Monday, May 9, 2011

Inter-commodity and Calendar Spreads - May 9th

Inter-commodity and Calendar Spreads
May 9th, 2011

After any large shift in the market, such as last week’s extremely volatile session, I prefer to wait a few days before looking at any new trade ideas, in other words ‘wait for the dust to settle’.  I will therefore use today to discuss spread trading in futures markets.  There are two broad categories of spread trading:  inter-commodity and intra-commodity (calendar) spreads. 

Inter-commodity Spreads

An inter-commodity spread entails buying one commodity and selling another related commodity, expressing a view on the relationship between the two contracts irrespective of the overall direction of the market.  This type of trading can be an excellent way of gaining exposure to a class of commodities (such as the energies, or grains), without a strong opinion on the outlook for the market in general.  By inoculating the trade against the movements of the broad market, it is possible to profit in both upward trending and downward trending markets.  Let’s look at some recent examples. 

On March 29th, 2011 I wrote in this blog:

The general rule of thumb when it comes to the seasonality of the refined products is that heating oil is strong in the winter months, when demand rises in response to cold weather, and gasoline is strong in the spring/summer months when more people ‘hit the road’ boosting demand for the fuel.  This seasonality is clearly demonstrated in the forward curve for RBOB gasoline futures, with higher prices seen in the summer months.

Spread Between RBOB Gasoline and Heating Oil
Courtesy of Bloomberg

As the chart above demonstrates, (with the exception of 2008) gasoline generally trades at a premium to heating oil starting somewhere around February or March, and trades at a discount sometime towards the end of the summer.  Currently the two products are trading at nearly the same price, and the trend is in favour of the RBOB, as would be expected based on historical seasonality.” 

Since then, the spread has moved steadily in favour of the gasoline (see chart).

Spread Between RBOB Gasoline and Heating Oil
Courtesy of Bloomberg

What is even more important to note, however, is how that spread has behaved over the past few sessions.  On Thursday of last week, the refined products fell precipitously, with June heating oil falling 2561 points, and June RBOB gasoline futures falling 2271 points.  The spread moved 290 points in favour of gasoline.  Since the plunge, markets have been recovering.  This morning the heating oil is up 531 points and the gasoline is up 1088 points.  Again the spread has moved in favour of the gasoline, by 507 points.  This shows that when you are correct about the direction of the spread, you can profit even during the most tumultuous of markets. 

Intra-commodity Spreads

The other common variety of spread trade is the intra-commodity or calendar spread, when you buy a commodity for delivery in one month, and sell the same commodity for delivery in another.  This type of trade expresses an opinion on differences in supply and demand during different type periods.  It is very commonly used in grain trading, especially when the months reflect different crop years.  Last week I wrote about one such spread in the corn futures, specifically the spread between July and December futures, or old and new-crop corn. 

I wrote, “In recent years, December futures have tended to trade at a 15-30 cent premium to July futures.  This year however, due to extremely tight physical supply, old-crop July futures have been trading at a steep premium to the new-crop December futures.  The spread peaked earlier this year at $1.33 ½ July over, and has since been declining.  Given recent developments, namely the difficulties planting the corn crop and thus the possibility of a smaller crop, and the waning demand for old-crop corn, this spread could continue to narrow.” 

At the close prior to that comment, the July futures were trading at a 73 ¼ cent premium to December.  Corn did not sell off as violently as most markets last week, but declined nonetheless.  This morning the corn market is trading higher.  Since that comment was written however, the spread between July and December has narrowed to 47 ½ cents.  By trading the spread and not taking an outright position in the corn, we were able to make money in both up and down markets.

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

1 comment:

  1. very good post, i was really searching for this topic as i wanted this topic to understand completely and it is also very rare in internet that is why it was very difficult to understand

    thank you for sharing this.
    Commodity Market