by commercials like commodity producers and dealers who seek protection from adverse price movements for their commodities.
Options offer strategies for "all" market conditions!
Below you will see that there is always a strategy for any market assumptions you come up with. Your assumptions or forecasts are more important for you, and why not pick the best strategy that suits you.
| Long Call | When to Use |
| Buying a Call option | When you are very bullish about the commodity. Returns will be excellent if the market stages a strong rally. These options can offer you much leverage advantage in a rising market with limited downside risk. |
| Long Put | When to Use |
| Buying a Put Option | When you are very bearish about the commodity. These options can offer you much leverage advantage in a falling market with limited upside risk. |
| Short Call | When to Use |
| Selling a Call Option | When you are bearish about the commodity. Based on the degree of bearishness, you can fine tune option strikes and premium. |
| Short Put | When to Use |
| When you are bullish about the commodity. Based on the degree of bullishness, you can fine tune your strikes and premium. |
| Long Straddle | When to Use |
| Involves Call and Put options | When market has been quite and playing in range, signaling potential break out, but not sure which way. |
| Short Straddle | When to Use |
| Involves short Calls and short Puts | When you expect market to consolidate or play in a tight range for some time. |
| Long Strangle | When to Use |
| Involves Puts and Calls | When market is playing within a specified range, and likely to break-out. You will gain money irrespective of the direction of the break out, either or down. If the market continues to play in range, you will loose lesser than with a long straddle. |
| Short Strangle | When to Use |
| Involves Puts and Calls | When market appears to be consolidating near or within a specified range. You will gain money as long as market is in the process of consolidation. In case of an active break out, you will loose lesser than with a short straddle. |
| Bull Spread | When to Use |
| |
| Bear Spread | When to Use |
| |
| Calendar Spread | When to Use |
| Involves either a set of call options or a set of put options with different expiry months. | Bullish in the long-term, but not expecting the rally soon. For instance, you think the market has hit the bottom and a bounce is highly likely, but it could be a month or two before the move actually starts. Returns will be excellent if the market stages a strong rally after the anticipated time frame. Downside risk is limited to the net amount of premium paid. On the other hand, put options should be used if you expect the market to go down after a specific time frame. |
Spread Trading Strategies
Spread trading is a low-risk strategy for profiting from market relationships. The essential condition for spread trading is the existence of a varying spread (differential) between the prices of futures contracts of two different months.
Let us consider one example of spread trading. Suppose the spread between the December and March crude oil is $1.50. An investor sold the crude oil spread in October and the spread gradually fell to 50 cents by mid December. The investors then decides to buy back the spread at 50 cents. This will result in a profit of $1000 per each spread position.
Most common types of spread positions
| Strategy | Example |
| Intracommodity spread | Sell Dec crude oil and buy Mar crude oil |
| Intercommodity spread | Buy gold and sell silver |
| Intermarket spread | Buy S&P 500 and sell FTSE 100 |
Why spread trading?
Spreads trading offers enormous opportunities in terms of profits with lower risk in comparison to futures.
- Many spreads within specific commodities follow seasonal patterns (example: crude oil)
- Spreads offer a means to trade directionally in volatile markets
- Spreads are good strategies to use in seemingly dull markets.
-
Spreads require incredibly lower margin, enabling to trade more positions than futures contracts. (Example: the margin required for a single crude oil futures contact is $3375, while spread requires a margin of only $340
Note: Spreads are low-risk strategies in normal market conditions. However, risk remains when the market suddenly swing from contango to backwardation due to unforeseen changes in supply and demand conditions. But many individual traders take good care of such risks by always being on the right side of the spread, i.e.
What drives spread relationships?
The major factors responsible for widening and narrowing of spreads are either fundamental (example: short-term supply shortages versus long-term availability of crude oil), seasonal (example: the heating oil usage in the winter versus the summer months), or cyclical which are commonly found in agricultural commodities.
Even after carefully researching the above factors for identifying trading opportunities, many traders use technical trading tools (mainly charts and associated analyses) to increase their chances of success. Main emphasis should be given to trend identification, market entry, market exit and money management.
Want to start trading spreads?
A full description of spread trading is beyond the scope of this web site. If you are interested to know more, or want start trading spreads, we will be able to assist you through a step-by-step procedure. Contact SFB Research today for securing an appointment.
Also see: Daily Options Data
