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3-Strategies Spreads Guy Bower
3-Strategies Spreads Guy Bower
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Acknowledgements
The charts in this eBook are kindly provided by eSignal. Over the
years, I have used many different systems. One I have kept is
eSignal. I absolutely love it. Thanks to Mina Delgado and all at
eSignal for their ongoing support.
Legal Information
Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of
future trading results. Information here is taken from sources believed to be reliable. We do not guarantee that such information is accurate or
complete and it should not be relied upon as such. There is no guarantee that the information given here will result in profitable trades. Only you
can take responsibility for your trading decisions. This document is meant as education, not advice.
Copyright 2009 Guy Bower. All Rights Reserved.
ProTrader LLC. 244 5th Avenue #2741. New York, NY 10001
ThreeLittleSpreadsWentToMarketGuyBower.com Page2
Contents
1. Introduction 4
2. MiniGlossary 5
3. Strategy#1:TheBullSpread 7
4. Strategy#2:TheBearSpread 9
5. Strategy#3:TheInterCommoditySpread11
6. Summation 13
7. AbouttheAuthor 13
8. BonusOffer 14
ThreeLittleSpreadsWentToMarketGuyBower.com Page3
INTRODUCTION
Mayyouliveininterestingtimes
ThisancientChinesecurseiswheeledouteverytimethestockmarketseesabitofvolatility.Ifitis
applicabletothestockmarket,thenitsneverbeenmoreapplicabletotheactionwehaveseenin
2008and2009.
Whatmakesitinterestingisnotsomuchthatthestockmarketsufferedmassivefallsorthatpeople,
unfortunately,lostmoneyinstocksandproperty,butinterestincommoditymarketspushedtoa
newhigh.
Theoffshoothasbeenmanypeoplearenowlookingpastthetraditionalassetclassesofproperty
andequities.Peoplearenowlookingatalternativesthatprovidediversification,liquidityandof
coursetheopportunitytoprofit.
Asaprofessionaltrader,Iseeimpactinthemarket.
MylittlenicheisgrowingandIpersonallythinkits
People are now looking
fantastic.Ifirststartedlearningaboutfuturesabout at alternatives that
20yearsagothankstoahighschoolexcursiontothe
SydneyFuturesExchange.SincethenIhavebeen
provide diversification,
hooked.Ihavesincebeeninvolvedinfuturesand/or liquidity and of course
optionsformostofthose20years.
the opportunity to profit.
Inthelastfewyears,andmoresointhelastyear,I
haveseenagrowinginterestincommoditytrading.ItsexcitingtoseeandIencourageeveryoneto
haveagoodlookattheopportunities.
ThatiswhatthiseBookisabout.Imintroducingthreerelativelystraightforwardstrategies.Theyare
allwhatyoucallspreads.Thatis,theyinvolvebuyingonefuturescontractandsellinganotherto
profitfromachangeinthepricedifferential.
Spreadtradingisverymuchaniche,butasthiseBookwillshowyou,itcanprovidesomefantastic
tradingopportunities.Iwillshowyouthreelittlestrategiesthatprofessionaltradersusefewothers
know.
Yes,thereissomejargonandyes,someconceptsmaymakeyouscratchyourhead,butplease
persist.Thesestrategiesarenotascomplexastheyfirstmayseem.Wearenottalkingrocket
scienceorcomplexmathematicshere.Themathematicsinvolvesadditionandsubtraction.
Soletsgetonwithit.Firstofall,IhaveputtogetherwhatIcallaminiglossary.Thesetermsare
particularlyrelevanttothefollowingdiscussion.Thenwelookatthethreespreadstrategies:thebull
spread,thebearspreadandtheintermarketspread.ThisisthegutsofthiseBook.Thenwelookat
wheretogetmoreinfoonhowtotradespreads.
ThiseBookisaimedatabeginnerlevel.However,someknowledgeoffuturestradingwouldbe
advantageous.
ThreeLittleSpreadsWentToMarketGuyBower.com Page4
MINIGLOSSARY
FuturesContract
Afuturescontractisacommitmenttomakeortakedeliveryofaspecificquantityandqualityofa
givencommodity[orasset]ataspecificdeliverylocationandtimeinthefuture.Alltermsofthe
contractarestandardizedexceptfortheprice,whichisdiscoveredviathesupply(offers)andthe
demand(bids).Thispricediscoveryprocessoccursthroughanexchangeselectronictradingsystem
orbyopenauctiononthetradingfloorofaregulatedcommodityexchange.
Allcontractsareultimatelysettledeitherthroughliquidationbyanoffsettingtransaction(a
purchaseafteraninitialsaleorasaleafteraninitialpurchase)orbydeliveryoftheactualphysical
commodity.Anoffsettingtransactionisthemorefrequentlyusedmethodtosettleafutures
contract.Deliveryusuallyoccursinlessthan2percentofallagriculturalcontractstraded.
