Teach me about trading spreads (futures)

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drm7
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Teach me about trading spreads (futures)

Post by drm7 » Fri Jul 22, 2011 11:11 pm

Moderator's note: Split off from parent to eradicate the scourge of the meandering thread.

Going on a different tack here, but does anyone on here trade spreads (futures not options)? Nothing exotic, but calendars, crack spreads in energy, etc. The liquidity (especially in energy) is pretty good, and they seem to trend as much as their single contract cousins (with low correlation).

Adding a few spreads could be a good way to gain diversification without having to scour the globe for obscure, illiquid commodities.

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Post by Chris67 » Sat Jul 23, 2011 3:52 am

where are you seeing these spreads traded with volume of some desription or are you synthetocally designing your own ?
c

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Post by rhc » Sat Jul 23, 2011 4:34 am

This is not really answering the question but . . . . . . ,

When I’m getting near to the date where I roll a contract from one delivery month to the next delivery month I always like to plot a chart of the spread. (i.e calendar spread) just to see what I can see.
I notice that, depending on the trend of the spread, sometimes it’s more advantageous to roll way before the designated roll date and other times it pays to wait until the last possible minute before rolling. (like OJ, where lately the currently traded month has been strongest)
It’s not get-rich-quick stuff & of course it doesn’t always work out and I’m only talking differences of a few tens & a few hundred dollars, but hey, I’ll take a hundred if I can.
(key word being ‘IF’)

I can’t help but think that there must be some way to make this more systematic such that it can be tested & used as an aid to rolling
Anyone got any non-trade secret ideas?

See, I told you I wasn’t answering the question.

Oh, one last thing.
Has anyone done a search on spreads in the Blox forum?. Not many posts to be found.
Also there’s not that many books on spreads around either.
I get the impression that spreads are seen as kind of nerdy (think ‘poindexter’)
It seems that very few operate in this field and perhaps that’s a good reason to investigate it further.

Like user ‘drm7’ above, I would be interested to hear comments from others.

Should this be a new thread? Perhaps?
Last edited by rhc on Sat Jul 23, 2011 4:45 am, edited 1 time in total.

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Post by rhc » Sat Jul 23, 2011 4:40 am

Chris67 wrote:where are you seeing these spreads traded with volume of some desription or are you synthetocally designing your own ?
c
Chris, Hi,
IB has a tool called Spread trader which trades, well, . . . spreads.
(I'm sure most online brokers would do the same)
It seems quite an active market with better bid and ask prices that what you would get if you traded the individual futures contracts
(i.e. Buy the calender spread in one hit rather than individually Buying the next future and selling the current future)

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Post by drm7 » Sat Jul 23, 2011 9:14 am

Chris67 wrote:where are you seeing these spreads traded with volume of some desription or are you synthetocally designing your own ?
c
Here is a link to the CME site which shows the activity in light crude calendar spreads for Friday's trading day:

http://www.cmegroup.com/popup/SpreadPop ... e&ggtype=f

The spreads are traded as a single contract (although you pay commissions on each "leg") and are executed via a nifty matching engine at minimal slippage. I don't have much direct experience with them, but have been doing more research recently.

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Post by Chris67 » Sat Jul 23, 2011 11:31 am

unless I'm being stupi (highly likely I know) - there is no CSI price data to backtest for these - so although the volume looks okay and Im sure that they trend and are tradable - you dont really know how they perform over the long tern unless a) you have collected the data yourself b) you crudely work it out on excel using the daily closing prices subtracted from each other and hope that at MOO you managed to do something similar ?

