You are on page 1of 15

GUY BOWER

Web Resources
Daniels Trading offer comprehensive, reliable
and customer-focused commodity futures
brokerage services to address all trading
preferences.

Their website is also a great place for


educational resources on anything relating to
futures trading.

Check it out at: www.danielstrading.com

My personal site GuyBower.com has loads of free


resources on futures, options and spread trading
including free videos and articles.

See www.GuyBower.com

Acknowledgements
The charts in this eBook are kindly provided by eSignal. Over the
years, I have used many different systems. One I have kept is
eSignal. I absolutely love it. Thanks to Mina Delgado and all at
eSignal for their ongoing support.

Legal Information
Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of
future trading results. Information here is taken from sources believed to be reliable. We do not guarantee that such information is accurate or
complete and it should not be relied upon as such. There is no guarantee that the information given here will result in profitable trades. Only you
can take responsibility for your trading decisions. This document is meant as education, not advice.
Copyright 2009 Guy Bower. All Rights Reserved.
ProTrader LLC. 244 5th Avenue #2741. New York, NY 10001

ThreeLittleSpreadsWentToMarketGuyBower.com Page2

Contents

1. Introduction 4
2. MiniGlossary 5
3. Strategy#1:TheBullSpread 7
4. Strategy#2:TheBearSpread 9
5. Strategy#3:TheInterCommoditySpread11
6. Summation 13
7. AbouttheAuthor 13
8. BonusOffer 14

ThreeLittleSpreadsWentToMarketGuyBower.com Page3

INTRODUCTION
Mayyouliveininterestingtimes

ThisancientChinesecurseiswheeledouteverytimethestockmarketseesabitofvolatility.Ifitis
applicabletothestockmarket,thenitsneverbeenmoreapplicabletotheactionwehaveseenin
2008and2009.

Whatmakesitinterestingisnotsomuchthatthestockmarketsufferedmassivefallsorthatpeople,
unfortunately,lostmoneyinstocksandproperty,butinterestincommoditymarketspushedtoa
newhigh.

Theoffshoothasbeenmanypeoplearenowlookingpastthetraditionalassetclassesofproperty
andequities.Peoplearenowlookingatalternativesthatprovidediversification,liquidityandof
coursetheopportunitytoprofit.

Asaprofessionaltrader,Iseeimpactinthemarket.
MylittlenicheisgrowingandIpersonallythinkits
People are now looking
fantastic.Ifirststartedlearningaboutfuturesabout at alternatives that
20yearsagothankstoahighschoolexcursiontothe
SydneyFuturesExchange.SincethenIhavebeen
provide diversification,
hooked.Ihavesincebeeninvolvedinfuturesand/or liquidity and of course
optionsformostofthose20years.
the opportunity to profit.
Inthelastfewyears,andmoresointhelastyear,I
haveseenagrowinginterestincommoditytrading.ItsexcitingtoseeandIencourageeveryoneto
haveagoodlookattheopportunities.

ThatiswhatthiseBookisabout.Imintroducingthreerelativelystraightforwardstrategies.Theyare
allwhatyoucallspreads.Thatis,theyinvolvebuyingonefuturescontractandsellinganotherto
profitfromachangeinthepricedifferential.

Spreadtradingisverymuchaniche,butasthiseBookwillshowyou,itcanprovidesomefantastic
tradingopportunities.Iwillshowyouthreelittlestrategiesthatprofessionaltradersusefewothers
know.

Yes,thereissomejargonandyes,someconceptsmaymakeyouscratchyourhead,butplease
persist.Thesestrategiesarenotascomplexastheyfirstmayseem.Wearenottalkingrocket
scienceorcomplexmathematicshere.Themathematicsinvolvesadditionandsubtraction.

Soletsgetonwithit.Firstofall,IhaveputtogetherwhatIcallaminiglossary.Thesetermsare
particularlyrelevanttothefollowingdiscussion.Thenwelookatthethreespreadstrategies:thebull
spread,thebearspreadandtheintermarketspread.ThisisthegutsofthiseBook.Thenwelookat
wheretogetmoreinfoonhowtotradespreads.

