Question about calendar spreads

[rog1111]

Hi all

A question for all you spread traders out there.

Suppose for the same commodity, the nearby contract is trading at a premium to the next one out, and I initiate a short/long spread in anticipation of the premium disappearing in the near future.

If I haven't already closed out the position approaching expiration of the nearby, because the premium is still there, or even higher, is there any specific financial risk I face at the time of expiration ? If I try to rollover the position, is there anything I have to watch out for or prepare for in advance that could cause large losses ? What concerns me is that, after expiration, the price relationship between the new nearby and new next one out might be substantially different to the old. Does this (often) happen in reality ?

Thanks in advance

rog1111

 

[Moneycat]

Unless you want to deliver, your broker might ask you to close your short leg after first notice, which could be several days before expiration.

Rolling your position to the "next" spread is like taking a quite new position in a different spread, so you should take care that fundamentals and technicals still show the same patterns.

 

[rog1111]

So in this example, I really need to wait until the premium is high enough so that by expiration (rather than some arbitrary time in future), it should have reduced enough to show a profit. Otherwise I will just end up taking a loss on the spread at expiration time.

I was wondering whether there is often manipulation of the front contract prices, waiting for the nearby to go off the board first, before the premium is unwound ?

rog1111

Unless you want to deliver, your broker might ask you to close your short leg after first notice, which could be several days before expiration.

Rolling your position to the "next" spread is like taking a quite new position in a different spread, so you should take care that fundamentals and technicals still show the same patterns.

 

[oatman]

You must know the commodity you are spreading. The delivery rules vary between markets. If you're long running into spot you could expect higher deposits and you may be delivered. Then you must sell your long or pay to carry each day you hold on. Near or spot positions are often squeezed or otherwise manipulated. It's equally dangerous to be short. You must know where the physical is, stock figures, who owns it, who needs it, and what they're likely to do. If you're not prepared to take additional risk you should liquidate before the "fun and games" begin.
good luck

 

[TWI]

When it comes to non cash settled futures it really is best practice to be out before first notice day. Believe me, you do not want the hassle. If you are trading a spread then before the front month comes into notice you should get out of both legs of the spread. It is not a good idea to roll a spread forward as relationship between the next two months may be totally different to the spread you originally had on. Unless of course independent analysis of the spread you are rolling into shows it is value.

 

[rog1111]

OK thanks all for the replies. The conclusion therefore is that I have to patiently wait for the premium to be way out of the ordinary, rather than just in positive territory, before initiating the spread, and then to exit before first notice. Essentially this means trying to predict timing of the premium reduction rather than just direction.

rog1111

 

[Moneycat]

OK thanks all for the replies. The conclusion therefore is that I have to patiently wait for the premium to be way out of the ordinary, rather than just in positive territory, before initiating the spread, and then to exit before first notice. Essentially this means trying to predict timing of the premium reduction rather than just direction.

rog1111

Timing AND direction.

The fact that the front month quotes at a premium vs. back ones doesn't mean that you can sell it and be sure to make a profit. This kind of inverted market, that doesn't take into account cost of carry, might last for long time and therefore is not something you should trade on.

This is especially true if you are planning to trade the front month.

It might be better to put under close observation the same kind of relationship when it happens between contracts with long residual life. In this case, your chances to see the normal market structure to resume are higher.

However, all spreads are to be scrutinized for timing AND direction; also, all spreads are diffrent from each other, you shouldn't assume that all spreads between (say) Wheat and Corn behave in the same manner, no matter their expiration.

Spreads are certainly a nice way to trade, but you should try to use at least the same techniques you use to trade outrights; Certainly not less.

 

[rog1111]

OK thanks. I guess that my next step is to check out the spread values historically for the commodities in question. Futuresource is not great for this, as the scales are slightly offset for the different contracts, making a visual appraisal of the spread very difficult. Any suggestions for suitable spread charting or spread data ?

rog1111

 

[rog1111]

I see that my last post was at 11:11. No surpise really.....

rog(11:11)

OK thanks. I guess that my next step is to check out the spread values historically for the commodities in question. Futuresource is not great for this, as the scales are slightly offset for the different contracts, making a visual appraisal of the spread very difficult. Any suggestions for suitable spread charting or spread data ?

rog1111

 

[-oo0(GoldTrader)]

Backwardation

A question for all you spread traders out there.

