Trading commodity spreads mechanically
by Louis P. Lukac & B. Wade Brorsen
Using a mechanical rule to trade a futures market is not new—countless mechanical methods exist
with the general purpose of creating a profit while eliminating the human factor from trading. One place
where mechanical trading rules have received increased attention lately is in spread trading. Spread
trading involves taking a long position in one market and a corresponding short position in the same or
related market, so the offsetting positions reduce the risk.
If a mechanical rule could be developed for spread trading, it could lead to a low-risk portfolio of spreads
that provides a superior alternative to a portfolio of outright futures positions.
There are several types of spreads, but most can be grouped into three general classes: intramarket,
intercommodity and intermarket. An intramarket spread—a long position one month and a corresponding
short position in another month in the same commodity—is the most common. An example is long
November soybeans/short January soybeans.
An intercommodity spread consists of a long position in one market with a corresponding short position
in a related market such as long December soybeans/short December soymeal.
Finally, an intermarket spread takes a long position in one market on one exchange and a corresponding
short position in the same market but on another exchange—long March Chicago wheat/short March
Kansas City, for example.