Intramarket spreads -- sometimes called calendar, horizontal or time spreads -- are an important part of futures markets because they allow traders to take positions on the expected value of assets at different points in time. An intramarket spread is composed of a long position in one contract month and a short position in another contract month in the same futures market on the same exchange. Here are three things you should know before trading a spread between two futures contracts in the same market:
1. Intramarket spreads offer reduced margins
If you have an outlook on the relative value among futures for some commodity or financial asset, trading the corresponding intramarket spread allows you to gain the desired exposure through a position that has reduced margin requirements. The difference in margin requirements can be substantial, and can allow traders with smaller accounts to access products that otherwise might be too large. For example, assume you have a bullish outlook on near term wheat. The initial margin required to buy a wheat contract outright is currently $2,700. However, a trader who buys the nearest wheat contract and sells the next closest contract has an initial margin requirement of just $338.
2. Intramarket spreads are less volatile than outright contracts
A calendar spread can offer an investor sensitivity to changes in the price of an asset with reduced volatility, since the spread tracks changes in the relationship between the two contracts, rather than the price of the asset itself. For instance, an investor who is short the near term sugar no. 11 futures will incur a point-for-point loss if sugar prices rise. However, if she is short the near term contract and long a further-dated contract, the risk to the position would be if the near term contract rose in price more than the further-dated contract. Since the difference between futures at different expirations is typically a small fraction of the outright value of those contracts, spread prices are less volatile.
3. The reason to trade intramarket spreads: term structure and carry.
The reason to trade an intramarket spread is that you have the view about the shape of the term structure of prices. If you expect the nearest contract to rise (fall) in value relative to the rest of the curve, you can buy (sell) that contract and take the opposite position in a further-dated contract to profit from the change in the relationship.
Take our previous wheat example, and assume you have reason to expect a supply shortage that is unanticipated by the market. If the shortage occurs, the price of wheat might jump significantly. But the change in the price of a calendar spread will depend also on the expected duration of the shortage. Imagine that we are long December 2013 futures and short May 2014 futures, and that the supply disruption is expected to be resolved fairly quickly. The December contract would be expected to rise by a much greater amount than the May contract would rise (if it rises at all), since the supply problem would only be expected to affect customers taking delivery soon. In that situation, the potential return on margin for an intramarket spread could be significantly larger than the corresponding return to an outright position.
Another catalyst that can drive a calendar spread is a change in the cost of carry. Remember that we know from the spot-futures parity relationship that the price of a given futures contract is determined by the spot price of the asset plus the cost of carry. The spread between two futures contracts will rise and fall with corresponding changes in the carrying cost, so a trader who can successfully predict those changes will best exploit that outlook using an intramarket spread.
OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits
Jared can be followed on Twitter at twitter.com/CondorOptions
Check Out Our Best Services for Investors
Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts
Check Out Our Best Services for Investors
David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
Every recommendation goes through 3 layers of intense scrutinyquantitative, fundamental and technical analysisto maximize profit potential and minimize risk.
Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.