Spread Trading Strategies

Discussion in 'Technical Analysis' started by bone, Jun 13, 2012.

  1. bone

    bone ET Sponsor

    Spread Trading - to me at least, is a completely different way of looking at markets. Statistical or fundamental relationships between instruments are the driving influence.

    I personally like to use both statistical analysis and a specialized charting technical study in terms of spread trade entry signals. I always set my profit target and my stop-loss level at the time of entry.

    If we enter into a hedged position using multiple instruments, the trader profits from the divergence or the convergence in price action between the instruments that make up the spread position. A spread can have two legs or twenty-two legs. A true spread trade position is frequently thought to be "delta neutral" when it is first executed in the sense that each of the components zeroes out the others when added together ( it is hedged ) - but of course, there is risk in the trade. Most spread traders try to make adjustments for volatility between the individual spread component instruments ( the legs ).

    Pure spread traders harbor the general conclusion that spread trading is more reliable and consistent than taking flat price directional bets on a single instrument. They might also be of the opinion that spread positions "behave" better than flat price instruments in terms of technical analysis and modeling.

    Many legitimate spread trade positions are recognized by trading exchanges to carry less risk - and therefore, they almost always cost less to carry overnight than flat price positions. For example, the CME SPAN initial margin requirement for the July Crude Oil Future is $6,210 for an overnight position. You can carry a Crude Oil Jul-Aug-Sept 1-2-1 Butterfly Spread overnight for $472. All exchanges give SPAN margin credits for spread positions. They even have intra-exchange agreements - for example, ICE and CME have a mutual agreement for SPAN credits to carry a mini-Russell versus a mini-Dow stock index spread position.

    I personally think that more "retail oriented" traders and "swing" or "position" traders should consider spread trading as a strategy. It works, it is consistent, and you can carry the positions for a long time for cheap.

    There are certainly negatives with spread trading. The most obvious issue is that execution slippage has to be considered.

    Arbitrage is technically a spread trade between two very highly correlated instruments - for example, physical gold versus Comex gold futures. Maybe even SPY versus ES, or ICE WTI versus Nymex WTI.

    Some very advanced thinking types will use fundamental and statitistical relationships between instruments to scalp one based on the price action of another ( or several ). Some really advanced HFT firms use 'lead-lag' relationships on an automated basis.

    I have inserted some examples in order to stimulate some discussion.

    Most spread traders like what they think is "better, more predictable behavior" as compared to a flat price instrument. Spreads should generally trend better and certainly be less volatile. A good spread should be submissive. Spreads can be position traded for size on the cheap - but your clearing firm will charge you the haircut for each leg. Clearing firms love spread traders for obvious reasons. But again, you can carry alot overnight for ridiculously cheap.

    Stock pairs, stock baskets, statistical arbitrage - gazillions of possible strategy combinations with stocks and ETFs. Note how the EQT + CHK versus UNG spread is far less choppy than the SPY index or even the XLE analog ETF. It is also just about the mirror inverse to the consolidated front month Natural Gas futures contract.

    Serious juice in this one; nice down-trending channel for a long time and it looks like it's found some support.

    Simple and obvious. Stevie Wonder could have seen this one:

    And for the encore; an adult swim that my paying clients will surely be pissed about me posting. Sophisticated arbitrageurs are simply spread traders who don't bother closing legs. And then the fuckers go and automate it:
  2. bone

    bone ET Sponsor

    One of the fantastic developments amongst the major futures exchanges the past few years has been the expansion and proliferation of the exchange spreads.

    For the exchange supported spread, the exchange matches the legs internally for you - there is no legging risk ! Better yet, at least using a Trading Technologies platform I can show a single DOM ladder for a spread market. ( CTS does this as well ) These exchange spreads can support any kind of order the flat price futures can take - stop limits, MOC, MOO, OCO, and all the rest. The exchange spreads are totally fungible - you can leg out of them if you choose to do so.

