Teach me about trading spreads (futures)

Discussions about the testing and simulation of mechanical trading systems using historical data and other methods. Trading Blox Customers should post Trading Blox specific questions in the Customer Support forum.
Jez Liberty
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Post by Jez Liberty » Fri Jul 29, 2011 3:01 am

Just found an interesting article on Emil Van Essen, who indeed trade spreads - mostly "rollover arbitrage"-type spreads on commodity (profiting from "dumb money" ETF index funds rolling every month) - LINK
At its base level, the Van Essen program looks to take advantage of the fact that futures based ETFs will have to roll their large positions before each contract delivery date by selling the nearer month contract which the ETF will have to sell in a few weeks time, and buying the further out contract which the ETF will have to buy at that time. This is called Rollover Arbitrage

At the more advanced level – the rollover arbitrage isn’t as easy as it may sound above, and how exactly Van Essen plays this Rollover Arbitrage is what they believe to be their edge – not the fact that rollover arbitrage is possible.

For Van Essen, they typically enter their spread trade (usually selling the nearer month and buying the further out month) several months prior to the nearer month’s expiration, and usually exit at least one month before expiration of the nearby contract. Exiting the trade before the last month of trading is done in an attempt to avoid the potentially dangerous moves that spreads often make just prior to expiration. Some special situation trades may last a few weeks to as little as a few days.
Van Essen’s greatest success over the past two to three years has been as a, “diversifierâ€

sluggo
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Post by sluggo » Fri Jul 29, 2011 8:13 am

Personally, I think the most informative article about Emil van Essen's spread trading is the one in Futures magazine, when they gave him a "Top Trader of 2009" award.

See page 4 of http://www.futuresmag.com/Issues/2010/M ... -2009.aspx . . . EMIL VAN ESSEN: FRONT RUNNING THE FRONT RUNNERS

svquant
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Post by svquant » Fri Jul 29, 2011 9:37 am

Yes sluggo that is a good article and for the Goldman-roll that is the current game, i.e. front running the dumb money (simple front runners) that front running the even dumber money (indexes).

There are a few other spread only traders out there of which a few are fully systematic although most just use technical analysis as an input to a more discretionary and fundamentally driven approach.

While some people discount academic works there was a recent paper which showed that trading a portfolio of calendar spreads via a momentum rule was as to more profitable then trading the outright instrument with the same momentum (trend) rule.

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Post by mojojojo » Fri Jul 29, 2011 11:58 am

svquant wrote: While some people discount academic works there was a recent paper which showed that trading a portfolio of calendar spreads via a momentum rule was as to more profitable then trading the outright instrument with the same momentum (trend) rule.
Do you have a link to that paper?

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Post by svquant » Fri Jul 29, 2011 6:15 pm

"Market Efficiency and the Risks and Returns of Dynamic Trading Strategies with Commodity Futures" by Lorne N. Switzer and Hui Jiang. The January 2010 version is the latest from what I know. Interesting, might have some flaws for the real world, but gets me thinking and doing my own research and backtesting.

Also if my memory does not fail me Lars Kestner in his Quantitative Trading Strategies book did some testing of spreads with trend and non-trend models. For the instruments & spreads he looked at the trend models did not perform well.

If you use your favorite search engine and put in such terms a "crack spread" or "crush spread" you will find many papers discussing trading methodologies and algorithms. Most of these papers use mean reverting strategies to trade - think standard deviation bands.

Let us know if you come across anything that excites you or is of interest and tempt us to fire up the old search engine.

Edit: Who put that paper there? Does it have "tradinglox.com" watermark on it like others in the forums?
Attachments
EFMA2010_0135_fullpaper.pdf
Switzer and Jiang
(433.23 KiB) Downloaded 239 times

SimJimons
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Post by SimJimons » Mon Aug 01, 2011 10:02 am

It is obviously not possible to create spread-bars (OHLC) using daily data. However, as several of you have pointed out, this is not a very big limitation for the average trendfollowing trader since a) a breakout from the close is more or less as powerful as a breakout from the high/low, b) ATR isn't the only measure of risk (stdev comes to mind :) )

We do spreads, even if it's not to the extent I would like, and they can definitely add to diversification. However, which someone pointed out, it's a very different beast than outright positions. Very often you end up with a more or less mean reverting time-serie when you cross two trending instruments. Hence, crossing every instrument with each other and trade them all is not a viable approach. Consequently, trading spreads increases the level of datamining since we have to pick only certain spreads to remain profitable in backtests (and live). This is the tricky part. We try to solve this by finding some kind of economic relationship between the instruments in the spread, which may explain a potential trend behavior (if we want to trendfollow, that is). Still, this is dangerous stuff.

In addition to the above, spreads come with a tricky decision how to risk adjust the legs, if at all. And depending on what you decide, the outcome will be different. Thus, spreads introduce an almost endless number of possibilities to overfit the system. Very interesting area, but also very dangerous.

A slightly less scary road to take (since the possibilities are much fewer) is to do "relative value" trades, which essentially is the same as portfolio wide, or sub-portfolio wide, spreads.

Just my 2 cents...

rabidric
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Post by rabidric » Mon Aug 01, 2011 10:48 am

your 2 cents are good, and agree with what i found over the years too. In the end , for me, i just decided to stay away from them, as i am happier with outrights and the often clearer momentums observed.

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