# Trading Spreads



## CanOz (13 August 2013)

I've been wanting to start a thread on spread trading for a while now. Its something that the Prop guys i know keep telling me to get into, as well as being something new to learn. I've got a few books, thanks to Boofis and Rajen Kapadia. 

Will post anything regarding the spreads here.


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## payday (13 August 2013)

That's a great idea CanOz. This is one area that I am not really well read about. Are you talking about futures spreads here or equities (pairs trading) or options etc?


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## CanOz (13 August 2013)

payday said:


> That's a great idea CanOz. This is one area that I am not really well read about. Are you talking about futures spreads here or equities (pairs trading) or options etc?




I'm ok with anything posted here on spreads Payday, but i was specifically thinking of spreads on futures contracts. The pairs thread cover equities quite well.

I'll also mention Rajen's book again and will post of few of things i learn out of the book on here.


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## havaiana (13 August 2013)

Spreading is something I'd like to learn a lot more about too.

Something that I would look into before spreading is the exchange rules. Given that spreading usually requires a position sizing which is a lot bigger to make profit from smaller movements (and in theory less risk), If an exchange can break one side of the trade can leave you in trouble (or rich).

Edited: article found so took out my explanation...

- - - Updated - - -

http://www.smh.com.au/business/sfe-sued-for-1m-over-cancelled-trades-20091011-gsd4.html

"By cancelling just one part of their trade, the traders claim the SFE annulled their insurance policy on the first trade which remained in play, leaving them exposed to losses. The traders say they lost a combined $861,150, on the 10 spread trades on interest rate movements"


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## CanOz (13 August 2013)

havaiana said:


> A few years ago there was an article in one of the aussie papers about a fat finger or something which caused an unusually large movement in the bonds. As per the exchange rules they ruled to break all of the trades that were made past %. This left some Spreaders with only one side of their spread on whhich happened to be the losing side. So they were stuck with a massive losing outright position as the profitable side of the spread was broken. In the article they were suing the asx, not sure what the outcome was, will keep looking for it
> 
> - - - Updated - - -
> 
> ...




These guys were part of a Prop Firm, a US one i believe. We were just talking about this the other day. We were having dinner with a Prop trader from Australia and he was talking about the old times. He mentioned that these guys got cut out of one leg and they lost a million, or at least that's what i think he said happened. They lost the lawsuit, packed up and went back overseas.

Kind of ironic seeing how spread trading is normally considered less risky than out-rights.


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## havaiana (13 August 2013)

Fair chance the spread would have been in profit too. Imagine the split second your thoughts change from what colour car you will buy to what you will say to the risk manager...


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## captain black (13 August 2013)

CanOz said:


> These guys were part of a Prop Firm, a US one i believe. We were just talking about this the other day. We were having dinner with a Prop trader from Australia and he was talking about the old times. He mentioned that these guys got cut out of one leg and they lost a million, or at least that's what i think he said happened. They lost the lawsuit, packed up and went back overseas.




The case was dismissed with the SFE's costs to be paid by the traders. Here's the case ruling if you've got an hour or two to spare:

http://www.austlii.edu.au/au/cases/cth/FCA/2010/534.html



> THE COURT ORDERS THAT:
> 
> 1.  The application be dismissed with costs.


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## CanOz (13 August 2013)

Thanks for that Captain...

Whats the bet they changed their procedures after the ruling too...


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## DJG (13 August 2013)

I'm also very interested to listen to anything you wish to share. Boofis directed me to an e-book which I've got printed up and have read a little.


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## havaiana (13 August 2013)

I've found all the stuff on spreading is either extremely basic or extremely quant heavy like this:

http://www.amazon.com/Trading-STIR-Futures-Introduction-Short-Term/dp/1897597819

That's probably the main reason it's a good area to look into, because there is suck a lack of quality info out there

Some stuff here too:
http://guybower.com/


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## CanOz (13 August 2013)

So there are different types of spreads involving futures, i always just thought it was trading two highly correlated instruments like bonds, or energies. Indeed many trade Calendar spreads as well. 