Not criticising as it sounds liek a very interetsing piece of anlaysis / work to do and I may crack on !!!! with it asap

C

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Post by rhc » Sat Jul 23, 2011 7:02 pm

Chris67 wrote: . . . there is no CSI price data to backtest for these . . . .
You have to make your own Spread price series by subtracting one delivery month with another.
I believe CSI supplies you with the individual contracts such that you can make your own back adjusted continuous futures charts. So you would use these same individual contracts to make your spread charts.
(You don't have to collect the data yourself, you already have it and all you need do is manipulate it)

For example, I took the CLOSING Prices from the Aug 2011 Lean Hogs contract and subtracted from it the CLOSING prices from the Oct 2011 Lean hogs contract.
The result is shown below.
(Note: I chose LH simply because it is rolling in the next day or so)
Attachments
LH_Aug-Oct Spread.jpg
LH_Aug-Oct Spread.jpg (113.71 KiB) Viewed 7759 times
Last edited by rhc on Mon Jul 25, 2011 4:57 am, edited 1 time in total.

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Post by Jez Liberty » Sun Jul 24, 2011 6:17 am

Chris67 wrote:unless I'm being stupi (highly likely I know) - there is no CSI price data to backtest for these - so although the volume looks okay and Im sure that they trend and are tradable - you dont really know how they perform over the long tern unless a) you have collected the data yourself b) you crudely work it out on excel using the daily closing prices subtracted from each other and hope that at MOO you managed to do something similar ?

Not criticising as it sounds liek a very interetsing piece of anlaysis / work to do and I may crack on !!!! with it asap

C
I believe some of the large CTAs (Transtrend, BlueTrend, etc.) do trade spreads as a way to get extra diversification and funnily enough, I am reading a piece on Ray Dalio right now and it has the following in it:
Dalio is a consistent hitter of singles and doubles—the José Reyes of Wall Street. Among the bets the Pure Alpha fund placed last year were long positions in Treasury bonds, the Japanese yen, and gold, and short positions in the euro and European sovereign debt. A potential problem with this type of global investing is that these days many markets move in the same direction, which makes it hard to achieve real diversification. Bridgewater’s solution is to place a lot of “spreadâ€
Attachments
Screen shot 2011-07-24 at 15.35.23.png
Screen shot 2011-07-24 at 15.35.23.png (69.78 KiB) Viewed 7713 times

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Post by drm7 » Sun Jul 24, 2011 3:02 pm

Another interesting place to use spreads is trade management. There was an interesting discussion on this forum back when Cotton went parabolic and everybody was debating whether or not to take profits, since the price was WAY above most people's stops.

I was reading Joe Ross's book TRADING SPREADS AND SEASONALS, and he described how position traders he knew would "spread out" their outright positions instead of closing them. So, in the case of Cotton, instead of selling your position, you would go short the next month's contract. If the current month collapses, the back month would at least partially follow, easing the impact on the equity curve.

One client of Mr. Ross's supposedly maintained a 100 contract long position in T-Bonds for 5 years by shorting either the back month or the T-Note contract to manage his position.

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Post by rabidric » Mon Jul 25, 2011 3:24 am

that joe ross advice is terrible, just terrible. imho ofc.

Years ago i used to trade various yield curve spreads and butterflies, and some index spreads too. Whilst legging in and out of spreads is ok for a scalper who is using microstructure to his advantage, legging longer term positions was generally a really bad idea, and nearly always got you in trouble.
if you are gonna trade a spread, then trade a spread. otherwise you are probably just doing something stupid like locking in a bad spread price and will watch it then get worse...

got a problem with your outright? adjust the open position size.

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Post by Chris67 » Mon Jul 25, 2011 3:32 am

DRM 7 - Im afraid I think thats very dangerous stuff too !! appreciate the post but the world of spreads is absolutely fraught with quotes such as x contact pukes so y will follow or vice versa - they selfdom do what their meant to do

One other point on the synthetically created spreads using CSI EOD data on the 2 contracts - how do you know intra day highs and lows ? You cannot work it out since the high on one contract cannot be assumed to have hit at the same time as teh high on another ?