Suppose for the same commodity, the nearby contract is trading at a premium to the next one out, and I initiate a short/long spread in anticipation of the premium disappearing in the near future.

Assuming you are talking about storable, redeliverable commodities, not financial futures. You are probably talking about a condition called Backwardation

Backwardation
A market condition in which a futures price is lower in the distant delivery months than in the near delivery months.

Why do you expect the premium to disappear?

If I haven't already closed out the position approaching expiration of the nearby, because the premium is still there, or even higher, is there any specific financial risk I face at the time of expiration?

The will be an additional cost if you take delivery.

If I try to rollover the position, is there anything I have to watch out for or prepare for in advance that could cause large losses?

Slippage for sure. But I think you are confused. Is there Backwardation in the next spread also?

What concerns me is that, after expiration, the price relationship between the new nearby and new next one out might be substantially different to the old. Does this (often) happen in reality ?

Depends on the commodity, you can tell by looking at the charts Backwardation is not normal.

 

[-oo0(GoldTrader)]

Testing

So, in this example, I really need to wait until the premium is high enough so that by expiration (rather than some arbitrary time in future), it should have reduced enough to show a profit.

If it has done so previously. You are pretty much on your own. You have better do your homework. Since its inception how many times has this strategy worked on these contracts?

Otherwise I will just end up taking a loss on the spread at expiration time.

You better hope it does not close two days outside of your available capital before then, or you may not be around at the end.

wondering whether there is often manipulation of the front contract prices, waiting for the nearby to go off the board first, before the premium is unwound ?

What happened the last time the premium was not unwound?

 

[-oo0(GoldTrader)]

History

you should liquidate before the "fun and games" begin.

Look at the previous price history. What happened since the contract started trading.

 

[-oo0(GoldTrader)]

Scale trading

The conclusion therefore is that I have to patiently wait for the premium to be way out of the ordinary, rather than just in positive territory, before initiating the spread, and then to exit before first notice. Essentially this means trying to predict timing of the premium reduction rather than just direction.

If you are going to try to profit by the convergence of the contracts. Figure out where the upper and lower area of the range is. Scale in resting orders to get in. Once in, place resting orders to get out.

Essentially this means trying to predict timing of the premium reduction rather than just direction.

Is this the way it always is?

Can you imagine any situations where you start in negative territory, then increase to zero?

 

[-oo0(GoldTrader)]

Return

OK thanks all for the replies. The conclusion therefore is that I have to patiently wait for the premium to be way out of the ordinary, rather than just in positive territory, before initiating the spread, and then to exit before first notice.

I would think that you should learn all that you can about backwardation and hang on until prices return to Contango.

Contango A condition in which distant delivery prices for futures exceed spot prices, often due to the costs of storing and insuring the underlying commodity, opposite of backwardation.

 

[-oo0(GoldTrader)]

Chart books

I guess that my next step is to check out the spread values historically for the commodities in question.

You stepped in it. Maybe you can find someone who already has chart books printed up that has the historical perspective that you will require.

Any suggestions for suitable spread charting or spread data?

Earl Haddady use to make charts suitable for finding convergence, but I don’t know anymore. Why don’t you email Jerry at Moore Research? They may have done studies like that, for one of the exchanges.

 

[-oo0(GoldTrader)]

one day loss

Unless you want to deliver, your broker might ask you to close your short leg after first notice, which could be several days before expiration.

As soon as you lift a leg you are no longer in a spread. Naked you will need much more margin. You can lose in a day what took months to gain with the spread.

Rolling your position to the "next" spread is like taking a quite new position in a different spread

This is something that has not been settled. It has to depend on what you think you are doing. If you are trading a six month seasonal trend using a series of shorter spreads with higher liquidity contracts. Then rolling over contracts might still be called trading the same seasonal spread, even though they are different contracts. So, you could be taking a position in the same spread.

 

[-oo0(GoldTrader)]

Use everything you know

Spreads are certainly a nice way to trade, but you should try to use at least the same techniques you use to trade outrights; Certainly not less.

Chart patterns, divergence, cycles, luck etc.

 

[rog1111]

Gold Trader

Thanks for your comments. Think I'll stick with GBP & YM outrights for the time being.

rog1111

 

[TWI]

Don't give up on spreads. They have some real advantages in commodities over the outrights, you just need to be sure ot be out well before FND.