Calendar spreads are buying and selling of the same security with different maturities or delivery months. Spreads can range from 1 month up to ten months...this was surprising for me. the closer the months, generally the better the correlations. So this might be long one month and short the next month contract...

Butterfly spreads are where you spread two calendar spreads together....so you might be long 1, short -2, long 1 in three different months....Rajen really does a better job of explaining this than me.

There are also condor spreads...see pic

- - - Updated - - -



havaiana said:


> I've found all the stuff on spreading is either extremely basic or extremely quant heavy like this:
> 
> http://www.amazon.com/Trading-STIR-Futures-Introduction-Short-Term/dp/1897597819
> 
> ...




Thats why Rajen wrote the book, for that very reason. I'm just replying to an email to him, maybe he can drop in and add to the thread. Seems like a real good fellow.


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## DJG (13 August 2013)

havaiana said:


> I've found all the stuff on spreading is either extremely basic or extremely quant heavy like this:
> 
> http://www.amazon.com/Trading-STIR-Futures-Introduction-Short-Term/dp/1897597819
> http://guybower.com/




That's the e-book I was talking about.


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## r4jen (14 August 2013)

Hi guys,
My name is Rajen,
Been trading spread for around 6 years now. Alot of the talk is about the FED tapering and if they do, we could continue to get a steepening of the Yield curve in the US and Europe pushing Bond spreads up.
Feel free to ask any questions regarding spreads or the ebook


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## havaiana (14 August 2013)

r4jen said:


> Hi guys,
> My name is Rajen,
> Been trading spread for around 6 years now. Alot of the talk is about the FED tapering and if they do, we could continue to get a steepening of the Yield curve in the US and Europe pushing Bond spreads up.
> Feel free to ask any questions regarding spreads or the ebook




Hi Rajen

I have just stumbled across your youtube channel, very glad to have you here



Do you mind if I ask you a bit about your market experience/background?


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## r4jen (14 August 2013)

Basically I started trading in 2006, doing the TED spread which is Euribor against Shatz(2 year gov bond). Then moved myself to interest rate spreads and now do a bit of everything.
I took the plunge straight after Uni doing this so, have had my ups and downs, but its been able to provide me with a living so in that case its worked out OK. 

I had a setback in 2011 when my funds were with MFglobal and as you may know they went bankrupt and i lost a sizable chunk of it, which im still waiting to to maybe recoup. Either way had to start over after that, and got back to where I was so now hopefully a good end to the year from here on.


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## skc (14 August 2013)

r4jen said:


> Basically I started trading in 2006, doing the TED spread which is Euribor against Shatz(2 year gov bond). Then moved myself to interest rate spreads and now do a bit of everything.
> I took the plunge straight after Uni doing this so, have had my ups and downs, but its been able to provide me with a living so in that case its worked out OK.




Hi Rajen, 

Do you mind sharing some stats on your spread trading? E.g. Win%, avg win/avg loss, hold duration, trade frequency, transaction cost as percent of PnL etc? 

How many potential pairs do you watch, and how many pairs would you be spreading at any one time?

I am also interested in how you determine position size and what criteria you have for stops...

By way of background I trade equity pairs on the ASX but know absolute nothing about spreading bonds/futures. I guess I am asking the questions above to see if I can steal any of your insights and apply it in the equity space. There's a pairs trading thread on this forum with my posts sprinkled over it... so if you have time I hope there might be something useful for you there as well.

https://www.aussiestockforums.com/forums/showthread.php?t=14508&page=48



r4jen said:


> I had a setback in 2011 when my funds were with MFglobal and as you may know they went bankrupt and i lost a sizable chunk of it, which im still waiting to to maybe recoup. Either way had to start over after that, and got back to where I was so now hopefully a good end to the year from here on.