ThiseBookisaimedatabeginnerlevel.However,someknowledgeoffuturestradingwouldbe
advantageous.

ThreeLittleSpreadsWentToMarketGuyBower.com Page4

MINIGLOSSARY

FuturesContract
Afuturescontractisacommitmenttomakeortakedeliveryofaspecificquantityandqualityofa
givencommodity[orasset]ataspecificdeliverylocationandtimeinthefuture.Alltermsofthe
contractarestandardizedexceptfortheprice,whichisdiscoveredviathesupply(offers)andthe
demand(bids).Thispricediscoveryprocessoccursthroughanexchangeselectronictradingsystem
orbyopenauctiononthetradingfloorofaregulatedcommodityexchange.

Allcontractsareultimatelysettledeitherthroughliquidationbyanoffsettingtransaction(a
purchaseafteraninitialsaleorasaleafteraninitialpurchase)orbydeliveryoftheactualphysical
commodity.Anoffsettingtransactionisthemorefrequentlyusedmethodtosettleafutures
contract.Deliveryusuallyoccursinlessthan2percentofallagriculturalcontractstraded.
Source:CME

Longposition
Buyingafuturescontractwithaviewofitincreasinginpricemeansyouhavealongpositionorare
longthemarket.

Bullish
Abullishviewmeansyouexpectthemarketpricetogoup.

Shortposition
Sellingafuturescontractbeforeyoubuyitiscalledgoingshortorshortselling.Thisconceptoften
confusesthenewcomerasthereflexthoughtisHowcanyousellsomethingyoudontown?

Thekeytogettingyourheadaroundthisoneistorememberfuturescontractsaresimply
agreementsorbetsonfutureprice,andaregenerallynotenteredwithaviewofdeliveringortaking
deliveryofthephysicalcommodity.

Toenterashortposition,youplaceanordertosellthefuturescontractorcontracts.Toclosethe
position,youplaceanordertobuythecontract(s)back.

Bearish
Abearishviewmeansyouexpectthemarketpricetogodown.

ExpiryorDeliverymonth
Allfuturescontractshaveafinitelife.Thatis,thereissomepointinthefuturewheretheyceaseto
trade.Anexchangewillmakeavailableanumberofexpirymonthsdependingondemandfor
trading.

ThreeLittleSpreadsWentToMarketGuyBower.com Page5

Somecontractscallforphysicaldelivery,somecallforcashsettlement,butveryfewpeoplekeep
tradinguntiltheexpirydate.Mostcontractsareclosedoutbeforehand,soactualdeliveryor
physicalsettlementisrare.

Margin
Whenyouenterintoafuturescontract,youdonotneedtopaytheentirecontractvalue.Instead
youarechargedadepositormargin.Thismarginvariesdependingontheparticularcontract.
Marginratestendtobeasmallfractionofthetotalcontractvalue.

FuturesBroker
Totradeinfuturescontractsyouneedafuturesbroker.Somestockbrokersmayhavefutures
tradingdepartmentsbuttherearealsomanybrokersthatofferfuturestradingonly.

Spread
InthecontextofthiseBook,aspreadisthesimultaneouspurchase(long)ofonecontractandsaleof
another(short)withaviewofprofitingfromachangeinthepricedifferential.

Toqualifyasaspread,thecontractshavetoberelated.Forexample,youcouldtakeonaspread
positionbybuying(goinglong)wheatandselling(goingshort)corn.

ThreeLittleSpreadsWentToMarketGuyBower.com Page6

STRATEGY#1:TheBullSpread
Thebullspreadconsistsoftwofuturescontractsonelong(bought)andoneshort(sold).Tocreate
abullspread,atraderwouldbuythenearertoexpirycontractandsellshortthedistantcontract.

