Table Of ContentFurures SPREAD TRADING:
THE COMPLETE GUIDE
Courtney Smith
1975-2000
25th Anniversary
‘Traders Press Inc.®
FO Box 6206
Greenville, SC 29606
Copyright® 2000 Courtmey Smith
Allrighsesrvd. rtd the United tae of Ametita No panto
iki peblicevor mey bereprodued sored na rcrevl system oars
tring, in any form ot by any means, cri, mesancl, photo
‘copying, cording, Folkers, witout the prio writen person
ofthe suber.
ISBN: 0-934380-48-1
‘This publication is designed to provide accurate and uthoriative ine
Formation with zepad othe subject matter covered tis sold with the
understanding thal he publisher is oct engaged in dering legal, c-
counting, oF athe professional advice, {legal advice ar other expert,
‘ssiatance is required, te services of a competent professional person
should be sough
Published by
Traders Press, Inc.”
Darty Atigovod
Editing and Layout
Kevin Stokes & Teresa Darty Allgood
1975-2000
25% Anniversary
‘Traders Press, inc.
PO Box 6206
Greenville, SC 29606
Publishers Foreword
Ik is ¢ privilege and an honor to be pub
lishing Courtney Smith’s definitive guide
to futures spread trading, My relationship
‘with Courtney goes back for many years,
to the time when he was head of Futures
risearch at Paine Webber and during a pe
riod when J was a futures account execu-
tive and Vice President at Paine Webber in
the carly 1980's, [have always considered
‘theresearch he produced among the best
ever had access to during my 22 year ca-
rear as a futures broker, especially in the
area of sprends, an area in which good information in virtuelly any
forrn nove is, and then was sorely lacking.
‘Spread related information was the very foureaticn on which Traders
hess was forded in 1978, with publication of my own first elf-pub-
lished book, Commodity Spreads: A Historical Chant Perspective My
‘own longstanding interest in and love of spread trading was reflected.
in this book, which encompassed the recults of hundreds of hours of
manual research and charting of spread relationships and data over a
ten year period extending back t0 1965. This book was reprinted in
‘updated form ancwally from 1975 unt] 1982, and many of the very
earliest customers of Traders Press stil tell me to this day that they
til have these charts in their trading Libraries.
{tia unfortunate that the literature on aptead trading isso greatly lian.
ited and comes nowhere close to satisfying the demand for kaovsledge
‘n this fascinating and worthwhile butte known aspect of futures
trading. Itis my hope that this book, which isa cubstantially expanded,
revised, and updated version of author Courtney Smith's 1983 book
con the same subject. will contribute materially 49 the knowledge of
interested in spread trading.
anh A Mahtou
Edward D. Dobson, President
‘Traders Press, Inc,, Publisher
June 6, 2000
Acknowledgments
‘A number of people have ooumibuted ideas, critleiem, and
help tothe writing of this book. Theis inpatis greatly appreciated,
Jack Grushcow provided inspiation and encouragement
and taught me much of whats inthis book. would lke to thank
Paul Bums for his superlative and insight fa job of editing and for
his many worthwhile suggcstions, am grateful to the Literary
Executor of the Inte Siz Ronald A. Fisher, FS, to Dr. Prank
‘Yates, F.R.S., and to Longman Group Ltd, London, for perais-
sim to reprint tables from ther book Statisveal Tables for Boe
logical, Agricultural and Modical Research (th Baton, (974).
In preparing the manuscript, Janet Mas took on a hard job and
did it well. Lee Tumbull contibuced ideas and encouragement
‘when dey were hard to come by. Jim McKeever helped me get
started in the right dicection with ce ight concepts, The patience
of my editor, Stephen Kippur, is greatly apprecisted.
‘ToTTari Gallagher, thank you.
CS.
Acknowledgements for the 2° Kadttion
1 would like to thank. Ed Dobson of Traders Prese for
‘wanting to keep this book in print. Broker extraordinaire Steve
‘Trimble and his staff helped get the up-to-date carrying charges.
Steve Moore and bis superlative staff provided the seasonal tables,
and charts,
cs.
Biography
CCourncy Smits i ell qualified write SeFnkive guide to fumes spread
\eaing- Hick lengthy and varedbockgroundmonany aspects of te ere
tend biseieseis ral unardieked among fears aur He tscurenty
President of Comey Samide co. acenpany WAses as posed vee
‘anageiou serves for eal at sons in 190,
le ialso Presiden and Chit lavetaen Ofer of nase Capa Ste.
