Spread Trading - A Simple Trading Strategy for Maximizing Your Profits

Discussion in 'Commodities' started by iGuru, Sep 29, 2010.

  1. iGuru

    iGuru Active Member

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    In todays volatile and sometimes uncertain markets, traders are looking for a trading strategies aims at protecting their profits while minimizing losses and managing risk. Hedging your trades using a 'Spread' is one such strategy. Commodity futures spread trading offers an exciting path for potential profits often overlooked by futures traders. Like anything else worthwhile, Commodity futures Spread Trading is not a piece of cake! Futures are a "zero-sum" game. One of my good friend says it as minus-sum game as it include brokerage & other charges in it. You don't want to be part of the "zero!" Take your time for trading. Hard work and discipline are required for trading. Learn things your futures broker never told you and perhaps never knew. Learn what the professional traders dont want you to know. Feel empowered and knowledgeable when you place your spread orders. And always remember that the Exchanges were set up for their Members, and not for you. The only purpose these professional traders/brokers have is to take as much of your money as they can from you.

    So I have decided to share my knowledge of spread trading because I realize that most current traders have never been exposed to it.

    A spread is defined as buying a futures contract and selling a related futures contract to profit from the change in the differential of the two contracts. In this the risk is in the difference between two contract prices rather than the risk of an outright/naked futures contract.

    There are different types of spreads and different methods for using each:

    Intramarket Spreads (My favourite Trading Strategy)

    An Intramarket spreads are done only as calendar spreads. In this method you are long and short futures in the same market, but in different contract months. An example of an Intramarket spread is that you are Long Dec Gold contract and simultaneously Short Oct Gold contract or viceversa depending on the spread opportunity.

    For Example:

    The closing price on 14th Sep 2010 for Gold future Dec contract @ Rs. 19284 and Oct contract @ Rs. 19195. Spread difference between these two contract is Rs. 89 and so my Spread strategy would be that, I would have buy Gold Dec contact @ Rs. 19284 and have sold Oct contract @ Rs. 19195. On 25th Sep 2010, the closing price for Gold future Dec contract @ Rs. 19281 and Oct contract @ Rs. 19135. So on this day I would have squared off my position by selling Gold Dec contract @ Rs. 19281 & Oct contract @ Rs. 19135. So Spread difference between these two contract is Rs. 146 and my gross gain/loss from this spread trade is Rs. 57 per lot. (i.e. Rs. 57 x 100 = Rs. 5,700 per lot). My net return, assuming brokerage @ 0.01%, will be Rs. (57-14) x 100 = Rs. 4300 per lot which is nearly 10% of the spread margin for Gold.


    Contract Buy Sell Return Brkg. + Other chrgs. Net Return
    Gold Dec 19284 19281 -3 -7 -10
    Gold Oct 19135 19195 60 -7 53

    So the net return will be [ (53-10)*100 ] Rs. 4300 per lot.

    This month I had applied a spread strategy on Lead & Zinc which gave me a return of Rs. 18,000 on an investment of Rs. 45,000 on two lots within 5 trading days (i.e. Return of 40%)

    For Spread trading we required only 25% of margin and margin required for Lead/Zinc is around Rs. 25,000 per lot. So two lots for spread trading needs:

    Lead = 2 lots x 25,000 =50,000 & Zinc = 2 lots x 25,000 =50,000
    Total = 1,00,000

    Total Spread margin for 2 lots = 25% x 1,00,000 = Rs. 25,000
    For M2M = Rs. 20,000


    Intermarket Spreads

    An Intermarket spread can be done by going long futures in one commodity and short futures of the same expiry month in another commodity. For example: Short May Wheat and Long May Soybeans.


    Inter Exchange Spreads (Everybody knows about it as Arbitrage Trading)

    An Inter Exchange spread can be done by going long futures contract in one exchange and simultaneous short the same futures contract on another exchange in the hope the sale price is greater than the purchase price.


    What makes Spread Trading such a profitable and easy way to trade?

    Spreads trading is considerably lesser riskier in trading as compared with straight futures trading. Because in spread trading every position is a hedge position & trading the difference between two contracts in an Intramarket spread results in much lower risk to the trader.
    Spreads on futures normally require lower margins than any other form of trading. This result in much greater efficiency in the use of your capital required for trading.


    Drawbacks:

    You need to put the right strategy according to your spread position else you will loss due to the contract expiry & M2M issue.
    It doesnt provide an opportunity on daily basis (even if it does, brokerage issue comes in between). Once or twice in a month you will get the opportunity for spread trading on each commodity (sometimes you will not get any opportunity in a month for a commodity to do spread trading).

    As a commodity futures spread trader, you will have the keys to intra-market and inter-market spreads. See yourself gaining more confidence with every futures spread trade you do. These are the basic which I explained here regarding Spread. All what you need to do is that explore more about this.
    So, lets go! And do well in Spread Trading.


