Commodity Spread Trading

Commodity Spread Trading is a strategy adopted by arbitrageurs for making risk-less profit. This article will try to give a clear idea about this unique trading strategy.

Commodity Spread Trading
Commodity Spread Trading is the strategy through which traders get opportunities to profit out of the difference in prices of commodity(ies) in two or more markets.

This particular trading style involves simultaneous placement of orders having opposite directions (commodity bought in one market is simultaneously sold in another) in two different markets.

Commodity Spread Trading is of two types:

Intra-Commodity Spread Trading:
In this type of trading, a trader performs two simultaneous transactions of the same commodity in two or more separate markets. Generally, commodity trading in the future market, having a different contract month, has correlation between its prices.
Arbitrageurs look at price differential among these contracts and if they find such opportunities then they sell one month’s contract and buy another month’s contract simultaneously. Thus, they lock-in this price difference and consequently make profit at the end of contract expiration.
Inter-Commodity Spread Trading:
In this case, arbitrageurs purchase a future contract of one commodity and simultaneously sell future contracts of another commodity. But the basic feature of such a trading strategy is that the two commodities must have a relation between them so that the movement in price of both the commodities takes place in the same direction. For example, crude oil and gasoline are co-related in the sense that the latter is a derivative of the former. Thus increase in the price of crude oil in the future market is bound to affect the gasoline price.
Market Indications
Commodity spread trading helps a trader as well as a farmer to get an idea about the future movement of price. If the near-month contract price is greater than the far-month one then the market is signaling that the price of the commodity is going to decrease in the future. A farmer could consequently make his decision of holding or selling the crop on the basis of such price signals.
Conclusion
Commodity spread trading is used by traders to make risk-less profit through arbitraging. These traders make their strategic moves on the basis of small price difference of one or more commodity(ies) in different markets. Thus, their margin of profit is also very small in relation to other trading strategies like speculation. Hence, brokers all over the world are promoting this trading style by reducing their brokerage charges associated with such trading.

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Last Updated on : 27th June 2013