Hi bone, What are the advantages of doing spreads instead of directional bets? Why do the big boys have this preference for doing spreads? Some size advantage that small retail traders don't have?
You are not contradicting him. His main point is that technical indicators and punting is not how the business gets done. You are making an orthogonal statement that most energy bets (I'd actually go as far as to say most non-equity bets) are relative value in nature. Both are definitely true.
The key advantage is that it's much easier to forecast the spreads and understand their behavior (based on hedging behaviors, supply/demand imbalances etc). If anything, you get better capacity by trading outright, but it's much harder to find alpha in these types of trades.
Please be patient if this question sounds too basic. Why is it easier to forecast spreads instead of single directional bets? Shouldn't forecasting spreads be more difficult? In spread bets, one needs to be correct on 2 directions since 2 bets are involved. For directional bet, one needs only to be correct on 1 single direction since only 1 bet is involved. Pardon my ignorance. I'm a retail person who only do directional bets.
Why, that's a very valid question. The general idea is that if you are looking at a spread between two highly related securities, it's going to be mean-reverting and it's easy to identify the extremes. When you are looking at outright price, you are trying to actually predict the future, which is much harder.
Thanks for the answer. I presume spread bets have higher win rates but the disadvantage is limited gain compared to directional bets with lower win rates but gain which is not limited? As a retail trader who makes directional bets, I had < 50% win rates even in a good year.
Ummm, I’d respectfully push back about alpha. A spread trade between two or more highly correlated instruments is about as close as you can get to pure portable alpha to my knowledge.
It depends on the spread. Firms (and independents) can have on many spread trades at once, and the possible combinations are huge. Since you’re in equities maybe look at CME vs ICE, UPS vs FedEx, MGM vs LVS, NextEra vs Duke... stuff like that. Build some models - adjust your hedge ratios for volatility and share price. Speaking for commodity futures - it is quite common to take a few to several hundred dollars out of a one lot intra commodity spread ( same commodity different expiries ). Inter commodity spreads will typically have greater volatility.
From your exposure to institutional desk on spreads etc. what are the average annual returns produced by traders on such strategies.
That is a loaded question - any answer I give will be exempted, overarching and refuted. I can’t honestly tell you what the desks at Citadel or DRW are returning at present. Tom Arnold at Enron and later at Centaurus is a good indicator of what was achievable in Natural Gas Intra Commodity Spreads in the late 90’s through mid 2000’s. There’s a reason the big prop firms and HF desks are doing it. They are an exercise in contradictions - they shun risk but demand returns.