The Basics of a Futures Spread: Its Types and Examples


Key Takeaways:

  • A Futures spread refers to buying and selling two contracts simultaneously to offset the risk in one contract with another. It involves taking opposite positions in two different futures contracts with the same underlying asset, while at the same time establishing a price difference between them.
  • There are four types of Futures Spreads: Bull spread, Bear Spread, Calendar Spread, and Inter-Commodity Spread. A bull spread involves buying a near-month contract while selling a deferred-month contract. A bear spread involves selling a near-month contract while buying a deferred-month contract. A calendar spread involves buying and selling contracts with different expiration dates. An inter-commodity spread involves buying and selling futures contracts of different, yet related, commodities.
  • For example, a trader who believes that the price of crude oil will increase may buy a near-month contract for crude oil while selling a deferred-month contract. This trader hopes that the price difference between the two contracts will grow, generating a profit. Another example of a futures spread is a calendar spread where the trader sells a near-month contract while buying a deferred-month contract.

Struggling to understand Futures Spread Trading? You're not alone! This article will provide an overview of the fundamentals and types of futures spreads, and an example of how it works.

Understanding Futures Spread

Understanding the Basics of Futures Spread in Trading

Futures spread involves traders buying and selling two different futures contracts simultaneously. The difference between the prices of the two contracts is the spread. This strategy can be used by traders to reduce risk and increase profits. By buying one contract and selling another, traders can benefit from both bullish and bearish price movements. Futures spread can be categorized into intermarket, intramarket, and calendar spread.

Intramarket spread refers to traders buying and selling the same futures contract with different contract months. Intermarket spread involves buying and selling two different, but related futures contracts, such as crude oil and natural gas. Calendar spread is a type of intermarket spread, where traders buy and sell futures contracts with different delivery dates.

It is essential to note that futures spreads are not guaranteed profits, as prices can fluctuate unpredictably. However, the strategy can be useful in minimizing risks and maximizing profits, especially when used in conjunction with other trading tools.

One experienced trader once used a futures spread strategy to profit from an anticipated increase in demand for gas due to a cold winter. The trader bought natural gas futures for the winter months while simultaneously selling the summer futures contracts. When winter approached, the spread between winter and summer contracts increased, leading to significant profits for the trader.

Types of Futures Spreads

Want to understand the various types of futures spreads? Dive into this section. It covers 'Bull Spread', 'Bear Spread', 'Calendar Spread' and 'Inter-Commodity Spread'. Each sub-section has its own strategy, risk management and profit potential. Check it out!

Bull Spread

A bullish futures spread is a strategy in which a trader buys a futures contract for a specific delivery date and simultaneously sells another futures contract for the same commodity, but with different delivery dates. This approach is known as buying the near-month contract and selling the far-month contract.

Below is a table that showcases an example of how this strategy works:

   Commodity Near-Month Futures Contract Price Far-Month Futures Contract Price Spread     Crude Oil $70 $72 -$2    

In this example, a trader buying crude oil futures for delivery in one month pays $70 per barrel. Meanwhile, to offset the cost of that position, he sells crude oil futures with delivery in two months at $72 per barrel.

An important thing to note is that while this strategy may incur lower losses than plain buying up front, it may not be as profitable if the price exceeds expectations.

Pro Tip: It's essential to have an understanding of market trends and price movements before implementing any spread strategy.

Bear Spread: Because sometimes it's worth betting on the market going down, just to have something to cheer about.

Bear Spread

A bearish spread is a trading strategy where a trader aims to gain profits when the market falls. It involves selling a futures contract with a higher price and buying another futures contract with a lower price to take advantage of the bearish market trend.

Bear Spread Table:

                           Type             Futures Contracts Involved             Profit Potential                                         Bear Call Spread             Short Call + Long Call             Limited                               Bear Put Spread             Long Put + Short Put             Limited                

In a bearish spread, traders try to sell high and buy low, simultaneously. The profit potential is limited but well-defined, as traders can hedge their risks. A bear call spread consists of an investor simultaneously selling one call option at a higher strike price and buying another call option at a lower strike price. It represents the profits from the uptrend while limiting the losses in case of rise in prices.

A commodity trader recently adopted the strategy by using a bear put spread tactic on Gold Futures Contracts at long-side commodities. This allowed them to mitigate their losses as the bearish market took shape amidst global crises.

Planning for the future is never easy, but with a calendar spread, at least you can schedule your losses in advance.

Calendar Spread

A Calendar Spread is a type of futures spread that involves buying and selling futures contracts of the same commodity but different expiration months. The goal is to profit from differences in the price of these two contracts as they converge at expiration.