Se tne. whieh manages hedge fonds. The Magship fund ithe Mato End
‘ahi he Bil compound rum of over 238¢per yeu fr aost five yeae
‘ih rally no conelaion wih te sek nade oroter hedge fate
‘Me. Smiths a world eaowaed weir and cohmmnig He ures 2 week oof
tna rhe world smostpopuarimmncil website CB8NarketWech ont, Ho
‘Sthcedier of Couey Sal's Wallet Wines pewaleter.anieesenen
‘aio eka wih a erulton of ove 32.00,
‘Me. Sth ie ner andor n- Ce f Cramodity Traders Consumer
Reger (CTCR). CTR is the preci aacking ccrvie for he fans inasey
stella he most presgtous publication for funue wading wsigh CTCR
Sbsbeesprovidaypinsighsto de heures eceazeniy since 1983.
He ssaleo the Chief lineaments of Crier Managerosnt le. Obie
tnanages and admunitere aver billiin ns unde abe prtolios oe
stintons nde
Previously, bes Presien and Chef Erect OfBiceref Quantan Financia)
Service, nc” 28100 mullon futures tnd sock brokerage frm ti, Seth as
Fiat Vice Peds and Treanse ofthe New You branch of Banca dala Segara
Tabane (831) Suis Bank. a1 BS), Me Sutnaanaged mumal fds, feat
seco ad srpski artes ote Ne Yr bch
‘S vellasuading and euketng Exod nevi and foreigneschange devas
frthcentre bank.
(Me. Smid was formerly Group Vice Preston in churge of Financial Deivg-
{Utes ae Preach bank Bangue Pass, Rew Yor, sad sas Vie Prose
[ahdaDurecor of escach and Cammncral Services fx Pune Webber, Int
Stathranage em accouns petra joing Pane Weber.
“Me. Sethe the suor ofa books, inching Profits Taroagh Seasonal Tease
ing, (Jake Wey & Sos, 1980), Commodi Spreads, ona Wie & Sons,
Toland Tradere Prey, 1989), How wz Mave Mopey ia Stock Indes Forres
(Metra Hil 1B), Somual Char fe Fuens Trade tn cy & Sons,
{B87} and Opn Staletes itn Wiley Sons, 1999), Mr Sh 30 te
suthor of chapters nsNerl Books,
‘Ms. Sunith hasbeen fared speaker ar vest confereaes trou heat
‘Non Aucrice and Europe. He ho spewed aay umes uo uch anal ee
‘iion shows es Wall Suva Jounal Report ond Manes ae el as thet
Shows on CBS, Fot News, Rloouberg, CNN, and CNA He Isa featured
uetoa CNBC,
Preface
Spread trading is an integral pat of the commodity fi-
tures marketplace, yet relatively ltlle has been written about
spreads. There are more fingers on one fend than books about
spreads.
‘Most books presentfittle more than a carsory look at spread
analysis: Fortnatey, there are several good reference texts on
scaoanal spread price action. This book concentrates onthe analysis
of spreads and spresd price action. Spread analysis is aimed at
he discovery and exccution of profitable spread trades. The sea-
sonal spread tetts are simply one Of the tools the spread analyst
Futures periodicals have provided most of the published
‘material about spreads. The articles i these periodicals make up
the bulk of commodity spread literature. Theis value ranges from
useless o exciting. The trader often wonders about the utility of a
ten-year-old aticle
A nutrber of advisory newsletters dedicated to spreads
have come and most have gone, They generally offer rationsles
for their read recommendations, which hela by providing the
reader with a lock over the anslyst’s shoulder, to discover what
{actors are important. Newsieners dedicated to spread trading have
‘been writen a8 offen froma fundamental as from a technical view-
poim. In other words, the analyst was looking at supply and de-
‘mand information a3 much as at price action. This is quite dffer-
ent fr the comniodity advisory letters that recommend outright
purchases and sales, Most of these conoentrate on price ation
tnd only incidentally Took ot the fundementls,
‘A few traders have been fortunate enough to have known
a experienced spread trader Well enough to have been able to
Team from him. This allows the student to interact withthe teacher.
‘The novier can ask questions of the more experienced trader and
et immediate answers
‘Gver the years there have been spread seminar, often
sponsored by commodity brokerage fits, The seminars have ben
of an introductory nature and have provide ite information on
spread analysis, However, they have provided the upportuniy for
Inquisitive attendees to ask questions of the experts giving the
seminars.
‘This book contains basic spread analysis techniques which,
T hope, wall stimulate readers to do their own rescarch. Along
withthe lack of literature on spreads, there has been @ fack of
spread analysts, A goal ofthis book isto increase interest in spreads
and provide the markeipoe of ideas with a larger supply of spread
trading analysts.
