Understanding Spreads by Edward Dobson and Roger Reimer (Traders Press, 2007) is really a pamphlet rather than a book. But it’s packed with information for anyone contemplating spread trading.
A spread is normally a hedged position where the trader is long a futures position and simultaneously short a position in a related futures contract—for instance, long corn and short soybeans or long October ’09 sugar and short July ’10 sugar. Like the pairs trade commonly used by hedge funds, the idea is to make money on the difference between the two legs of the position.
Spreading has less upside profit potential than trading from only one side of the market, but it usually has less downside risk. It’s considered a conservative trading strategy. It’s not, however, for the uninitiated. I can laugh now over the fact that the first time I heard someone talk about trading beans I thought they were referring to green beans. But the depth of my agricultural ignorance (despite gardening for many years and actually growing soybeans for the first time this year) is such that I would be loath to venture into an area where I should be familiar with crop year cycles and planting acreage expectations. I may be basically a technical trader, but that’s no excuse for total ignorance of the fundamentals. Fortunately there are inter-market spreads virtually everywhere—for instance, bonds, currencies, and the energy complex.
Dobson and Reimer point out one reason to trade spreads that I was unaware of. “Spreads generally trend more often than outright futures and will occasionally trend strongly when outright futures are flat.” (p. 12) That’s definitely an area for further exploration.
Spread trading usually relies at least in part on seasonal analysis. Understanding Spreads offers a solid introduction to seasonals as they affect various commodities and suggests that a seasonal approach might be profitable even outside the world of commodities. Seasonal traders have not been particularly successful of late, but then virtually every trading strategy has been challenged by recent market dislocations. As markets start to right themselves and leverage is capped at more modest levels, the time might be ripe to start learning about spread trading.