    Once I enter a trade, I can enter resting profit targets and stop-limit orders ( I specify the payup tic range ).

    The CME Globex and the Liffe exchanges will accomodate butterflies, condors, and other more complex futures spreads.

    This has totally revolutionized spread trading for my clients who swing or position trade futures spreads.

  3. sentrix


    Hi bone,

    could you provide some information about the complex spreads like butterfly, condor etc? I've been trading futures spread so far and I am searching for another alternative ways how to develop this strategy. I was unable to find any relevant info on this.

  4. bone

    bone ET Sponsor

    While most of my clients are seasoned professionals, I have taken on a few more "retail oriented" clients who are starting out with very modest futures accounts. They want to position trade, which makes sense. They can carry about a dozen different spread combinations, overnight, in several different market sectors, for just a few thousand bucks.

    Spreads are the cheapest leverage around.

    Here are the initial performance margins for a single flat price futures contract for the CME Eurodollar:

    Here are the initial performance margins for some Eurodollar futures spreads combinations. There are, literally, thousands of potential combinations.
  5. bone

    bone ET Sponsor

    Here are the performance bond margins for a flat price Nymex Crude Oil futures contract:


    Here are the performance bond margins for a few Crude Oil Butterfly and Condor futures spreads. Again, this is the cheapest futures leverage going:

  6. bone

    bone ET Sponsor

    The CME publishes new position hedge ratio and charting price ratio guidance for each CBOT Treasury Contract Expiry according to the cheapest-to-deliver ( in this case for the Sept 12 contracts ).


    Charting the CBOT 10 Year Note versus 30 Year Bond Spread:


    Charting the CBOT 10 Year Note versus 30 Year Bond Exchange Spread Intraday:


    And this is what the CBOT 10 Year Note versus 30 Year Bond Exchange Spread Order Book looked like during the 10:00 am highs for previous chart:

  7. londonkid


    Thank you for making an intelligent and informed post. I didn't realise the margins on spreads were that much lower. Could you add a bit more colour to the bottom chart which charts 4 instruments, could you explain what you see and where they may be opps?

    Thanks again. Good trading.


  8. I wish CTS let you chart treasury spreads. They have NOB, BOB, etc charts, but they are useless as they always reset to zero. Maybe they will work on adding more flexibility to their charting as you can only chart the obvious spreads. If CTS had customizable charts, I wouldn't think of switching when the time comes, but I'm looking at my options for now.
  9. bone

    bone ET Sponsor

    It means that if you have multiple products that are very highly statistically correlated to each other, that cointegration presents opportunities for 'lead-lag' arbitrage. Many very developed and complex traders will use these relationships as highly effective and reliable entry signal indicators. In other words, if RBOB Gasoline is just sitting there and the S&P 500 is rallying hard - it would behoove you to step out and lift an RBOB offer quick like a bunny.
  10. bone

    bone ET Sponsor

    You can indeed customize the CTS charting studies - I have a few clients who have modified CTS to use my proprietary study which I designed for spreads. What you need to realize is that the CBOT Exchange Interest Rate Spreads do in fact always reset to zero every day. It is an idiosyncracy from the floor broker days, as they always quoted the yield curve for clients and to other floor traders as net change for the day. You will notice upon closer inspection that the 360 minute NoB chart is not the ICS chart. But if you take that 360 minute NoB chart and make the intervals the same as the ICS chart, the curve shape for a particular day in isolation will look identical but the scaling will be different.

    The real point I am trying to make is that you cannot use the CBOT exchange spread charts for Treasuries ( ICS ) for long term charting. You have to use a charting package sythetic combination, like the 360 minute NoB chart I had posted. This is a quirk applicable only to the CBOT Interest Rates.

    I have used CTS in the past and I personally think that it is OK. I have lots of clients who use CTS. The primary reason I use TT Pro for myself is that I trade multiple accounts.
    #10     Jun 14, 2012