Scoville – The PRICE Futures Group Wed Apr 8, 9:58AM CDT
DJ U.S. April Grain, Soybean Stockpiles Estimates — Survey CHICAGO–The following are analysts’ estimates in millions of bushels for U.S. ending stockpiles.
Allendale Inc – Allendale, Inc Wed Apr 8, 6:47AM CDT
Traders Remain Cautious As Markets Rebound
Tfm Intelligence Solutions – Total Farm Marketing Wed Apr 8, 5:47AM CDT
Grains firm overnight; Livestock start from Tuesday’s Limit Up
John Walsh – Walsh Trading Tue Apr 7, 7:06PM CDT
A brief overview of the corn market.
John Walsh – Walsh Trading Tue Apr 7, 7:03PM CDT
A brief description of the soy markets.
Tom Fritz – International Futures Group Tue Apr 7, 4:51PM CDT
The Export Basis For SRW Tumbles
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The All Futures page lists all open contracts for the commodity you’ve selected. Intraday futures prices are delayed 10 minutes, per exchange rules, and are listed in CST. Overnight (Globex) prices are shown on the page through to 7pm CST, after which time it will list only trading activity for the next day. Once the markets have closed, the Last Price will show an ‘s’ after the price, indicating the price has settled for the day. The page will always show prices from the latest session of the market.
End-of-Day prices are updated at 8pm CST each evening, and includes the previous session volume and open interest information.
The Cash Contract is listed as the first contract at the top of the page.
For pages showing Intraday views, we use the current session’s data, with new price data appear on the page as indicated by a “flash”. Stocks: 15 minute delay (Cboe BZX data for U.S. equities is real-time), ET. Volume reflects consolidated markets. Futures and Forex: 10 or 15 minute delay, CT.
The list of symbols included on the page is updated every 10 minutes throughout the trading day. However, new stocks are not automatically added to or re-ranked on the page until the site performs its 10-minute update.
Pages are initially sorted in a specific order (depending on the data presented). You can re-sort the page by clicking on any of the column headings in the table.
Most data tables can be analyzed using “Views.” A View simply presents the symbols on the page with a different set of columns. Site members can also display the page using Custom Views. (Simply create a free account, log in, then create and save Custom Views to be used on any data table.)
Each View has a “Links” column on the far right to access a symbol’s Quote Overview, Chart, Options Quotes (when available), Barchart Opinion, and Technical Analysis page. Standard Views found throughout the site include:
Main View: Symbol, Name, Last Price, Change, Percent Change, High, Low, Volume, and Time of Last Trade.
Technical View: Symbol, Name, Last Price, Today’s Opinion, 20-Day Relative Strength, 20-Day Historic Volatility, 20-Day Average Volume, 52-Week High and 52-Week Low.
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Horizontal Scroll on Wide Tables
Especially when using a custom view, you may find that the number of columns chosen exceeds the available space to show all the data. In this case, the table must be horizontally scrolled (left to right) to view all of the information. To do this, you can either scroll to the bottom of the table and use the table’s scrollbar, or you can scroll the table using your browser’s built-in scroll:
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View the latest top stories from our trusted partners, with a focus on today’s futures and commodity markets.
Wheat Futures Trading Basics
A futures contract is an obligation to buy or sell a commodity at or before a given date in the future, at a price agreed upon today. While the term “commodity” is usually used when referring to contracts like corn, or silver, it is also defined to include financial instruments and stock indexes. One of the benefits to the futures industry is that contracts are traded on an organized and regulated exchange to provide the facilities to buyers and sellers.
Exchange-traded futures provide several important economic benefits, but one of the most important is the ability to transfer or manage the price risk of commodities and financial instruments. A simple example would be a baker who is concerned with a price increase in wheat, could hedge his risk by buying a futures contract in wheat.
Not all futures contracts provide for physical delivery, some call for an eventual cash settlement. In most cases, the obligation to buy or sell is offset by liquidating the position. For example, if you buy 1 S&P500 e-mini contract, you would simply sell 1 S&P500 e-mini contract to offset the position. The profit or loss from the trade is the difference between the buy and sell price, less transaction costs. Gains and losses on futures contracts are calculated on a daily basis and reflected on the brokerage statement each night. This process is known as daily cash settlement.