Someexamplesofbullspreadsare:

Long(bought)Contract Short(sold)Contract

July2010Soybeans September2010Soybeans

October2009NaturalGas November2009NaturalGas

September2009Corn December2009Corn

Generallyspeaking,abullspreadisabullishposition.Thatis,thespreadisastrategyatraderwould
placewhenhe/sheisbullishonthemarket.

WhatMakesitaBullishPosition?

Theanswertothisoneisverysimple.Whenamarketrallies,itisnormallythenearercontractthat
leadstheway.Thatis,thecontractthatisclosertoexpirytendstomovefurtherthanthemore
distantcontract.Sobuyingthenearercontractandsellingthemoredistantcontractisabullish
strategy.

Asanexample,letshavealookatSoybeanMealovertheearlypartof2009.Thechartonthenext
pageshowsthepriceforDecemberSoybeanMealandthebullspreadpriceofDec2009lessJuly
2010SoybeanMeal.

YoucanseeabullmarketoccurredinbothSoybeanMealfuturesandthebullspreadaroundsame
time.

Inthemarket,traderscanusethespreadasanalternativetotradingasinglefuturesposition.There
areseveralreasonswhyaspreadmaybepreferred:

Significantlylowermargins.Thatis,itcostslesstoplacethetrade.

Reversalsinspreadscanoftenprecedereversalsintheunderlyingmarket.Thatis,the
spreadcanactasanearlywarningindicator.Thisisevidentinthechartabove.Ifyoulook
closelyatpoints1and2,youllseethespreadstartingandfinishingitsbullrunbeforethe
samemoveinthefuturescontract,madeamovehigher(point1)andcompletedtherally
(point2)beforethefutures.

Lowervolatility.Generallyspeaking,aspreadwillcarrylessvolatilityorriskthantrading
outrightfutures.Thiscanmakespreadsmoreattractivetothenewcomerorconservative
trader.

ThreeLittleSpreadsWentToMarketGuyBower.com Page7

Diversification.Lowermarginsmeansthetradercanspreadriskacrossmoretrading
positionsthanwouldbepossiblewhentradingoutrightcontracts.

WhenisaBullSpreadNotaBullishSpread?

Therearetimeswhentheunderlyingmarketmayrallyandthespreaddoesnotmoveinthesame
direction.Thescenariosinwhichthiscanhappendovaryfrommarkettomarket.

However,asageneralstatementitismoreoftennewsorfundamentalsupplyinformationthatwill
pushabullspreadhigherwhereasatechnicalorspeculatorledrallymaynotseethespreadmovein
thesamedirectionastheunderlyingfutures.

Whilethisconceptmayatfirstseemcomplex,itssimplyamatterofknowingwhatisdrivinga
certainmarket.Allthatisneededhereisagoodsourceoftradinginformationandmarketnews.

ThreeLittleSpreadsWentToMarketGuyBower.com Page8

STRATEGY#2:TheBearSpread
Likethebullspread,thebearspreadconsistsoftwofuturescontractsonelong(bought)andone
short(sold).Tocreateabearspread,atraderwouldsellshortthenearertoexpirycontractandbuy
thedistantcontract.

Someexamplesofbearspreadsare:

Short(sold)Contract Long(bought)Contract

July2010Soybeans September2010Soybeans

October2009NaturalGas November2009NaturalGas

September2009Corn December2009Corn

Youcanseethebearspreadissimplythereverseofthebullspread.Itstandstoreasonthatabear
spreadisabearishposition.Thatis,thespreadisastrategyatraderwouldplacewhenhe/sheis
bearishonthemarket.

Aswitharallyingmarket,whenamarketisinabeartrend,thenearercontracttendstoleadthe
way.Assuchabearspreadisanalternativetoanoutrightshortposition.

Justlikethebullspread,tradercanpreferabearspreadinabearmarketforreasonsoflower
margins,lowerrisk,betterdiversificationpotentialandthefactaspreadcansignalaturninthe
underlyingmarketaheadoftime.

