Intra-Commodity Spreads
By Carl Loffmark
Please enjoy this article free of charge.
For timely insight and analysis on the futures market and successful trading strategies, subscribe to our Commodity Futures Weekly Newsletter.
What are intra-commodity spreads?
Understanding intra-commodity spreads is an important part of futures trading strategies. Intra-commodity spread refers to the price difference between various calendar months of the same commodity, on the same exchange. For example, crude oil for September vs December, traded on the NYMEX exchange. When the spot price is lower than the nearby futures contract the market is in contango. Conversely, when the spot price is higher than the nearby futures contract the market is in backwardation.
Why are futures months priced differently?
Futures contracts are priced differently for two reasons: (1) Seasonal tendencies; (2) Availability of supply in the spot market. Seasonal tendencies include factors such as harvest time for a crop, whereby the distant futures contract during harvest time is priced lower than the preceding futures contract due to an expected increase in supplies. Aside from seasonal tendencies, availability of supply in the spot market has a significant bearing on the intra-commodity spreads: abundant supplies tend to lead to a contango market structure, while tight supplies tend to lead to a market in backwardation.
What are the effects of supply and demand?
When a futures market for a commodity has significant moves between contango and backwardation it reflects changes in the underlying supply/demand balance for the commodity. Strengthening of the spread from contango into backwardation suggests supply tightness. Conversely, weakening of the spread from backwardation into contango suggests ample supplies.
How to profit from intra-commodity spreads.
If the spreads move from contango into backwardation this would indicate supply tightness and therefore exert upward price pressure on the underlying commodity. However, if the spread weakened significantly from backwardation into contango this would indicate ample supplies and therefore exert downward price pressure on the underlying commodity. Price direction of a commodity is greatly influenced by the intra-commodity spread, usually pressuring the price in the same direction as the spread. Intra-commodity spreads should be viewed as a strong contributing influence on price direction and should be an important part of a trader’s checklist.
Free Insight.
To learn more about futures trading and the futures markets, please visit free articles.
Subscribe Today
The Commodity Futures Weekly Newsletter is an invaluable resource for trading professionals, seasoned retail investors, and those looking to expand their trading into the futures market.
© Contango Futures Advisory Inc. 2024