C

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Post by rhc » Mon Jul 25, 2011 5:03 am

Chris,
I have edited my post above as follows;

From:
For example, I took the Aug 2011 Lean Hogs contract and subtracted from it the Oct 2011 Lean hogs contract.
To:
For example, I took the CLOSING Prices from the Aug 2011 Lean Hogs contract and subtracted from them the CLOSING prices from the Oct 2011 Lean hogs contract.
As far as other price fields such as HIGH & LOW are concerned;
On Friday 22/07/2011

Aug. Contract
O = 98.40
H = 101.10
L = 98.40
C = 100.825

Oct. Contract
O = 90.875
H = 93.175
L = 90.575
C = 92.575

Spread (Aug-Oct)
O_Spread = 7.525
H_Spread = 7.925
L_Spread = 7.825
C_Spread = 8.250

****************

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Post by Moto moto » Mon Jul 25, 2011 5:09 am

i am with rabidic and others on this one..... unless you are trading spreads they are a whole other beast - and while money can be made, we always joked in equities - you get half the profits for twice the risk.
Obviously futures spreads are different as you have the same underlying, but unless you really understand how these move you can get seriously hurt.
Even in stocks - RIO Australia, RIO UK - for years people have said how it has to stay close as its the same instrument - well if I remember it was around 4-5%, now at last check some one says its out to 25% - I never traded it but know plenty who did and lost - unless of course they traded with the trend of the spread :)

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Post by Chris67 » Mon Jul 25, 2011 5:16 am

RHC - thanks
My point is that I do not believe you can take away one intra day monthly high from another contract intra day high and derive the high for the spread on the day - or am i missing something - you dont know when during teh day each contract hit hits high/ low and if not at the same time it will be spread high / low is not accurate

Thanks
C

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Post by sluggo » Mon Jul 25, 2011 8:54 am

One of the Market Wizards (Gil Blake?) used 100% mechanical systems to trade mutual funds. And yet mutual funds don't have an Open or a High or a Low price, just a Close. If he can trade mutual funds with only a Close price to work with, maybe he can trade spreads too.

Consider simple system A:

Code: Select all

RULE_1: If (Close(today) > Highest(Close, Ndays)) then reverse to long tomorrow at market on Close
RULE_2: If (Close(today) < Lowest(Close, Ndays)) then reverse to short tomorrow at market on Close
which uses only the Close price and implements a breakout strategy.

Or perhaps simple system B:

Code: Select all

RULE_1: If (SMA(Close, 50) > SMA(Close,200)) then reverse to long tomorrow at market on Close
RULE_2: If (SMA(Close, 50) < SMA(Close,200)) then reverse to short tomorrow at market on Close
which trades the golden cross double moving average strategy using Close prices only.

Maybe you prefer simple system C:

Code: Select all

RULE_1: If (RSI(30) > 75) then reverse to long tomorrow at market on Close
RULE_2: If (RSI(30) < 25) then reverse to short tomorrow at market on Close
which uses Welles Wilder's Relative Strength Index. A bit of googling will prove or disprove my claim that RSI uses the Close only; no Opens or Highs or Lows.

If your broker will accept price orders for Spread trades, you might decide that you prefer slightly-less-simple system A*:

Code: Select all

RULE_1: Reverse to long tomorrow at price (Highest(Close, Ndays) + 1 tick), Stop Close Only
RULE_2: Reverse to short tomorrow at price (Lowest(Close, Ndays) - 1 tick), Stop Close Only
which is a breakout system that trades on the day of the breakout rather than on the day after.

I am certain that a motivated and clever spread trader could invent dozens and dozens of these. For example I feel sure that you could replace the volatility indicator "Average True Range" (which uses the Open, High, and Low prices) with some other indicator of volatility that only uses the Close. If, that is, you are a motivated hard worker.

I wonder whether any bloggers will be desperate enough for "new content" that they republish these ideas -- time will tell. . . . +SLUGGO+

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Post by rhc » Mon Jul 25, 2011 9:14 am

Chris,
‘Spread’ just means the difference between one item and another & when measured over time it’s an indication of how much something is underperforming or outperforming something else.

Using the Hogs example from above;
If, today, Aug. Hogs move to a new contract high and Oct. Hogs do not, then we know Aug. is stronger than Oct. on that day.
They don’t have to both make new highs in order to construct the spread chart.
Remember it’s just the difference in prices regardless of whether one is high and the other is not.

