What is a Futures Spread?

A futures spread is an arbitrage technique in which a trader takes two positions on a commodity to capitalize on a discrepancy in price. In a futures spread, the trader completes a unit trade, with both a long and short position.

Basics of a Futures Spread

A futures spread is one type of strategy a trader can use to seek out profit through the use of derivatives on an underlying investment. In a futures spread, the goal is to profit from the change in the price difference between two positions. A trader may seek to take a futures spread on an asset when they feel there's a potential to gain from price volatility.

A futures spread requires taking two positions simultaneously with different expiration dates to benefit from the price change. The two positions are traded simultaneously as a unit, with each side considered to be a leg of the unit trade.

Key Takeaways

  • A futures spread is an arbitrage technique in which a trader takes offsetting positions on a commodity in order to capitalize on a discrepancy in price.
  • An inter-commodity spread utilizes futures contracts in different, but closely related commodities with the same contract month.
  • An intra-commodity calendar spread uses contracts of the same commodity, looking for discrepancies between different months or strikes.

Types of Futures Spreads

Inter-Commodity Futures Spread: This is a futures spread between two different, but related commodities with the same contract month. For example, a trader who is more bullish on the wheat market than the corn market would buy wheat futures and simultaneously sell corn futures. The trader profits if the price or wheat appreciates over the price of wheat.

Intra-Commodity Calendar Spread: This is a futures spread in the same commodity market, with the buy and sell legs spread between different months. For instance, a trader could buy a March wheat futures contract and sell a September wheat futures contract. Alternatively, the trader could sell a March wheat futures contract and buy a September wheat futures contract.

Bitcoin Futures Spread Trading

Bitcoin futures began trading in December 2017. These futures products offer an opportunity for a futures spread to benefit from price volatility. A trader who believes a price will go up over time can take a buy contract one month out and a sell contract two months out at a higher price. They exercise their option to buy in the one-month contract and then sell in the two-month contract benefiting from the differential.

Futures Spread Trading Margins

Margins are lower for futures spreads than for trading a single contract due to reduced volatility. If an external market event occurs, such as a surprise interest rate movement or terrorist attack, both the buy and sell contacts, in theory, should be affected equally e.g., the gain on one leg offsets the loss on the other. A futures spread effectively provides a hedge against systematic risk, allowing exchanges to reduce the margins for spread trading. For example, the Chicago Mercantile Exchange (CME) has a $1,000 margin requirement for one contact of corn, whereas it has a $140 margin requirement for the same crop year futures spread.

Practical Example of a Bull Futures Spread

Suppose it’s December, and David is bullish on wheat. Therefore, he buys one contact of March wheat at 526’6 and sells one contract of September wheat at 537’6, with a spread of 11’0 between the two months (526’6 – 537’6 = -11’0). David buys March wheat and sells September wheat because front months typically outperform deferred months. David called the market correctly and by March, the spread between the two months has narrowed to -8’0, meaning he has made profit of 3’0 (-11 + -8), Since one contact is for delivery of 5,000 bushels of wheat, David makes a profit of $150 on the spread trade (3 cents x 5,000).