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Futures Dictionary Series: Futures Spread

In the sixth installment of our Futures Dictionary Series today, we are going to explain a term that is important for futures traders to know and you might have probably heard of: futures spread.

Futures Spread

Futures spread is a speculative trading strategy of simultaneously buying and selling futures contracts. The goal is to profit from the price difference between the purchase price and the selling price of the futures contracts. This price difference is known as spread.

There are generally two types of futures spread:

(1) Intracommodity Spread
Also known as time spread or calendar spread, intracommodity spread involves buying (going long) and selling (going short) the same futures contract with different delivery months. In other words, a futures trader longs one contract month and shorts another contract month of a particular commodity on an exchange. For example, you long FBM KLCI futures (FKLI) November 2012 contract and short FBM KLCI futures (FKLI) June 2013 contract.

(2) Intercommodity Spread
Intercommodity spread involves buying a futures contract and selling a different futures contract that is economically related to the contract that you buy.

How Futures Spread Works

To see how futures spread works, let’s say at the beginning of this month, you bought one lot Crude Palm Oil futures (FCPO) January 2013 at RM3200 and sold one lot Crude Palm Oil futures (FCPO) February 2013 at RM3210. The price difference or spread between the two contracts is -10.
[3200 – 3210 = -10]

According to your analysis, the price difference will be more than RM10. By the end of this month, the price of Crude Palm Oil futures (FCPO) January 2013 has risen to RM3240 and Crude Palm Oil futures (FCPO) February 2013 is RM3220. Therefore the price difference or spread between the two contracts is +20.
[3240 – 3220 = +20]

To take profit, you sell the Crude Palm Oil futures (FCPO) January 2013 and buy the Crude Palm Oil futures (FCPO) February 2013. By closing both contracts, you gain +30 points in spread and realize a handsome profit of RM750.

Futures Dictionary Series: Futures Spread

Why Trade Futures Spread?

Futures traders use spreading for a number of reasons such as:

(1) To make profit from the difference between the purchase price and the selling price of two futures contracts.

(2) Futures spread is considered less risky than outright positions as it minimizes the risk associated with external factors that can affect commodity prices.

(3) Futures traders pay lower margins and commissions because futures spreads are less volatile thus enabling them to get greater return on investment (ROI).

That’s all for today. Have a profitable trading!

Read more of our past Futures Dictionary Series:

1. Futures Dictionary Series: Approved Delivery Facility
2. Futures Dictionary Series: Capital Market Services Representatives (CMSR)
3. Futures Dictionary Series: Actuals
4. Futures Dictionary Series: At The Market
5. Futures Dictionary Series: Back Months

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