Good to hear you are bouncing back. I was in a similar situation but was fortunate to have most of my money out the day before it collapsed. But the unfortunate thing was that I was holding a very large renounceable rights arbitrage trade - which means I couldn't close my position and take all the capital out...

The whole bankruptcy process has been a joke - trading is hard enough without counterparty risks.


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## havaiana (15 August 2013)

skc said:


> There's a pairs trading thread on this forum with my posts sprinkled over it... so if you have time I hope there might be something useful for you there as well.
> 
> https://www.aussiestockforums.com/forums/showthread.php?t=14508&page=48




Awesome thread


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## havaiana (15 August 2013)

skc, i'm only on page 20 of the thread so maybe this question is answered after that but...

Have you ever done a test to compare the profitability of just taking an outright position in the stock that has moved away from the mean to see if it is more profitable than trading it in a pair?

I know there are more things to consider than just the profit, but I'm just interested, because in theory it seems that pairs trading could be used by outright traders to find outright trades


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## havaiana (15 August 2013)

Another question skc/r4jen

Have you found that mean revision spreading/pairs trading has or is becoming less profitable over time?

It seems to me like a type of style that could be 'easier' to automate in comparison with other styles


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## skc (15 August 2013)

havaiana said:


> Have you ever done a test to compare the profitability of just taking an outright position in the stock that has moved away from the mean to see if it is more profitable than trading it in a pair?
> 
> I know there are more things to consider than just the profit, but I'm just interested, because in theory it seems that pairs trading could be used by outright traders to find outright trades




A mean reversion strategy on outright share may be completely valid, but you wouldn't trigger it based on divergence away from the *mean of a pair's ratio*. If you are simply looking at divergence from mean with the stock itself - then really that's just trading off Bollingar bands or moving average etc. Otherwise you can trade a stock divergence from a sector's mean. But without hedging the resulting equity curve would be very different I'd imagine.

On odd occasions I do use signals from pairs trading to take outright trades, but the position sizing, stop placement etc will be completely different.

Anyway, if you have questions on equity pairs probably best to ask them on the pairs trading thread to keep it all together.



havaiana said:


> Another question skc/r4jen
> 
> Have you found that mean revision spreading/pairs trading has or is becoming less profitable over time?
> 
> It seems to me like a type of style that could be 'easier' to automate in comparison with other styles




Falling profitability - not really. And if there's any fall in profitability it's due to reduced volatility (compared to say 2009-2011) rather than equity pairs being a crowded trade. Automating equity pairs can certainly be done but there's a lot of discretion in my own trading that's probably not programmable.

I do however have the same question wrt spreading bonds. It seems like a simple thing to program... (showing my ignorance)


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## DJG (15 August 2013)

havaiana said:


> Another question skc/r4jen
> 
> It seems to me like a type of style that could be 'easier' to automate in comparison with other styles




By the time you finish the Pairs Trading thread you will notice SKC knows ALOT about the companies his trading. A computer does not. He also knows the announcements coming up and the potential effect it may have on his pairs, a computer won't. Many more examples. I suppose to an extent it could be programmed, ie - X% from the mean etc etc but I would imagine your equity curve and trading statistics wouldn't be very smooth with more than usual drawdown. My thoughts anyway


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## r4jen (15 August 2013)

Hi,
Basically with Spreads the time I hold varies alot depending on the market conditions. I can hold anywhere from a few seconds to multiple days. My philosophy is that I dont want to take a loss so ill average until it comes my way (within reason). Since my primary trade is interest rate futures, the movement of that spread especially trading 3 month or 6 month, isnt as much as other more volatile spreads, so with the right risk management you can average knowing that 99% of the time it will come back. Generally it doesn't come back when there is a significant fundamental shift, ie new policy, interest rate changes etc etc.
But in terms of strategy, I always try keep it simple, its not rocket science to play the ranges, i tend to always try find spreads that mean revert well.
Spreads that act like an outright defeat the purpose. 
I do keep a daily blog called day in the life of a bond trader.


