Track 'n Trade Futures End of Day Spreads
Types of Spreads
In this section, we want to talk about the different types of Spreads. Probably, one of the most difficult components of Spread trading is knowing the different terminologies. I'm just going to quickly read down through these three different terminologies, and then we'll discuss them.
An Intra-Market, or Delivery Spread: This type of Spread entails the simultaneous purchase of one delivery month and the sale of another delivery month of the same commodity on the same exchange. That's the key, right there. The same commodity on the same exchange. An example would be: Buying March Cotton and selling July Cotton on the New York Cotton exchange.
Then, we have an Inter-Market or Inter-Exchange Spread. This type of spread entails the simultaneous purchase of a given commodity and a delivery month on one exchange and the sell of the same commodity and delivery month on a different exchange. An example would be: buying March Wheat on the Chicago Board of Trade Symbol W, and selling the March Wheat on the Kansas City Board of Trade, which is their symbol KW.
Then, we have Inter-Commodity Spreads. This type of spread entails the simultaneous purchase of one commodity and delivery month and the sale of another different, but related commodity with the same or similar delivery month. An example would be: Buying the August Lean Hogs and Selling August Live Cattle. These are two different commodities.
Scott: I have a heck of a time remembering these names. I tend to get confused between Intra and Inter, I think of them as the delivery spread. The delivery spread makes sense to me in that you are looking at one delivery month vs. another delivery month of the same commodity. For example: Let's look at a July December Wheat Spread. Let's pull one up here.
Lan: Okay. Wheat, Wheat.
Scott: This is your typically this is your least risky of all of your commodities spreads. You look at the amount of movement there, and it wasn't terribly huge. It's the least risky, it's also the most common spread. These are the ones that have the highest liquidity in them. Very easy to place orders in, the whole nine yards. It's probably the easiest one to understand as well.
Scott: Now, the next one that we have the Inter-Market. I call them exchange spreads.
Lan: It makes sense because you're going between two exchanges. I think your definition, I think the Inter-Market and Intra-Market and Inter-Commodity Spreads are kind of the industry acronyms for these things. Then, you have gone in and Scott has thrown in this delivery and Inter-Exchange to try to help us understand the definitions a little bit better. I think Inter-Exchange Spread makes a lot more sense than just simple Inter-Market Spreads.
Scott: Exactly, because what you're doing is for example- the most common exchange spread out there is the Chicago Board of Trade Wheat vs. the Kansas City Board of Trade Wheat, which is soft bread winter wheat vs hard red winter wheat. They're both wheat, you know, we're trading the same commodity, but they are on two different exchanges and they represent two different classifications of wheat. Soft red, hard red. They're grown in different regions, they're different crops, but they all end up kind of being flour, cakes, and cookies, and Wheaties. The last, you can look at that spread, that's a very..
Lan: There are some other, like Silver and Silver.
Lan: 1,000 Silver and the Standard Silver on the CBOT.
Scott: Exactly, you can look at a whole bunch of other, and I'm not-
Lan: But those are pretty much dried up. We're limiting now, basically the inter-market wheat.
Scott: Right, that's about our only... inter-market spread that we have.
Lan: It's kind of limited to the wheat markets at this point, right?
Scott: Yeah, you used to be able to do a lot more of them. You used to be able to trade Euro Dollars on the CIMAX vs. Euro Dollars in the MERCK. Now they're mutually offsetting. I can call up in the middle of the night, if I'm having trouble sleeping and buy some Euro's on, (and I mean the interest rate Euro's not that currency), but I can buy Euro's on the CIMAX and then in the morning, sell them on the Chicago and I have no position. They mutually offset each other. That has happened a lot with the exchange partnerships, or you just look at..
Lan: So that's why the inter-market or the Inter-Exchange Spreads are kind of limited down into just the Wheat markets.
Scott: Right, and we have the three week markets. The Kansas City Board of Trade, Chicago Board of Trade, and Minneapolis Grain Exchange.
Lan: The last of the Inter-Commodity Spreads.