US futures trading is regulated by the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). The CFTC is an independent federal agency based in Washington, DC that adopts and enforces regulations under the Commodity Exchange Act and monitors industry self-regulatory organizations. The NFA, whose principal office is in Chicago, is an industry-wide self-regulatory organization whose programs include registration of industry professionals, auditing of certain registrants, and arbitration.
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If you are new to futures trading, be sure to check out our tips for futures traders & watch our FAQ video below. Get answers to common questions such as the role of commission in overall trading costs and learn how leverage can impact margin requirements.
For a free educational guide to “Trading Futures and Options on Futures”, provided by the National Futures Association (NFA), please click here.
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Futures, foreign currency and options trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one’s financial security or lifestyle. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. View Full Risk Disclosure.
What are the basics of futures trading?
Not sure if futures trading is right for you? In this article, weвЂ™ll help you find out by taking a close look at what futures are and how they work.
What are futures?
To start, hereвЂ™s a quick definition: Futures are contracts for the delivery, or cash settlement, of many things you may encounter every day, like materials, products, or even the stock market itself. But what does that really mean? LetвЂ™s break it down by exploring a few key traits that make futures unique.
All futures share the following three characteristics:
- Easy contract trading. Futures are contracts that trade on an exchange. That means if you buy or sell them, closing your trade is as easy as it would be for a stock. The futures market is relatively deep and liquid.
- Settlement by cash or physical delivery. Like stocks, most futuresвЂ”including the CME E-mini S&P 500 and other equity index futuresвЂ”settle in cash. ThereвЂ™s no exchange of physical goods or shares of stock. The only thing that changes hands is money.
However, some commodity futures, like corn and soybeans, are physically settled, meaning each party to the trade is expected to deliver or receive the actual commodity at expiration. But very few futures contracts are settled this way, and at E*TRADE, while you should be sure to close your positions on time, there are mechanisms in place to minimize this risk.
Equity index futures are one of the most popular, providing another way for investors to trade on price movement in the stock market. These include the CME E-mini S&P 500 mentioned above, plus the CME E-mini Nasdaq and CME E-mini Russell 2000.
What are the basic terms used in futures trading?
Now that weвЂ™ve seen what futures are, letвЂ™s explore how they work by defining and illustrating some essential futures terms.
- Tick . Futures contract prices move in minimum increments called вЂњticks.вЂќ These are different for each futures product and can usually be found by checking the futures page. As an example, the CME E-mini S&P 500 has a tick size of a quarter of an index point.
- Tick value. Unlike stocks (where each tick is worth a penny), tick size for futures is product-dependent, and as a result, the dollar value will vary. The tick value of the CME E-mini S&P 500 is $12.50, so if you buy a contract and end up selling it, say, two ticks higher, youвЂ™d make $25.00, assuming no commissions or fees.
- Contract size. The specified quantity behind each futures contract (i.e., how much of a commodity or financial instrument is backing that contract) is called its contract size. For example, the CME gold futures contract represents 100 troy ounces of gold.
- Notional value. Knowing the size of a futures contract enables you to determine its notional valueвЂ”i.e., how much each contract is worth. You can figure this out by multiplying the contract size by the current price of the futures contract.
Consider gold: If gold futures are trading at $1,300 per ounce and the size of the CME gold futures contract is 100 ounces, the contractвЂ™s notional value would be $130,000 ($1,300 x 100). In dollar terms, thatвЂ™s how much one gold contract is worth.
If a contractвЂ™s notional value ever seems too big for your wallet, check to see if thereвЂ™s a contract with a smaller size. With gold, there is. ItвЂ™s the CME E-micro gold, which has a contract size of 10 ouncesвЂ”and a notional value of $13,000 ($1,300 x 10). ThatвЂ™s one-tenth the size of the bigger contract.
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