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## kid hustlr (15 August 2013)

skc said:


> *I do however have the same question wrt spreading bonds. It seems like a simple thing to program... (showing my ignorance)*




*I am by no means an expert here*

Most of the bonds (or more accurately aussie bills, ie the short end futures stuff) is played by the big boys as simple mean reversion. I remember one of the guys showed me a chart of a couple of flys or condors or whatever they were and even during the GFC the spreads between these instruments just didn't get that out of whack. They almost always mean revert (I'm sure there's examples when they don't but I don't know of them).

The big thing with the spreads (atleast in the aussie front 12 strip) is que position. If you can get front of the queue in certain spreads then its hugely advantages. Otherwise you need to 'leg them' which is definitely doable but you take on legging risk by doing so.

In some regards it is an easy concept and I can see what you mean in terms of programming an algo to enter spread trades. They have these (called auto spreaders) but truth be told markets are so tight/efficient in these regards these days that the best spread traders are able to identify where the market is positioned as well as where the buying + selling pressure is in the market and then act accordingly.


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## boofis (3 September 2013)

This isn't how or what kind of moves I trade but I keep a chart of it open during the day to keep an eye on the sengs progress relative to the china enterprise futs and thought the example might spark some convo in here. There were a couple successive sessions where the seng was showing strength and the HHI just wasn't holding up. This is one of those scenarios where I see why people like to trade spreads on very liquid markets; fairly low volatility trend all afternoon that allows for the legs to be added to nicely on many occasions.


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## Trembling Hand (3 September 2013)

boofis said:


> View attachment 54215




What is the chart set up for that?


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## boofis (3 September 2013)

Trembling Hand said:


> What is the chart set up for that?




1min, is that what you mean?


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## Trembling Hand (3 September 2013)

boofis said:


> 1min, is that what you mean?




No, what and how are you charting?


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## boofis (3 September 2013)

Trembling Hand said:


> No, what and how are you charting?




one contract price minus the other. I'll trade you more info for an update of your buy and hedge thread  haha


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## ThingyMajiggy (6 September 2013)

Can anyone tell me what would be wrong with trading this spread once it got to the extremes as a mean-reversion system? As it seems like a good idea to me, but no doubt I'm missing something as I've never spreaded stocks.


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## havaiana (6 September 2013)

ThingyMajiggy said:


> Can anyone tell me what would be wrong with trading this spread once it got to the extremes as a mean-reversion system? As it seems like a good idea to me, but no doubt I'm missing something as I've never spreaded stocks.




I reckon you're better off asking here

https://www.aussiestockforums.com/forums/showthread.php?t=14508&page=37

Lots of info in the thread about trading stock pairs this way, read skc's posts


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## ThingyMajiggy (6 September 2013)

Eh potato potahto  

Feel free to move it then Mr Admin, although I hope to do this with futures data soon, just easier with stocks atm.


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## symmetry (9 September 2013)

skc said:


> A mean reversion strategy on outright share may be completely valid, but you wouldn't trigger it based on divergence away from the *mean of a pair's ratio*. If you are simply looking at divergence from mean with the stock itself - then really that's just trading off Bollingar bands or moving average etc. Otherwise you can trade a stock divergence from a sector's mean. But without hedging the resulting equity curve would be very different I'd imagine.
> 
> On odd occasions I do use signals from pairs trading to take outright trades, but the position sizing, stop placement etc will be completely different.
> 
> ...