    Spread Trading - Strategy & Calculation

    Link: http://www.traderji.com/commodities/45523-spread-trading-strategy-calculation.html#post474453



    Regards,

    iGuru
     
    Last edited: Oct 5, 2010
  2. comm4300

    comm4300 Well-Known Member

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    thank you for introducing this low risk strategy.

    looks like spread opportunities pay off nicely.

    what would be the range of spread that you'd consider as "abnormal" that'd trigger a spread opportunity?

    [​IMG]
     
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  3. sprintravi75

    sprintravi75 Active Member

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    hi iguru

    thanks for the nice post and startegy. but pls let me know how to identify the right contract.

    regards

    ravi
     
  4. iGuru

    iGuru Active Member

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    Hi Ravi,

    currently I’m working on that and hope to come up with a thread soon regarding Spread strategies, methods & the script on which it will be profitable etc. I will update the link here once I will done with it.

    Regards,

    iGuru
     
  5. hyraj

    hyraj Member

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    Nice work Guru........:clapping:
    Keep it uppppp, we r al with U Guru:thumb:
    I read it, m also interested about to kno th diffrnt stategies of Commodity.
    Especially Guru think about th metals like Al,Cu,Lead,Zn whose lot size is in btwn 1000-to-5000. Bt i think Al & Lead being having lot size 5000, they hav very little price movements.....so it will b worth important if u find the best spread srtategy........:thumb:
    A request u to Guru is that whr i can avail th historical data of th commodities(At least regarding with metals)....plz convey me url of any site if u know.

    With Good Wishes:thumb:
    Thankz
     
  6. iGuru

    iGuru Active Member

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    Hi Raj,

    Thanks for your comment. Im working on that only. So that it will be helpful for every member here.

    Dear friend, I would like to clear one thing that Spread doesnt give an opportunity to trade intraday (very rarely you will find any intraday opportunity). But it is ideal & worth for holding a position from a day to a month. Because a professional Spread trader dont trade in 1 lot....... but they trade in 5-20 lots depending upon their holding & risk taking capacity.

    I would like to tell you one of the real example that happened on the month of July-Aug this year which shocked and surprised me when I got to know about it (as I am not suppose to tell anyone).

    One of my dealer called me and he asked me that one of his client is interested to speak with me to understand more about commodity trading, as that client had make a loss of around Rs. 2,00,000 trading in Lead & Zinc only in some couple of months. (as he trade in 10-40 lots at a time)

    While discussing about commodity market & trading, just I mentioned about the spread trading and I gave him an example of a spread difference of around Rs. 7 in Aluminium & Zinc. I told him within a month and half it will come down to around zero and even to negative figs as I am studying and experimenting the different spread strategies at that time. I asked him to keep an eye on it whether its going to happen or not. (Personally I dont advice anyone for doing spread in Aluminium & lead/Zinc. As it is very risky as compared to any other commodities....... even I dont think of trying to do it)

    After a month I got a call from him thanking for giving him the advice for that spread strategy (actually which I didnt give him) and that actually helped him to recover his losses. He told me that he made a profit of around Rs. 5.5 per lot on 20 lots which comes to around Rs. 5,50,000.

    Since then I never suggested and said anything regarding Spread trading to anyone (Until I come up with the article).

    Here, Im not showing you the dream with above example, but what Im trying to tell you that what can be done and achieve with Spread trading. Really friend if I had more than Rs. 4,00,000 with me then I must be doing the Spread trading only (I never do the intraday trading).

    As I told in the article w.r.t. to Spread Trading is that applying it requires lots of skill, knowledge & experience to put the right strategy else it will be a losing position, if it is so simple & profitable always then everyone in the market must be doing this only and nothing else.

    You can get the historical data for commodity at MCX site.There you can get it by:

    http://www.mcxindia.com/

    Market Data (in Homepage) Bhav Copy - Bhav Copy (Commoditywise) (clicking at the check box)


    Regards,

    iGuru
     
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  7. hyraj

    hyraj Member

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    ==========================================================Thankz Guru once agn:yahoo:
    What a nice and elaborate explaination........keep it up:thumb:
    Wish u al th best n do work on it...our wishes r with u.
    U behaved like a sailor to th person whose ship was amidst of loss...so here i quote u Guru...that "The person who helps other without any EXPECTAION...GOD is always with HIM":clapping:
    We expect soon u'll work-out it n th outcome will b surely fruitfull.

    Regards
    HYRaj
     
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  8. hyraj

    hyraj Member

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    iGuru
    Member
    Intermarket Spreads (Never explored this one)

    An Intermarket spread can be done by going long futures in one market and short futures of the same month in another market. For example: Short May Wheat and Long May Soybeans.

    ========================================================
    here Guru
    one market and another market----------Do u mean in one commodity and in another commodity
     
  9. sprintravi75

    sprintravi75 Active Member

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    dear iguru

    u are really a guru in this. pls tell me can this be applied to futures and options in indian market

    regards

    ravi
     
  10. iGuru

    iGuru Active Member

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    Hi Raj, Thanxs for your comments.

    Yes, it means going long in one commodity and short in another commodity with same expiry. eg: Lead & Zinc, Gold & Silver....... anything but it need to have a relation between the two commodities (like: correlation, same asset class, lot size etc.)


    Regards,

    iGuru
     
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