V.1:6 (147-148): Commodity Spreading: An Art of Price Differentials by DR. BASIL VENITIS

V.1:6 (147-148): Commodity Spreading: An Art of Price Differentials by DR. BASIL VENITIS
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Commodity Spreading: An Art of Price Differentials by DR. BASIL VENITIS

A Commodity Spread or Straddle is a combination of a long position and a short position in related commodity futures. It is a sort of arbitrage between futures. (The same way hedging is a sort of arbitrage between spot commodities and futures.)

Four basic types of spreads are the following:

1. The arbitrage between different delivery months of the same commodity is called an interdelivery spread.

2. The arbitrage of the same commodity in different exchanges is called an intermarket spread.

3. Arbitrage of different but related commodities is called an intercommodity spread.

4. Arbitrage between a commodity and its products is called a product spread. The most popular product spread is the BOM (Bean-Oil-Meal) spread between soybeans and their crushed forms, i.e. soybean oil and meal. This is called soybean crush when one buys the beans and sells the products, or reverse soybean crush when one buys the product an sells the beans.

Commodity spreads are usually expressed as the long futures price minus the short futures price; however, if the two legs of an intercommodity spread are of different sizes, the spread can be expressed either as a balanced spread with unequal sized contracts on each leg but equal numbers of units on each leg; or, it can be expressed as money spreads in total dollar value of the two contracts. For example, the spread 4 October hogs minus 3 October cattle is a balanced spread with both legs representing an equal size of 120,000 lbs. of meat.

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