Source:CME
Longposition
Buyingafuturescontractwithaviewofitincreasinginpricemeansyouhavealongpositionorare
longthemarket.
Bullish
Abullishviewmeansyouexpectthemarketpricetogoup.
Shortposition
Sellingafuturescontractbeforeyoubuyitiscalledgoingshortorshortselling.Thisconceptoften
confusesthenewcomerasthereflexthoughtisHowcanyousellsomethingyoudontown?
Thekeytogettingyourheadaroundthisoneistorememberfuturescontractsaresimply
agreementsorbetsonfutureprice,andaregenerallynotenteredwithaviewofdeliveringortaking
deliveryofthephysicalcommodity.
Toenterashortposition,youplaceanordertosellthefuturescontractorcontracts.Toclosethe
position,youplaceanordertobuythecontract(s)back.
Bearish
Abearishviewmeansyouexpectthemarketpricetogodown.
ExpiryorDeliverymonth
Allfuturescontractshaveafinitelife.Thatis,thereissomepointinthefuturewheretheyceaseto
trade.Anexchangewillmakeavailableanumberofexpirymonthsdependingondemandfor
trading.
ThreeLittleSpreadsWentToMarketGuyBower.com Page5
Somecontractscallforphysicaldelivery,somecallforcashsettlement,butveryfewpeoplekeep
tradinguntiltheexpirydate.Mostcontractsareclosedoutbeforehand,soactualdeliveryor
physicalsettlementisrare.
Margin
Whenyouenterintoafuturescontract,youdonotneedtopaytheentirecontractvalue.Instead
youarechargedadepositormargin.Thismarginvariesdependingontheparticularcontract.
Marginratestendtobeasmallfractionofthetotalcontractvalue.
FuturesBroker
Totradeinfuturescontractsyouneedafuturesbroker.Somestockbrokersmayhavefutures
tradingdepartmentsbuttherearealsomanybrokersthatofferfuturestradingonly.
Spread
InthecontextofthiseBook,aspreadisthesimultaneouspurchase(long)ofonecontractandsaleof
another(short)withaviewofprofitingfromachangeinthepricedifferential.
Toqualifyasaspread,thecontractshavetoberelated.Forexample,youcouldtakeonaspread
positionbybuying(goinglong)wheatandselling(goingshort)corn.
ThreeLittleSpreadsWentToMarketGuyBower.com Page6
STRATEGY#1:TheBullSpread
Thebullspreadconsistsoftwofuturescontractsonelong(bought)andoneshort(sold).Tocreate
abullspread,atraderwouldbuythenearertoexpirycontractandsellshortthedistantcontract.
Someexamplesofbullspreadsare:
Long(bought)Contract Short(sold)Contract
July2010Soybeans September2010Soybeans
October2009NaturalGas November2009NaturalGas
September2009Corn December2009Corn
Generallyspeaking,abullspreadisabullishposition.Thatis,thespreadisastrategyatraderwould
placewhenhe/sheisbullishonthemarket.
WhatMakesitaBullishPosition?
Theanswertothisoneisverysimple.Whenamarketrallies,itisnormallythenearercontractthat
leadstheway.Thatis,thecontractthatisclosertoexpirytendstomovefurtherthanthemore
distantcontract.Sobuyingthenearercontractandsellingthemoredistantcontractisabullish
strategy.
Asanexample,letshavealookatSoybeanMealovertheearlypartof2009.Thechartonthenext
pageshowsthepriceforDecemberSoybeanMealandthebullspreadpriceofDec2009lessJuly
2010SoybeanMeal.
YoucanseeabullmarketoccurredinbothSoybeanMealfuturesandthebullspreadaroundsame
time.
Inthemarket,traderscanusethespreadasanalternativetotradingasinglefuturesposition.There
areseveralreasonswhyaspreadmaybepreferred:
Significantlylowermargins.Thatis,itcostslesstoplacethetrade.
Reversalsinspreadscanoftenprecedereversalsintheunderlyingmarket.Thatis,the
spreadcanactasanearlywarningindicator.Thisisevidentinthechartabove.Ifyoulook
closelyatpoints1and2,youllseethespreadstartingandfinishingitsbullrunbeforethe
samemoveinthefuturescontract,madeamovehigher(point1)andcompletedtherally
(point2)beforethefutures.
Lowervolatility.Generallyspeaking,aspreadwillcarrylessvolatilityorriskthantrading
outrightfutures.Thiscanmakespreadsmoreattractivetothenewcomerorconservative
trader.
ThreeLittleSpreadsWentToMarketGuyBower.com Page7
Diversification.Lowermarginsmeansthetradercanspreadriskacrossmoretrading
positionsthanwouldbepossiblewhentradingoutrightcontracts.