The following table demonstrates an example of a Calendar Spread in the Gold futures market:

                           Month             Contract Price (Buy)             Contract Price (Sell)                                         May             $1,800             N/A                               June             N/A             $1,850                

As seen above, in this scenario, one would simultaneously buy a May Gold futures contract at $1,800 and sell a June Gold futures contract at $1,850. Then, as expiration approaches and both contracts' prices converge, traders can make a profit if the difference between the two prices narrows.

One unique attribute of Calendar Spreads is that they involve buying and selling different delivery months for the same underlying asset. Traders often use them to capture seasonal or cyclical price fluctuations within a particular market.

Interestingly, according to some sources, Calendar Spreads were first used in trading pork bellies on the Chicago Mercantile Exchange during the early 1960s. However, variations of this spread type can be found throughout history dating back centuries.

Mix and match your commodities like a crazy fashionista with Inter-Commodity Spread futures trading.

Inter-Commodity Spread

Introducing the Concept of Diversified Commodity Spread Trading. In diversified commodity trading, inter-commodity spreads play a vital role in hedging and risk management. The inter-commodity spread is one of the popular types of futures spreads that involves simultaneous buying and selling of futures contracts of different commodities.

This Futures Spread involves various commodities such as Corn-Wheat, Corn-Soybeans, Gold-Silver, Crude Oil-Natural Gas where the price correlation between two related assets is exploited to create market opportunities. Here's how inter-commodity spreads work:

Table: Inter-Commodity Spread

               Commodity       Current Market Price       Futures Contract Expiry Date       Quantity                       Corn       $5.45       October       5000 bushels                 Wheat       $6.70       December       5000 bushels          

The above table represents an example using Corn and Wheat contracts in which long futures position on Wheat December contract was bought and simultaneously a short position was taken on Corn October contract.

Additionally, traders can also opt for financial instruments like Exchange-traded funds (ETFs) to gain exposure to these diversified commodity markets efficiently. However, traders should keep an eye on macroeconomic factors influencing individual contracts.

To increase profitability in Inter-Commodity spread trading, traders are recommended to study historical prices analysis and seasonal tendencies between two assets linked in a spread to optimize their positions accordingly. Risk Management should never be ignored, so it's critical to set up stop-loss orders while maintaining sufficient margins during volatile market conditions for better decision-making abilities for traders.

Get ready to spread some future love with these examples of futures spreads.

Example of Futures Spreads

Gain a practical insight into Futures Spreads by exploring examples. This section covers four topics:

  1. Example of Bull Spread
  2. Example of Bear Spread
  3. Example of Calendar Spread
  4. Example of Inter-Commodity Spread

Understand how each spread works in different market scenarios.

Example of Bull Spread

A professional introduction to an example of a bullish futures spread presents itself as a potential learning opportunity. A futures spread is a strategy employed by traders in the derivatives market to manage their risk exposure. It involves buying and selling two or more related Future contracts simultaneously to capitalize on price discrepancy.

Table 1 shows the example of a Bull Spread where an investor buys one contract of crude oil for delivery in January and simultaneously sells a February contract. The prices reflected are not exact but shall suffice for illustrative purposes.

BuySellCrude Oil$80/barrel$85/barrel AvgJanuaryFeb Delivery

Unique details concerning bull spreads include understanding the difference between them and bear spreads, straddles, and other trading strategies. In addition, holding periods may vary greatly with these types of trades; some may have expiration dates only days apart while others may be several months away.

One trader who had previously bet against markets opened a bullish futures trade after studying consumer trends over time. Despite materializing after much deliberation, it proved profitable as his insight was correct, resulting in lucrative gains over time.

Feeling bearish? Here's an example of a spread that'll make a grizzly look positively cuddly.

Example of Bear Spread

A bear spread is a futures trading strategy where an investor sells a put option with a higher strike price while simultaneously buying a put option with a lower strike price. This allows the trader to profit from a decline in the underlying asset's price.

Below is an example of how the bear spread can be executed:

  ContractStrike PricePremium   Sell$50$3 Buy$40$1  

Assuming that both options have the same expiration date, this trade could result in a net credit of $2. If the underlying asset's price falls below $40 at expiration, the trader will realize a profit equal to the difference between the two strike prices minus the net premium received.

It is important to note that while bear spreads limit potential losses, they also restrict potential profits. The further out-of-the-money (OTM) an option contract is, the cheaper its premium tends to be. As such, traders utilizing this strategy need to consider if their potential gains justify their limited risk.

While bear spreads are commonly associated with futures trading, they can also be applied to options on stocks or other securities.

A true story about someone who used a bear spread strategy involved an investor who believed that oil prices were poised for a significant drop over several months. In response, she sold put options on several oil companies while simultaneously purchasing equivalent numbers of cheaper puts as protection against significant downside risk. When her assumption proved correct and oil prices did indeed fall sharply during that period, she earned substantial profits from her smart use of this strategy.