Soletslookatanexample.ThefollowingpageshowsthesameSoybeanMealchartasthatinthe
bullspreadexample.NotethespreadisplottedasDec(near)lessJuly(far).Withthebearspread,
beingshorttheDec(near)andlongtheJuly(far)contracts,thetraderwouldwanttoseethisspread
falltomakeaprofit.

ThethingtoseeinthischartisthefallinthespreadastheoutrightDecembercontractfalls,as
shownbythetwoarrows.

AWordonMargins

Asmentionedearlier,onereasontradersliketotradespreadsisthelowermarginrequirements.In
theSoymealexample,amarginforanoutrightfuturescontractwouldbe$2000.Fortheabove
spread,itwouldbe10percentofthat,or$200.Thatsabigdifference.

Nowwhilethespreadhaslessvolatilitythanthefuturescontract,thespreadstillgivesyoufarmore
bangforyourbuck.Ofcoursethatcanworkforyouoragainstyoudependingonwhatthemarket
does,butitremainsanattractivefeatureofspreadtrading.

ThreeLittleSpreadsWentToMarketGuyBower.com Page9

GreatMarketsforTradingBullandBearSpreads

Thislistisbasedonexperienceandgeneralopinion.Theremaywellbemarketsnotlistedherethat
offergoodspreadtradingopportunity.

Energies:
CrudeOil,HeatingOil,NaturalGas

Grains:
Wheat,Corn,Soybeans,SoybeanOil,SoybeanMeal

Metals:
Copper

Food&Fibre:
Cocoa,Coffee,Sugar

Financials:
Eurodollars,Tbonds,Tnotes

Livestock:
FeederCattle,LiveCattle,LeanHogs

ThreeLittleSpreadsWentToMarketGuyBower.com Page10

STRATEGY#3:TheInterCommoditySpread
Ourthirdtypeofspreadisanintercommodityspread.Itisaspreadbetweentwodifferentbut
relatedmarkets.

ConsidermarketssuchasWheatfuturesandCornfutures(below).Theyaresimilarcommodities
(beinggrains)andthepricesarerelated.Amoveinonemarketcanmovetheother,buttheydonot
moveoneforone.Thiscreatesspreadtradingopportunities.

Consideranothertwomarkets:LiveCattlefuturesandLeanHogfutures(below).Botharelivestock
bredforhumanconsumption.Bothfuturesmarketscanmoveinline,buttheycanalsohaveunique
influences.Thiscreatesspreadtradingopportunities.

AnotherexampleisSilverandGold(notpictured).Botharepreciousmetalsandassuchtendto
moveinlinewitheachother.Buttherearealsoinfluencesthatareuniquetoeachmarket.This
createsspreadtradingopportunities.

ThreeLittleSpreadsWentToMarketGuyBower.com Page11

Thereareessentiallythreetypesofintercommodityspreads:

1. Spreadsbetweenrelatedcommodities.Allexamplesabovefallunderthiscategory.

2. Spreadsbetweenacommodityanditsderivatives.AnexampleisSoybeansversusSoybean
OilandSoybeanMeal.TheOilandMealisderivedfromSoybeans.AnotherexampleisCrude
OilversusHeatingOilorUnleadedGas.HeatingOilandGasisderivedfromCrude.

3. Thethirdtypeofintercommodityspreadisspreadingthederivativesasoutlinedabove.An
exampleisSoyOilversusSoyMeal,orHeatingOilversusUnleadedGas.Thepricesofthese
contractsarerelatedbuttherelationshipdoesvaryandthereforespreadtrading
opportunitiesexist.

Soletslookatanexample.OnespreadIenjoytradingisLiveCattleversusLeanHogs.Asmentioned
above,botharelivestockbredforhumanconsumption.

Ononehandtheyareinterchangeablefoods.Ifthepriceofporkchopsistoohigh,youmaybuybeef
steaksinsteadforexample.However,therearealsosomedifferences.Pork,forexample,isusedto
makeprocessedmeats.Theseporkproductshavedifferentdemandcharacteristicsfrombeef
products.