WhenisaBullSpreadNotaBullishSpread?
Therearetimeswhentheunderlyingmarketmayrallyandthespreaddoesnotmoveinthesame
direction.Thescenariosinwhichthiscanhappendovaryfrommarkettomarket.
However,asageneralstatementitismoreoftennewsorfundamentalsupplyinformationthatwill
pushabullspreadhigherwhereasatechnicalorspeculatorledrallymaynotseethespreadmovein
thesamedirectionastheunderlyingfutures.
Whilethisconceptmayatfirstseemcomplex,itssimplyamatterofknowingwhatisdrivinga
certainmarket.Allthatisneededhereisagoodsourceoftradinginformationandmarketnews.
ThreeLittleSpreadsWentToMarketGuyBower.com Page8
STRATEGY#2:TheBearSpread
Likethebullspread,thebearspreadconsistsoftwofuturescontractsonelong(bought)andone
short(sold).Tocreateabearspread,atraderwouldsellshortthenearertoexpirycontractandbuy
thedistantcontract.
Someexamplesofbearspreadsare:
Short(sold)Contract Long(bought)Contract
July2010Soybeans September2010Soybeans
October2009NaturalGas November2009NaturalGas
September2009Corn December2009Corn
Youcanseethebearspreadissimplythereverseofthebullspread.Itstandstoreasonthatabear
spreadisabearishposition.Thatis,thespreadisastrategyatraderwouldplacewhenhe/sheis
bearishonthemarket.
Aswitharallyingmarket,whenamarketisinabeartrend,thenearercontracttendstoleadthe
way.Assuchabearspreadisanalternativetoanoutrightshortposition.
Justlikethebullspread,tradercanpreferabearspreadinabearmarketforreasonsoflower
margins,lowerrisk,betterdiversificationpotentialandthefactaspreadcansignalaturninthe
underlyingmarketaheadoftime.
Soletslookatanexample.ThefollowingpageshowsthesameSoybeanMealchartasthatinthe
bullspreadexample.NotethespreadisplottedasDec(near)lessJuly(far).Withthebearspread,
beingshorttheDec(near)andlongtheJuly(far)contracts,thetraderwouldwanttoseethisspread
falltomakeaprofit.
ThethingtoseeinthischartisthefallinthespreadastheoutrightDecembercontractfalls,as
shownbythetwoarrows.
AWordonMargins
Asmentionedearlier,onereasontradersliketotradespreadsisthelowermarginrequirements.In
theSoymealexample,amarginforanoutrightfuturescontractwouldbe$2000.Fortheabove
spread,itwouldbe10percentofthat,or$200.Thatsabigdifference.
Nowwhilethespreadhaslessvolatilitythanthefuturescontract,thespreadstillgivesyoufarmore
bangforyourbuck.Ofcoursethatcanworkforyouoragainstyoudependingonwhatthemarket
does,butitremainsanattractivefeatureofspreadtrading.
ThreeLittleSpreadsWentToMarketGuyBower.com Page9
GreatMarketsforTradingBullandBearSpreads
Thislistisbasedonexperienceandgeneralopinion.Theremaywellbemarketsnotlistedherethat
offergoodspreadtradingopportunity.
Energies:
CrudeOil,HeatingOil,NaturalGas
Grains:
Wheat,Corn,Soybeans,SoybeanOil,SoybeanMeal
Metals:
Copper
Food&Fibre:
Cocoa,Coffee,Sugar
Financials:
Eurodollars,Tbonds,Tnotes
Livestock:
FeederCattle,LiveCattle,LeanHogs
ThreeLittleSpreadsWentToMarketGuyBower.com Page10
STRATEGY#3:TheInterCommoditySpread
Ourthirdtypeofspreadisanintercommodityspread.Itisaspreadbetweentwodifferentbut
relatedmarkets.
ConsidermarketssuchasWheatfuturesandCornfutures(below).Theyaresimilarcommodities
(beinggrains)andthepricesarerelated.Amoveinonemarketcanmovetheother,buttheydonot
moveoneforone.Thiscreatesspreadtradingopportunities.
Consideranothertwomarkets:LiveCattlefuturesandLeanHogfutures(below).Botharelivestock
bredforhumanconsumption.Bothfuturesmarketscanmoveinline,buttheycanalsohaveunique
influences.Thiscreatesspreadtradingopportunities.
AnotherexampleisSilverandGold(notpictured).Botharepreciousmetalsandassuchtendto
moveinlinewitheachother.Buttherearealsoinfluencesthatareuniquetoeachmarket.This
createsspreadtradingopportunities.