“The techniques in this book will not make you aillion-
size overnight. They certainly haven't made me ane. On the other
hhand, they have provided significant profits when most traders
were taking losses. Each reader of this book will aequite some-
thing different from it Some traders willbe atracied othe tech
‘ical analysia, while others will prefer the fundamental and sttis-
‘icat analysis.
The key to the successfuluseof this hook Hesin trying the
‘methods outlined. Oly through experience can traders understand
swhatis being said, After reading this book, trader til ms find
the method they felis she most profitable and best fits their per-
spective on the market. the one they feel most comfortable with.
‘COURTNEY SMITH
New York, NY
September 1998
One
Introduction
Over the years, commodity markets have increasingly caught
the attention of investors and the general public. The rapidly
escalating prices of 1973 and the explasion in 1980 probably did
‘ore to spark this interest than any event in recent times. In-
creasing volume and increasing value have been the hallmarks
of commodity matkets for many years,
In apite of the greater interest in commodities, spread trading
has received little attention. Spread trading is the siraultaneous
putchase of one commodity futures contract and sale ofa differ-
ent contract. The contracts can be different delivery months in
thesame commodity; they can be two different commoditiesthat
are related; they can be the same comunodity traded in two dif-
ferent locations.
Spread trading has always been an important part of the com-
modity futures marketplace. Latge commercial firms are often
large spreaders that analyze and utilize commodity spreads in
many ways, As a simple example, commercial fires frequently
use spreads to move their hedges from one contract month
Futures Spread Trading
another, They trade spreads in an effort to recover the costs of
storing and financing their inventories. They examine spreads
to determine where they will deliver their particular commod-
ity. These are but a few of the ways in which commercial firms
utilize commodity spreads.
Large speculatorsare alsoheavy users of commodity spreads. It
is not uncommon for large speculators to have more than
‘one-thied of their positions in spreads. Let's look at the wheat
market asan example. On Novernber 30, 1980, large specutative
traders had 80% of their contracts involved in spreads! Why large
speculators are so interested in spreads is examined in Chapter
3
Nearly all spread trades are traded by either the lange specula-
tors or by the commercial firms. These sophisticated participants
in the commodity futures market are knowledgeable about
spreads and are extensive users of spread trading techniques.
Gn the other hand, the small speculafor isan infrequent user of
spreads,
‘There are a umber of possible reasons why small speculators
don't trade spreads frequently. tcould be because of the greater
complexity of analysis: they must analyze two positions instead
of one. The fundamentalist will have to analyze the relative sup-
ply and demand of two contracts rather than just the overall
supply and demand. Analysis of relative supply and demand is
a very subtle problem. It could also be that the majority of small
‘speculators are not famibiar enough with fundamentals to trade
spreads, Most analysis of spreads centers on fundamental analy-
sis, whereas most speculative analysis of outright positions cen-
‘ers on technical analysis,
In spite of these factors, the small specillator should be vitally
interested in spreads. For reasons that are explained mare Fully
Introduction
in Chapter 3, the small speculator can improve profit potential
by trading spreads property. Asthe prices and volalility of com=
smodity futures contracts increase, there becomes an even greater
need for information on spread trading, Spread trading can pro-
vide a vehicle to decrease the volatility and the risk of futures
trading. The two major approaches to analyzing commodity
futures are called fundamental analysis and technical analysis.
Fundamental analysis is directed primarily toward the elucida-
‘ion and analysis of the supply and demand situation, The fun-
damentalist will look at such factors as planting, exports, crop
production, domestic disappearance, weather, and currency flue-
tuations. Fundamental analysis seeks not only to discover the
factors that go into making the current price what it is but also
{ predict what those factors will be in the future,
‘Technical analysis can consider only those factors the market
place itself is composed of. The technician will look at such things
as price action, volume, and open interest to help determine an
opinion of the market. The technician largely seeks to either de-
scribe ot predict the market action. That is, she or he tries to
describe the present market action and assurnes thatthe current
situation will continue in the future. The descriptive technician.
assumes that a market will continue for a long enough time to
create a profitable trade. The predictive technician tries to dis-
cover techuical factors that give insight into the future of prices,
and is less concemed with the marketplace as it exists,
Many people believe the fundamentalist has the harder task. The
sources af information, the sheer weight ofthe information, and
the greater depth of insight necessary to analyze the informa-
tion are all factors that uiake the fundamentalist’s job more dif-
ficult,
Its no accident that the state of the art of technical analysis Is
