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Spreads Introduction

Video Transcript

Lan: Welcome to Track 'n Trade Pro Spreads Plug-In and Educational CD-Rom. My name is Lan Turner, I'm the president of Gecko Software. I'm sitting here with a gentleman by the name of Scott Barry, he's the president of CFEA, Commodity Futures Equities & Analytics. He's a research firm, he comes from a research firm. Where we hire Scott out to help us make sure we're doing everything correctly.

Scott is an expert in the field, and of course, I want to make sure that when we do the educational side of Spreads, we want to do things correctly and give you the best information we can possibly can. So, I'm going to ask Scott a few questions, basically what are Spreads, why you would want to trade them, and how you make money trading Spreads. So, we've gone through and done a lot of development, the software developers have done a good job of creating this Spreads Plug-In into Track 'n Trade Pro. We've worked really hard along side of Scott.

We have a wonderful product here that's going to give us all another tool, for hopefully making money in the Futures market. Scott, simply put, what are Spreads?

Scott: A Spread position is a bet that one contract will outperform another. It involves a long position in one futures contract and a short position in another or similar futures contract. Either within the same market or a different market.

Lan: Now, I have to ask the question, Scott, if I am buying one corn contract and I'm selling another corn contract, how do I make any money in that? That's a zero sum gain, isn't it? To an extent you may be right, there. Except that we have within corn, we have different crop years, and you have a passing amount of time. So, you're not really buying corn when you're doing a futures contract, you're buying the right to buy corn in May, or July. Then, the one you're selling is you're selling Corn in December.

What's going to happen to the price of corn in between July and December? We kind of think of them both the same Corn. They're actually different Corns, it's old crop and new crop. But we're also going to see a bit of today's perception of prices in July vs. today's perception of prices in December going on there. That would be what we call intra-market, or a delivery spread. That's probably the most common type of spread that there is. They don't move nearly as much as a straight futures contract, or an outright position would. But you know, there's definitely movement. Why don't we take a look at a the software and let's just pull up a July 2002 Corn contract.

Lan: Okay, Corn 2002.

Scott: July, we'll buy that.

Lan: We're going to buy on the first one.

Scott: We'll buy a one lot.

Lan: And we'll sell on the second one.

Scott: Yes, let's sell a contract of corn.

Lan: You want to sell which one? 2002 December. So, we're not actually buying a July contract of corn and selling a July contract of Corn. We're buying a July contract and selling a December contract.

Scott: Exactly!

Lan: So, the difference between the two is not the price of the underlying commodity, but the difference between the price of the July and the December contract. That's what we're charting.

Scott: Right.

Lan: We're not charting corn prices, we're charting the difference between corn contracts.

Scott: Yes, and that's a very important point to make. We're looking at the spread and not the price of the underlying commodity. If we look at that, and why don't we increase the scale on it a little bit? You can see, it doesn't move a whole lot. That's a nice slow and steady downtrend.

Lan: Often times, that's the reason why you might want to trade a spread, because it's a much slower moving type of product. It's not as volatile.

Scott: Exactly! Look at trading futures, we tend to look at a long term trade, or a position trade or in futures, is somebody that holds for 2 or 3 weeks, or a month.

Lan: You're a long term trader, aren't you?

Scott: I remember being down on the trading floor and I was called position trader, and you know, I held for a half an hour. Long term trade, 10 minutes. Yeah, you know look at that move there, that is a 5 month move- but it's only.. $300.00?

Lan: Yeah, $235.00 from point to point.

Scott: It's a 5 cent move in corn.

Lan: $400.00 from top to bottom. That's over a period of what? 1, 2, 3, 4, 5, 6 months.

Scott: Yeah, you know, it's an 8 cent move in the price differential, but it's a hedged position. You trade this from a much longer term standpoint, because they are a nice, slow, gentle trends to them. Or at least some type of spreads, there are other spreads that will get you excited.

We could look at the same spread, but on the soybean market. I mean, the corn market is a stayed market, anyway. Why don't we take a look at a July/November Soybean spread?

Lan: Okay, 1S2002N:1S2002X.

Scott: For November.

Lan: I'm going to center that chart. That's good, we have a big move there at the end.

Scott: That's kind of giving you an idea here.

Lan: So, we're zoomed way in. Let's zoom out a little bit. Still, that's quite a move.

Scott: The Soybean market moves. We're all familiar with that, and this is the, this is the Pork Belly market. This is the equivalent to trading Pork Bellies of the intra-market or delivery spreads.

Lan: So, this s a volatile product, right here.

Scott: Yes.

Lan: But still, it's a $2,000.00 move over a period of what, 1, 2, 3, 4 months.

Scott: Exactly!

Lan: And what are the margins on these, Scott?

Scott: That is another benefit of trading spreads, is when you trade an exchanged recognized spread, and all of the intra-market like July to November Soybeans, those types of spreads or delivery spreads are all exchange recognized. And you get a big margin break. This margin break for this spread, let's assume that the soybean margin is $800.00. You might pay $300.00 in initial margin for this spread.

You're going to get a savings, you're going to have initial margin requirements of 25%-35%. Maybe at most 50%. I do have to state that in some spreads like the July November spread, there are times where you will not get a margin break. Even though it is exchange recognized. But looking at this spread, look at it- it is a very volatile spread.

Lan: Basically, our risk vs. our reward, we have less of a risk and we have less of a reward.

Scott: Exactly, this is slowing everything down.


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