Your honest discourse I for one encourage. I traded CBOT, CME, Eurex, and Liffe interest rate spreads from 1992 until about 2004 ( pit and screen ). I also from time-to-time traded cash basis. Your comments are certainly spot on for the rates. Having said that, I would encourage you to dip your toes in the water with some other markets - especially energy and grains in terms of intra market spread trading. If you can trade interest rates you can trade those other markets as well. There really is a great deal of opportunity there, especially if you stay away from the prompt months. Most of the inter market spreading I see amongst clients, outside of interest rates, is with the stock indices and actually baskets or individual equity names. I would agree that for the most part, an inter market spread will typically show a great deal of momentum and acceleration in terms of convergence and divergence. Typically much more so than intra market spreads. And as you say, "horses for courses" - some clients like it and many don't have the appetite for it.
Thanks for the generous response. If I was trading spreads right now I'd definitely consider other markets. Although fixed income is where I have the most experience in the past I have dabbled in spread trading most futures although not equities; though I know the maths well enough. In fact I'd stay away from spread trading quite a lot of fixed income for another year or so. Why? Well once we're out of ZIRP the spreads will be much better behaved in rates (so as a simple example the duration weighted 2y10y spread wouldn't end up being an outright 10y bet due to the relatively low vol in the 2y). However I'm not currently thinking about spread trading for a number of reasons. My current directional futures system is consuming all my risk capital. To trade something else I'd need to reduce the diversification I have in that system. On paper it would make sense to do that if the sharpe of the new system was significantly higher. On paper it would make sense to trade something with more negative gamma, to balance out the positive trend following. A decent short biased options system would have a good sharpe ratio (north of 2.0), but the engineering involved in getting clean data is relatively involved. Trading fully systematically as I do, spreads are also slightly more difficult from an engineering perspective. So for example getting a tradeable sychronised price might be tricky. Just looking at closing prices is fine for a slowish directional system, but the spread of closing prices may not be accurate. Obviously some intra market stuff has a tradeable spread price, but these might not be liquid. These problems then map on to the fully automated execution algo, which again needs to be far more involved than for directional trading. These problems are all soluble (and with about one third the work of building an options system) but right now its not a project I want to commit time to.
ZM Soybean Meal Butterfly, taken as a buy by clients and documented here in February, is performing nicely and is very close to the profit target:
ICE Sugar Condor, taken as a buy by clients and documented here in February, is performing but at turtle-like pace. Since the front month is March 2016, there is plenty of time for this trade to develop.
Euribor Butterfly, taken as a sell by clients and documented here in February, was stopped out for a loss the second week in April.
Wheat Calendar Spread Pair, as documented here earlier and was shorted by some of my clients in the Feb and early Mar time frame, has hit it's profit target earlier this week.
I had a client short this spread a couple weeks into March. For this type of scenario ( massive range extension ), our rules call for the use a Fibbo extension as a profit target - which was reached this week.
The Nat Gas trade previously posted was indeed closed out this week, as it had reached the profit target established at the time of trade entry.
Hi Bone, I've been following your posts for a while and have a couple of spread-related questions which I'm sure you can answer: 1) I've seen you refer to STIR spreads. What does STIR mean. 2) This question will take some explanation to set up. When trading stocks if one wants to outperform some index, say the SP500, then (obviously) one has to be in stocks that are outperforming the SP500. Let's say you have some measure of the relative performance of stock X versus some benchmark B ... PERF(X,B), where for example PERF(GOOG,SP500) is TRUE if Google is currently outperforming the SP500. For the sake of argument let's not even care exactly what this measure is but just that it exists and can be quantified. Now to my question. Does this concept apply to futures spreads and if so what would/could the benchmark be? For example, let's say you're long a soybean calendar spread (SX5-SN5) does the concept of comparing its value against some benchmark to see if it's outperforming the benchmark make sense? If yes, what would/could be the benchmark? Regards
Tony, Great questions, very constructive and much appreciated. Spread trading is a heavily used strategy by IB's, big prop traders and fund traders. As such, my answers reflect my own experiences - there are literally hundreds of thousands of arbitrage and relative value trading strategies and my answers are not by any means all encompassing. If you have properly done your homework in terms of modeling your spread trade, the trade should be largely immune from broader market delta directionality. As such, if indeed your spreading strategy models and trades with minimal immunity from broad market delta directionality you are generating pure portable alpha - and that's a good thing. Spread traders are essentially betting to profit from either the convergence or divergence between at least two ( but sometimes many ) highly correlated products. To accomplish such a feat, you have to essentially choose from a statistical standpoint highly correlated products. Could be 10 Yr. Cash Treasury Note versus the ZN future, could be a basket of the top 30 stocks listed in the S&P versus the ES future, could be the GC future versus a Gold Mining ETF, could be Jan16 NG vs Mar16NG vs May16NG... sky's the limit. You are essentially trading a market within a market. There is an incredible amount of dimensionality to this. A very good friend of mine makes markets at a major bank in OTC interest rate swaps - and he immediately hedges them with a specific Eurodollar month/year future dependent upon the swap duration he either bought or sold for an institutional client. These guys are essentially grinding out income; they are not betting the farm. Many of these traders work at a desk and they wish to remain employed - they want to get paid, and their managers want to get paid. No one is interested in taking what they would consider to be huge directional bets or crazy risk. I digress. Your questions: 1. STIRS are short term interest rates. The most commonly traded cash products are Treasury Bills and the most commonly traded OTC products are duration proxy plain vanilla swaps. The most commonly traded STIR futures are the US Eurodollars and the ECB Euribor. There are also lower liquidity national instruments in Liffe and the SFE. These are basically zero coupon money market instruments. For the longer termed STIRS, there is an elevated level of convexity risk. 2. Properly constructed spread combinations do NOT require a benchmark per se. Having said that, many spread traders incorporate "benchmark" products into their spread trading strategies purely for liquidity reasons. FDX vs UPS could statistically be just as viable as SPY vs a basket including AAPL, MSFT, XOM, JNJ, GE, BRK-B. There is often more opportunity in the road less traveled.