ThreeLittleSpreadsWentToMarketGuyBower.com Page11
Thereareessentiallythreetypesofintercommodityspreads:
1. Spreadsbetweenrelatedcommodities.Allexamplesabovefallunderthiscategory.
2. Spreadsbetweenacommodityanditsderivatives.AnexampleisSoybeansversusSoybean
OilandSoybeanMeal.TheOilandMealisderivedfromSoybeans.AnotherexampleisCrude
OilversusHeatingOilorUnleadedGas.HeatingOilandGasisderivedfromCrude.
3. Thethirdtypeofintercommodityspreadisspreadingthederivativesasoutlinedabove.An
exampleisSoyOilversusSoyMeal,orHeatingOilversusUnleadedGas.Thepricesofthese
contractsarerelatedbuttherelationshipdoesvaryandthereforespreadtrading
opportunitiesexist.
Soletslookatanexample.OnespreadIenjoytradingisLiveCattleversusLeanHogs.Asmentioned
above,botharelivestockbredforhumanconsumption.
Ononehandtheyareinterchangeablefoods.Ifthepriceofporkchopsistoohigh,youmaybuybeef
steaksinsteadforexample.However,therearealsosomedifferences.Pork,forexample,isusedto
makeprocessedmeats.Theseporkproductshavedifferentdemandcharacteristicsfrombeef
products.
Assuch,wehavetworelatedbutdifferentfuturescontracts.Thereinliesthetradingopportunity.
Forexample,duringtheUSsummerholidayanddrivingseason,demandforprocessedmeatspicks
uprelativetobeefproducts.Conversely,duringwinter,demandforbeefproductstendstobe
stronger.
Itstheshiftinrelativedemand(orsupply)thatcreatesaseasonalvariationinthespreadprice.
Generallyspeaking,thefuturescontractswillstartpricingintheseendproductdemandpatterns
wellaheadoftime,butwithawelltimedtrade,itispossibletomakemoneyfromthesepatterns.
FactsAboutInterCommoditySpreads:
Intercommodityspreadstendtobealittlemoreriskythanthekindofbullandbearspreads
welookedatearlier.
Marginsarestilllessthanoutrightfuturesmargins,butmorethanbull/bearspreadmargins.
Thereisgenerallymoreprofitpotentialfromanintercommodityspreadsthanabullorbear
spread.Thisisnotalwaysthecase,butitismoreoftenthannot.
ThreeLittleSpreadsWentToMarketGuyBower.com Page12
GreatMarketsforTradingInterCommoditySpreads
Metals:
GoldSilver
FinancialSpreads:
Combinationsof5yrnote,10yrnoteand30yrbond.
Grains:
CombinationsofWheat,CornandSoybeans
SoybeansCrush(Soybeans,SoyOilandSoyMeal)
Livestock:
CombinationsofFeederCattle,LiveCattle,LeanHogs
EnergyMarkets:
CrackSpreads(Crude,HeatingOil,UnleadedGas)
ThreeLittleSpreadsWentToMarketGuyBower.com Page13
SUMMATION
ThiseBookpresentedthreespreadtradingstrategies.Thesearepopularstrategiesamongmany
professionalandveterantraders.
Despitethelowriskprofilerelativetotradingoutrightfutures,veryfewnewcomersknowofthese
strategies.Theglobalfinancialcrisishoweverisdrivingchange.Privatetradersarestartingtolook
beyondtheequityandpropertyinvestmentsandfocusonopportunityinsteadoftradition.
Thisiswherespreadtradingcancomealive.SpreadtradingofferssomegreatopportunityandI
hopethisshorteBookwillwhettheappetiteofsomenewtradersoutthere.
ABOUTTHEAUTHOR
GuyBowerhasbeeninvolvedinthefinancialmarketsforcloseto20
years.
Hehasworkedasananalyst,broker,authorandwasadirectorofa
managedfuturesfund.Hehasstartedandownedacommoditybroking
businessandtradingadvisoryservice.HehasalsobeenaCEOofastock
brokerandfundsmanagementbusiness.
GuynowrunstheProTraderDigestnewsletter.Usingknowledgeand
experience,hedelivershighprobabilitytradingopportunities.
ThreeLittleSpreadsWentToMarketGuyBower.com Page14
BONUSOFFER
For readers of this eBook, I am offering a 10% discount on the monthly subscription
rate of us$199/month. To take up this offer, go to www.ProTraderDigest.com and
when prompted type in the code: ebook. This offer is limited.
Its that easy. However if you have more questions, please email at the address
below. Best regards and good trading!
Disclaimer
Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of
future trading results. Information here is taken from sources believed to be reliable. We do not guarantee that such information is accurate or
complete and it should not be relied upon as such. There is no guarantee that the information given here will result in profitable trades. Only you
can take responsibility for your trading decisions. Copyright 2009 Guy Bower. All Rights Reserved.
ProTrader LLC. 244 5th Avenue #2741. New York, NY 10001
ThreeLittleSpreadsWentToMarketGuyBower.com Page15