From the chart images below, the Aug. contract made a new high close at 100.825 but the Oct. contract did not, it closed at 92.575 (which was below its high of 7 days ago) . . . . but that doesn’t matter since as we said above that the spread just means the difference between the 2 items and in this case the difference is 100.825 minus 92.575 = 8.25.

If yesterdays spread value was, say, 7.25 then we can say that the Aug contract is stronger (i.e. outperforming) the Oct. contract.
If yesterdays spread value was 9.25 then Aug. is weaker since it lost ground relative October.
Attachments
LH_Q and V.jpg
LH_Q and V.jpg (133.43 KiB) Viewed 7532 times

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Post by Jez Liberty » Mon Jul 25, 2011 10:37 am

Chris67 wrote:RHC - thanks
My point is that I do not believe you can take away one intra day monthly high from another contract intra day high and derive the high for the spread on the day - or am i missing something - you dont know when during teh day each contract hit hits high/ low and if not at the same time it will be spread high / low is not accurate

Thanks
C
Chris,

We briefly touched on this topic when we met for the London TB meeting you organised a couple of years ago - and we did discuss this exact same issue (ie you can only use the spread closing "price" - but as sluggo points out, we can still design systems around this "limitation").

The subject was actually raised by two of your acquaintances, running an emerging TF fund in London (their name/fund name escape me). They were planning to investigate trend following on spreads, on the assumption that they would be much less likely to all correlate to +/-1 when the proverbial hits the fan - and therefore provide more "robust diversification" (same idea as in Ray Dalio's article). I have not kept in touch with them, but it might be interesting to hear their practical experience on this (if you did keep in touch...).

This has been on my list of future ideas to research/test ever since but I have not gotten round to it yet!..

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Post by rhc » Mon Jul 25, 2011 5:39 pm

sluggo wrote:I wonder whether any bloggers will be desperate enough for "new content" that they republish these ideas -- time will tell. . . . +SLUGGO+
Imitation is the sincerest form of flattery . . . . apparently

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Post by svquant » Thu Jul 28, 2011 7:20 pm

Jez:

Just an opinion from what I can see - don;t read too much into the New Yorker article and what they say about how Bridgewater trades. I have seen much more financially and hedgefund savvy publications get what goes on under the hood 100% wrong. Either they were purposely misled or fed a partial or "for example" story which is then treated more like a fact. I have no real knowledge of what is or isn't under the hood at Bridgewater.

On Transtrend they do state they trade spreads as mentioned and it appears to be more interest rate and possibly stock index driven. This is going from memory based some old documents I had (can't find them now).

Bond/IR spreads are of course very large and liquid markets to trade as are stock indexes. Of course fx is always a spread trade. This fits well with both funds mega-size.

There are a few commodity funds that do trade only spreads (well at least according to their marketing documents). Look up Emil van Essen.

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Post by Jez Liberty » Fri Jul 29, 2011 2:11 am

Thanks svquant - I definitely agree with the general dose of skepticism one should apply to "second-hand" information, like this one. :wink:

It does seem to make sense to include more "exotic" markets, less correlated to a portfolio though - and as drm7 says:
Adding a few spreads could be a good way to gain diversification without having to scour the globe for obscure, illiquid commodities.
We know that Amaranth went down because of a big move on seasonal spreads - some Trend Followers like Transtrend might have been able to be at the other end of the trade. Maybe Roundtable members could have been too!

I also suspect that some more sophisticated rolling methodologies used by large Trend Following CTAs might take into account intra-market spreads during roll-over time - exactly as rhc is suggesting to roll earlier/later - especially to benefit from temporary distortions created by long-only commodity funds (who roll at fairly set intervals - apart from a few like DB Optimal Yield, which you actually pointed me to last year...).

Disclaimer: talk is cheap... This is not really something I have tested/verified yet (this thread might push me to look into this sooner and report on the results here...) - and one can only speculate on what the big CTAs actually do in that department... Would be interested to read these documents you mention (if you can find them).

Thanks for the hint on Emil van Essen.

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