Assuch,wehavetworelatedbutdifferentfuturescontracts.Thereinliesthetradingopportunity.
Forexample,duringtheUSsummerholidayanddrivingseason,demandforprocessedmeatspicks
uprelativetobeefproducts.Conversely,duringwinter,demandforbeefproductstendstobe
stronger.

Itstheshiftinrelativedemand(orsupply)thatcreatesaseasonalvariationinthespreadprice.
Generallyspeaking,thefuturescontractswillstartpricingintheseendproductdemandpatterns
wellaheadoftime,butwithawelltimedtrade,itispossibletomakemoneyfromthesepatterns.

FactsAboutInterCommoditySpreads:

Intercommodityspreadstendtobealittlemoreriskythanthekindofbullandbearspreads
welookedatearlier.

Marginsarestilllessthanoutrightfuturesmargins,butmorethanbull/bearspreadmargins.

Thereisgenerallymoreprofitpotentialfromanintercommodityspreadsthanabullorbear
spread.Thisisnotalwaysthecase,butitismoreoftenthannot.

ThreeLittleSpreadsWentToMarketGuyBower.com Page12

GreatMarketsforTradingInterCommoditySpreads

Metals:
GoldSilver

FinancialSpreads:
Combinationsof5yrnote,10yrnoteand30yrbond.

Grains:
CombinationsofWheat,CornandSoybeans
SoybeansCrush(Soybeans,SoyOilandSoyMeal)

Livestock:
CombinationsofFeederCattle,LiveCattle,LeanHogs

EnergyMarkets:
CrackSpreads(Crude,HeatingOil,UnleadedGas)

ThreeLittleSpreadsWentToMarketGuyBower.com Page13

SUMMATION
ThiseBookpresentedthreespreadtradingstrategies.Thesearepopularstrategiesamongmany
professionalandveterantraders.

Despitethelowriskprofilerelativetotradingoutrightfutures,veryfewnewcomersknowofthese
strategies.Theglobalfinancialcrisishoweverisdrivingchange.Privatetradersarestartingtolook
beyondtheequityandpropertyinvestmentsandfocusonopportunityinsteadoftradition.

Thisiswherespreadtradingcancomealive.SpreadtradingofferssomegreatopportunityandI
hopethisshorteBookwillwhettheappetiteofsomenewtradersoutthere.

ABOUTTHEAUTHOR
GuyBowerhasbeeninvolvedinthefinancialmarketsforcloseto20
years.

Hehasworkedasananalyst,broker,authorandwasadirectorofa
managedfuturesfund.Hehasstartedandownedacommoditybroking
businessandtradingadvisoryservice.HehasalsobeenaCEOofastock
brokerandfundsmanagementbusiness.

GuynowrunstheProTraderDigestnewsletter.Usingknowledgeand
experience,hedelivershighprobabilitytradingopportunities.

ThreeLittleSpreadsWentToMarketGuyBower.com Page14

BONUSOFFER

The ProTrader Digest newsletter identifies spread trading opportunities in the


market. Trading updates cover:

For readers of this eBook, I am offering a 10% discount on the monthly subscription
rate of us$199/month. To take up this offer, go to www.ProTraderDigest.com and
when prompted type in the code: ebook. This offer is limited.

Its that easy. However if you have more questions, please email at the address
below. Best regards and good trading!

Guy Bower Guy@ProTraderDigest.com

Disclaimer
Futures trading involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of
future trading results. Information here is taken from sources believed to be reliable. We do not guarantee that such information is accurate or
complete and it should not be relied upon as such. There is no guarantee that the information given here will result in profitable trades. Only you
can take responsibility for your trading decisions. Copyright 2009 Guy Bower. All Rights Reserved.
ProTrader LLC. 244 5th Avenue #2741. New York, NY 10001

ThreeLittleSpreadsWentToMarketGuyBower.com Page15