What is an Intermarket Spread
An intermarket spread is a trading strategy for trading in the commodity futures contract marketplace. Using this method, the trader places the simultaneous purchase of a commodity futures contract with a given expiration month and then sells the same delivery or expiration month of a closely related commodity futures contract. The goal is to profit from the changes in the gap between the two futures commodity prices.
A commodity futures contract is an agreement to buy or sell a predetermined amount of a commodity at a specific price on a particular date in the future.
BREAKING DOWN Intermarket Spread
The intermarket spread strategy uses one exchange platform to complete the spread. In trading, a futures spread strategy involves trading a long position and short position, the legs, simultaneously. The idea is to mitigate the risks of holding only a long or a short position in the asset. These trades are executed to produce an overall net trade with a positive value called the spread. An intermarket spread involves placing long futures of one commodity and short futures of another product in which both legs have the same expiration month.
An example of an intermarket commodity futures spread is if a trader purchases May Chicago Board of Trade (CBOT) feed corn contracts and simultaneously sells the May live cattle contracts. The best profit will come if the underlying price of the long position increases and the short position price falls. Another example to use the CBOT platform to buy short contracts for April Soybean and long contracts for June corn.
The Risk of Intermarket Spread Trades
Trading using spreads can be less risky because the trade is the difference between the two strike prices, not an outright futures position. Also, related markets tend to move in the same direction, with one side of the spread affected more than the other. However, there are times when spreads can be as volatile. Knowing the economic fundamentals of the market, including seasonal and historical price patterns, is essential. Being able to recognize the potential for spread changes can be a differentiator as well.
The risk is that both legs of the spread move in the opposite direction of what the trader may have expected. Also, margin requirements tend to be lower due to the more risk adverse nature of this arrangement.
Other Commodity Spread Strategies
Different types of commodity spread contracts include:
- Intra-market spreads, created only as calendar spreads, meaning a trader is in long and short futures in the same underlying commodity. The legs will have the same strike price but expire in different months. An example of would be an investor going long in January soybean and short in July soybean.
- An inter-exchange spread uses contracts in similar commodities, but on different exchange platforms. They can be calendar spreads with different months, or they can be spreads in which use the same expiration month. The commodities may be similar, but they can trade because the contracts occur on different exchanges. Returning to our example above, the trader will purchase the May Chicago Board of Trade (CBOT) feed corn contracts and simultaneously sells the May live cattle on the Euronext. However, traders need the authorization to trade products on both exchanges.