After you get familiar with the basics of spread trading, you can start to explore more complex strategies that involve more than two legs. In the first article of this series we will focus on multi leg intra commodity spreads like Butterflies. In the second article we will cover inter commodity Crush spreads. The third article will finish with Crack spreads and summary.
Multi leg intra commodity spreads are usually used for speculating on changes in the term structure of futures contracts. Another play can be mean reversion as they can move in nice range.
The most common multi leg spread is Futures Butterfly (don’t get confused with their better known options version). Butterfly is complex spread constructed over three different maturity dates/legs. These three legs consist of the body and the wings. To achieve prefect hedge, each leg has to have same distance from each other. But unequal distances are common too. Example spread can be Corn Butterfly: CZ14-2*CH15+CK15. We can also view Butterfly as combinations of a near term bull spread and a longer term bear spread with the short mid term leg placed on the same calendar month. By creating spread of two spreads, we are trading the relative movement of two correlated spreads, which takes out individual outright direction out of the trade. So we are speculating on changes in the term structure of futures contracts rather than on the movements of the underlying. When you think that mid term futures prices are going to fall while near term and long term futures prices are going to rise or remain flat, then you can trade it with Butterfly.
For example in agricultural markets like wheat, corn and soybeans etc., the term structure can offer many opportunities to get profit from the changes in prices in different months. Fundamentals and the reality that new supply is on the market only a couple of times a year can extremely change the term structure which depends on supply and demand.
Even more complex form is Double Butterfly spread, which you can imagine as a calendar spread between two conventional butterflies, where the second and third legs of the nearer butterfly also serve as the first and second legs of the more distant Butterfly.
Another kind of multi leg spread is Futures Condor, which is similar to Butterfly. The difference is that the body of Condor has two legs rather than one, therefore making the spread have four legs in total. Example spread can be Eurodollar 3 month Condor: EDU14-EDZ14-EDH15+EDM15. The idea is the same, Condor is two calendar spreads, spreaded against each other. Condor like butterfly can range pretty well and also is good way to play different parts of the maturity curve. Taking an example of Eurodollar, if you think that the curve will steepen more at the near term than the longer term of the curve, you can search for opportunity to buy Condor (you are taking advantage of the spread going up in the front relatively more then on the back).
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The risk of loss in trading commodities can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well for you. The use of leverage can lead to large losses as well as gains. Past results are not indicative of future results. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight.
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