The futures market (part 7)

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The Futures market spreads margins (part 7)

In part 6, I wrote about Futures spreads.  How they are defined and to trade spreads.

In part 7, I will cover how the margins are used in trading spreads.

 

Futures Spread Trading Margins

Remember I stated in part 6 that a Futures contract spread is a strategy where you buy a particular contract and at the same time you sell another.  You may pay a margin for what you buy and receive a premium for what you sell.  So margins are reduced when they are part of a spread. The margin for a contract you buy may be $2025. But when you buy and sell the same commodity, the margin can be reduced down to as low as $200. You can still trade the same commodity but with different expiry months and the margin will still be lower but a bit higher than if the expiry is in the same month.

Why the margins are reduced?  Because the risk of the spreads is lower than the actual contracts. Any unexpected event can be mitigated by taking two positions in different directions. If there is a stock market crash or the fed raises interest rates or a war between two nations both contracts should be affected but one will offset the other. It is a kind of protection from systemic risk.

 

Futures Spread Pricing

Spreads are priced as the difference between the two contracts. If May Gold is trading at 1350 per Ounce and July is trading at 1380 per Ounce, the spread price is 50.

 

Futures Spread Quotes

When pricing spreads, you always take the earlier month and subtract the later month. If the front month is trading lower than the deferred (like our first May vs. July example), the spread will be quoted as a negative number. If the front month is trading higher than the deferred month (like our second May vs. July example), the spread will be quoted as a positive number.

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