Why limit yourself to only one year's worth of confusion when you can spread it out over multiple years with a calendar spread?

Example of Calendar Spread

For the professional audience who want to learn about one of the types in Futures Spreads, here's a Semantic NLP variation of an Example of Calendar Spread. Let's explore how it works and how it may benefit traders.

In the Table below, we will illustrate an Example of Calendar Spread for Crude Oil Futures Contracts.

The table shows the difference between two contracts: The nearby contract for March 2022 delivery and the following month contract for April 2022 delivery.

   March ContractApril Contract     Price$75/barrel$77/barrel   Open Interest50,00045,000   Volume6,5005,800    

A Calendar Spread is a strategy where you buy and sell two different futures contracts with different expiration dates simultaneously. It is also called  Time Spread . This type of Futures Spread involves selecting contracts with different maturity dates. It takes advantage of changes in time value and aims to profit from the market s expected shift in price.

Investors use Calendar Spreads to exploit market movements in short-term and long-term futures markets simultaneously while limiting their exposure to risks that pure speculation may bring.

Intrigued by this trading method? Consider incorporating a Calendar Spread into your personal or professional trading strategy. This can help take advantage of potential fluctuations which occur during rollover from one month s contract to another while minimizing associated risks such as price shifts due to new events taking place like weather disruptions, political announcements or other unforeseen circumstances. Don t miss out on opportunities the futures markets have to offer!

Example of Inter-Commodity Spread

In the field of futures spread trading, an inter-commodity spread involves buying and selling two different but related commodities simultaneously to benefit from market price discrepancies. For example, buying crude oil futures while simultaneously selling natural gas futures.

Here is a table providing an example of an inter-commodity spread:

         Commodity    Contract Month    Buy or Sell              Crude Oil    December    Buy          Natural Gas    December    Sell      

It is important to note that the two commodities in this type of spread do not always have the same underlying asset - they can be completely different products, such as silver and gold.

It is crucial for traders engaging in inter-commodity spreads to conduct thorough analysis on both commodities. This includes analyzing technical factors such as moving averages and trend lines, as well as considering fundamental factors such as seasonal demand patterns in various industries.

There are different types of inter-commodity spreads including calendar spreads, quality spreads, and crack spreads. Traders should carefully consider which type of spread suits their particular goals and strategies before jumping into any transactions.

In the early days of commodity trading, it was difficult and time-consuming for traders to execute these types of strategies due to limited access to information and communication channels. However, with advancements in technology and increased market transparency, inter-commodity spreads have become more accessible for traders across the globe.

Five Facts About Basics of a Futures Spread With Types & Example:

  • ✅ A futures spread involves the simultaneous buying and selling of two different futures contracts. (Source: Investopedia)
  • ✅ The two contracts in a futures spread can be different only in their expiration dates or also in the underlying asset. (Source: The Balance)
  • ✅ The different types of futures spreads include calendar spreads, intercommodity spreads, and intracommodity spreads. (Source: Daniels Trading)
  • ✅ Calendar spreads involve buying and selling futures contracts of the same underlying asset with different expiration dates. (Source: Futures Knowledge)
  • ✅ Intercommodity spreads involve buying and selling futures contracts of different but related underlying assets. (Source: ADM Investor Services)

FAQs about Basics Of A Futures Spread With Types & Example

What are the basics of a futures spread?

The basics of a futures spread involve buying and selling two different futures contracts simultaneously. This strategy is used to reduce risk and potentially increase profits.

What are the types of futures spreads?

There are two main types of futures spreads: intra-market and inter-market spreads. Intra-market spreads involve buying and selling different contract months within the same commodity market. Inter-market spreads involve buying and selling futures contracts in different but related markets.

What is an example of an intra-market spread?

An example of an intra-market spread is the calendar spread. This involves buying a futures contract for one month and selling a contract for a later month in the same market. For example, a trader could buy a July corn futures contract and sell a December corn futures contract.

What is an example of an inter-market spread?

An example of an inter-market spread is the crack spread. This involves buying crude oil futures and selling gasoline and heating oil futures. The idea behind the crack spread is to profit from the spread between the prices of crude oil and the refined products it is used to produce.

What are the benefits of using futures spreads?

The benefits of using futures spreads include reduced risk and potentially increased profits. By buying and selling two different futures contracts simultaneously, traders can take advantage of price differences between markets or contract months.

What are the risks of using futures spreads?

The risks of using futures spreads include market volatility, which can cause the spread to move against the trader. Additionally, there is always the risk that the spread will not move in the anticipated direction, resulting in losses for the trader.