Scott: Right, and these are what I just shorten to as a commodity spread. This is too similar, but different Futures contracts.
Lan: So, this is where you can get the Live Cattle, and maybe the Lean Hogs.
Scott: Exactly, they're both meat. Slap them both on the bbq, but a cow is different than a pig.
Lan: But we don't do, we don't do Live Cattle and T-Bonds.
Lan: That wouldn't be an inter-commodity spread.
Scott: By the definition, they're not similar. Really, there's another way of looking at it.
Lan: Are corn and live cattle similar? Live cattle eat corn.
Lan: Are they similar? Would that be considered an inter-commodity spread?
Scott: That is a spread that people watch. The difference there is, we have exchange recognized spreads and non-exchange recognized spreads. What I mean by exchange recognized is you get the margin break. A very popular inter commodity spread is the corn wheat spread. It's heavily traded. It's not exchange recognized.
Lan: You don't get the break on the..
Scott: Right, if you're going to buy some wheat and sell some corn against it, you're paying full boat on the wheat and full boat on the corn.
Lan: Margins both sides.
Scott: Take a look at the inter-commodity spreads, here. Why don't we pull up the list of the inter-commodity spreads. These are at the time we're doing this, these are the exchange recognized spreads. Like anything else that has to do with margins, it can change. I can remember getting a break for the Corn Wheat Spread. No break anymore, not recognized, the correlation between the two of them disappears. The correlation isn't high enough, the exchange doesn't recognize it.
You'll notice within these that everything is within a group. We have the basic groupings that..
Lan: So, this is where you get your similarity? So, that's why I can't cross T-Bonds with Live Cattle.
Scott: Right, because T-Bonds are in the financials, you know, or I would even call them in the interest rate group. While Cattle is a Livestock. We see that when you sort your, when you can sort everything within Track 'n Trade.
Lan: We have the groups and these are the groups, basically that you're finding in the software.
Scott: If you're looking at doing a commodity spread within a group, there may be one. Notice that one of the groupings is missing from this list.
Lan: The softs.
Scott: Exactly, and the softs...we all kind of throw them together. Typically if you're an analyst, you're given the grains, the meats, petroleum's, metals, and then they just kind of throw all the softs at you. But really...
Lan: How is Cotton and Orange Juice similar? They're not, but they're both softs.
Scott: Exactly, we don't have anything else to call them. So.. we'll call them softs. Food and fiber- tropical. I've heard them referred to a dozen different ways. The only thing they tend to have in common is they're a trade in New York and coffee, sugar, and cocoa exchange. They're all on the same exchange. We can all have them all for breakfast, put syrup on our chocolate chip pancakes, and have a cup of Joe with it.
Lan: I like to sprinkle a little cotton on top of my..
Scott: A linen tablecloth.
Lan: I was going to say, you can't eat your cotton.
Scott: And you drink your glass of OJ. But these are also your most risky spreads. You're looking at, as we talked about in another section, you're looking at one out-performing the other. Typically what you see is if you buy July Corn, or July Wheat, say July Chicago Board and you sell December Board of Trade Wheat. If the Wheat market rallies really hard, they're both going to go up.You're just hoping if you bought July, it goes up more than December.
Now, if you're trading the Cattle Hogs spread, and hoof and mouth disease breaks out cattle might go up and hogs might go down. You could see Hogs limit down and cattle limit up. If you're long cattle and short hogs, that's beautiful thing. But if you're long hogs and short cattle and both are locked limit against you... ouch!
Lan: So, it's more likely that these markets will go in different directions, where if you're doing a delivery spread, then it's more likely if there's underlying fundamental pressure to go one direction, both contracts are going to go that direction.
Scott: Exactly, and I would almost throw within the delivery spreads, you know, looking at old crop and new crop and almost consider them to be kind of toned down inter-commodity spreads. I still they're toned down, but they can move in different directions. You typically don't see one locked limit one way, and the other locked limit the other way. There's story of that happening, I want to say back in 71 and it took down a 150 year old Grain trading firm. They were short the July beans and long the November beans and July beans lock limit up and November beans lock limit down and did it for a couple of days.