Spreads are very easy to work,  target  commodities these are far simpler and easier to work out. spreads are extremely rewarding with 1/6 of the margin required and very little risk on entry when your looking for the right  setup. Spreads is about understanding.

some of the biggest gains i ever made were spreads


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## CanOz (25 October 2013)

Today being practice and recovery from the week, i took a look at spreading the DAX off against the FESX. Now for the ratio i just used 2.5 to 1 given that the DAX is a 25 EUR contract and the FESX is a 10 EUR contract. So i was actually using 5:2. I have no idea if this is even right and i'm just going by what i've read.

So, today was an interesting day as the DAX was quite a ways out in front of the FESX in filling the gap as its much more volatile. I have the indicator for pairs but really once you have the ratio about right its just a matter of looking for some plays, i guess. 

I'm just trying to figure out how to take profits, as its seems the spread never really gets that far out of whack before it comes back in...

Also, sometimes it looks like it may be better to drop one leg and then take the outright trade if that looks or feels like a better play...

I'm really just thinking out load here so please steer me right if I'm of course...

In an up trending market i'm generally looking to short the DAX and go long the FESX as the Dax corrects itself...its really just an eye ball thing...obviously key levels will play a part here too....


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## CanOz (25 October 2013)

After reference Rajen's book again, I'm using an 8:1 ratio, so we'll see how that works. I've also got my charts setup correctly now too...before i had the YT and XT on my correlation charts...


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## CanOz (28 October 2013)

Handy spread trading guide from Eurex...


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## CanOz (2 November 2013)

I've been continuing my research into trading spreads and in particular calendar spreads with some seasonal trends. These types of spreads can be traded with a 1:1 ratio as they are intra-market. Inter-Market spreads need careful consideration for the hedge ratio so you get closer to a 1:1 ratio at the time you take the trade.

Here is an example of a play I'm watching.

This is Live Cattle and the strategy here is to sell the February contract and buy the June contract, expecting the spread to reverse and trend down sharply. We first need the spread to give us a signal, a place to enter the trade. We know that we are entering the period in the season where this spread usually takes a dive. Its been pretty strong this year though, but its at the upper side of the channel. If we can make a lower high we will have a place to enter the trade should it turn lower again....

There are a couple of ways to find the seasonal opportunities. One way is to subscribe to a service like Moore Research. The other is to subscribe to a search algorithm service like Seasonalgo.com. Either way you need to be able to mine the seasonal history of the spreads to look for opportunities.

The seasonal trends don't happen every year, but often enough that it can provide a little edge provided that everything else on the trade is agreeing with it. 

Also, you must check the COT to make sure the commercial interests are positioned on the correct side of the market. You can see from COT report that the commercials and the funds are at extremes with the funds well long and the commercials fully hedged to lock in their prices...This also tells us that if we do see a move to liquidate longs then it could move pretty swiftly.

There are several Agricultural commentators indicating that they are very long live cattle outright at the moment, so we must wait for the spread to give us signs of a reversal.

We'll need to also check the latest COT report when its issues this coming week.


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## CanOz (5 November 2013)

Larry Williams on Seasonality....



- - - Updated - - -

A great explanation on how spreads work by Jay Richards of JustSpreads...





Enjoy!


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## CanOz (25 November 2013)

Setting up spread charts in IB's TWS....

[video=youtube_share;GPeScAFUEkU]http://youtu.be/GPeScAFUEkU[/video]


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## RADO (5 December 2013)

This Video does a good job at explaining spread Futures with real examples


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## CanOz (9 January 2014)

Trading and charting spreads with IB's TWS...this supersedes post 38...

[video=youtube_share;byiKS05v4tk]http://youtu.be/byiKS05v4tk[/video]


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## CanOz (9 January 2014)

Another good webinar on spreads...


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## ChaosHedge (13 June 2015)

In the book I'm currently reading on spreading Euribor & Eurodollar, it shows a trading platform with a spread matrix. Is this essential?

I'm still in the learning stage and want to practice opening & closing spreads and try out a few ideas on SIM. I have the free version of ninja trader and would like to know if this platform is any good for spreading or if there is something better I should use?

Thanks


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