Understanding Spreads

Understanding Spreads is a brief but thorough and informative introduction to spread trading in futures. Material on this topic is scarce, and there has long been a need for an introductory primer like this for those interested in learning about spread trading.

Introduction:

Spread trading fell from favor in the early 1980’s when a major revision of the United States tax codes was written that served to remove favorable long-term capital gains tax treatment on certain types of spread trading activity. Other signifi cant developments occurred in the trading arena during this timeframe. These developments included the introduction of many early generation computerized trading systems, the release of personal computers bringing signifi cant number crunching power to the private trader at a reasonable cost, and the growth of public commodity pools and funds. The focus of the trading public was concentrated on these new ideas as they were introduced and spread trading became a neglected way to profi t.

Since then, retail traders have long assumed that spread trading is too slow and boring to generate much interest. Because there has been little public interest in spread trading, published material and research addressing the subject has been introduced slowly. The most recent books on the subject of spread trading have been used as primary sources of information in this compilation.

It is worth noting that commercial fi rms and professional traders have continued to use spread trading as a major part of their trading strategies. With this thought in mind, some hidden value to spread trading must exist and should be explored. It may be that spreading is better for trading longevity and fi nancial health than it appears to be at fi rst glance. Doesn’t it make more sense to trade on the same side of the market as the deep pockets with intimate market knowledge rather than hope to catch a move with the small speculators who are notorious for losing money?

There are several generations of traders with little knowledge of and no interest in spreading. New traders are typically more interested in using high-speed computing technology and short-term trading systems that rely strictly on technical concepts. This Understanding Spreads installment will hopefully bring some knowledge and direction to this long ignored “old” subject with great appeal.