You can really tell the amount of risk involved to a good extent or get a good judge by it of the amount of margin that you have to post. Margin is a reflection of risk. As we go through the list, your delivery spreads have the least amount of margin requirement, typically. Then, you get into your inter-market, or your inter-exchange spreads, (I can't even remember what to call them)! Inter-exchange spreads, they go a little more and then you get into your inter-commodity spreads and of course they have the highest.
Lan: Because of the highest risk.
Scott: If we looked at the Cattle Hogs spread, you know, why don't we take a look at that.
Lan: I think we have that up here. Yeah, Cattle Hogs spread.
Scott: You can see that..
Lan: It's a little bit more volatile, a little more movement.
Scott: Yeah, you know, we're looking at that market picking up 7 cents.
Lan: That distance, that's a $3,800.00 move. That's a spread, a spread move, a $3,800.00 spread move. That's pretty big.
Scott: Exactly! This one moves. Look at that little spike there. Okay, now, even.. I was going to say, the other side, which is fell a little faster than it rose. How many days is that?
Lan: 11 trading day, approximately.
Scott: 2 weeks and $3,000.00. That's trading an outright, almost.
Lan: That's the kind of movement you would see in a direct futures contract.
Scott: Yeah, and you'll see that the margin on that, let's just say that, you know, the margin for cattle is $800.00 and the margin for hogs is $800.00. So, if you have no benefit of a decreased margin, you would be $1,600.00 to initiate that position. In an initial margin, what you're going to see in an initial margin on that instead of $1,600.00, you might see somewhere around $1,200.00. You get a break. It's more than just trading cattle, it's more than just trading hogs, but it's less than trading the two without the benefit of a break.
Lan: If we go back and look at the Wheat, Wheat, you can see basically the same time period. You have this move in here, it's only $262.00, in approximately a 10 day move.
Scott: Exactly, you can get the idea of between the different types, the level of risks, and level of reward that are possible.
Lan: I just have to say, this software is great!
Scott: Yeah, I'm extremely impressed with it. Really, I don't know if anybody listening to this ever has traded Spreads and they're kind of coming in with an interest already. I find it very difficult to find, but you go out and you try to find the spread charts, and it's very difficult.
Lan: And to find good ones, and the ones that are doing it correctly. We found several on the internet that are doing it incorrectly.
Scott: Yeah, there are- we'll get further into this in another segment but just as there are different types of spreads, there are different ways of charting them. Especially when you're dealing with commodities that have different tic sizes. Contract sizes, but we'll get into that in a another video. Another example would be Live Cattle Feeder Cattle. But there's a way of charting that, so you can look at it, and it makes sense, then I can't find it out on the internet. Trust me, I've looked really hard.
Lan: Which is, you know, part of the major reason why Scott is here with us, is he's a large part of the development of this piece of software, so we appreciate his help in making it happen.
Scott: The other really neat thing is the Spread charts that you can find out there, nobody will allow you to put indicators on them, draw on them, do all the wonderful things. Not to mention, to have all the spread information available right at your fingertips, so you can go back and you can test out your ideas, you can quote on quote count them. Then, see if somebody is saying that you know April Cattle, tends to gain on the deferred months of the beginning of the year; you read that in an article somewhere, you know, you can open up your Track 'n Trade. Is this guy just spitting up, you know, talking out the left side of his mouth?
Lan: Which happens a lot in this industry, we've found.
Scott: Yeah, that happens way more than...
Lan: People will take assumptions and rumors and expound on them and suddenly they're gospel. Then, you pull up your Track 'n Trade software to prove what he just said, and it's like, wait a second, yeah, 50%/50% of the time.
Scott: Right, or wow, that's really neat, that works fantastic in the Cocoa market, but gosh, if I apply it to the Corn market and it...
Lan: Blows me out of the water! DEAD! This is a good tool.
Scott: It's a fantastic tool, and all the hard work that has gone into it is definitely paid off.