TYPES OF SPREADS

INTER-COMMODITY SPREADS

Not to be confused with intra-commodity spread (buying one month and selling another in the same commodity), inter-commodity spreads are formed from two distinct but related commodities, reflecting the economic relationship between them.

Some common examples are:

• The crack spread between crude oil and gasoline, reflecting the premium charged to refine oil into gasoline
• The spark spread between natural gas and electricity, for gas-fired power stations

CALENDAR SPREADS

Calendar spreads are executed with legs differing only in delivery date. They price the market expectation of supply and demand at one point in time relative to another point.

A common use of the calendar spread is to “roll over” an expiring position into the future. When a futures contract expires, its seller is nominally obligated to physically deliver some quantity of the underlying commodity to the purchaser. In practice, this is almost never done; it is far more convenient for both buyers and sellers to settle the trade financially rather than arrange for physical delivery. This is most commonly done by entering into an offsetting position in the market.

For example, someone who has sold a futures contract can effectively cancel the position out by purchasing an identical futures contract, and vice versa.

The contract expiry date is fixed at purchase. If a trader wishes to hold a position in the commodity beyond the expiration date, the contract can be “rolled over” via a spread trade, neutralizing the soon to expire position while simultaneously opening a new position that expires later.

BUTTERFLY SPREADS

Butterfly spreads are complex futures spreads that combine a near term bull spread with a longer-term bear spread in order to profit from a change in term structure.

Futures butterfly spreads are a complex spreading strategy in futures trading. Futures butterfly spreads are used by traders when they are of the view that mid-term futures prices are going to drop while short-term and long-term futures prices are going to remain stagnant or rise. These term structure changes are generally related to seasonal factors i.e. Commodities…

While futures bull spreads and bear spreads use only futures contracts from two different expiration months, futures butterfly spreads use futures contracts from three different expiration months. In fact, futures butterfly spreads are a combination of a bull spread and a bear spread with the short leg centred on the same calendar month. This forms a futures position with two long wings and one short body, which is how the name “Butterfly Spread” was coined.