back start next


[start] [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75] [76] [77] [78] [79] [80] [81] [82] [83] [84] [85] [86] [87] [88] [89] [ 90 ] [91] [92] [93] [94] [95] [96] [97] [98] [99] [100] [101] [102] [103] [104] [105] [106] [107] [108] [109] [110] [111] [112] [113] [114] [115] [116] [117] [118] [119] [120] [121] [122] [123] [124] [125] [126] [127] [128] [129] [130] [131] [132] [133] [134] [135] [136] [137] [138] [139] [140] [141] [142] [143] [144] [145] [146] [147] [148] [149] [150] [151] [152] [153] [154] [155] [156] [157] [158] [159] [160] [161] [162] [163] [164] [165] [166] [167] [168] [169] [170] [171] [172] [173] [174] [175] [176] [177] [178] [179] [180] [181] [182] [183] [184] [185] [186] [187] [188] [189] [190] [191] [192] [193] [194] [195] [196] [197] [198] [199] [200] [201] [202] [203] [204] [205]


90

3. Place a sell order at price T If the maitet is alreadj trading above T just after the NASE close, then entering the order as Market-on-Close of ftitures is likely to be best.

4. if filled, cover your short if your profit is .50 during the 16 hours of GLOBEX frading.

5. Close out the trade on the close of GLOBEX if your profit has not been reached. Do not carrj the trade into the next session.

The justification for this situation is the investors fear of an ovemight drop in price, it depends on the lack of ovemight news that would drive the maricet higher; however, analjsts might note that S&P price diocks alwajs cause prices to drop. It is shongly suggested that no position be taken on the evening that the President gives the State of the Union

Message.

CARRYING CHARGES

The carrjing charge structure of a maricet determines the underijing differences in the relative price of each confract. For metals and most storaUe commodities, these charges con

Laurence A Corner-andElafce E Hayn-.«.L Inve.-nuent Secrets ..f aEcige FundMau.lger ilr.t.us, 1995.

FIGURE 13-7 Corrections to interdelivery pattems.

sist of interest, storage costs, and insurance. All else being equal, a maricet with normal carrj can be expected to show steadily higher prices for deferred contracts based entirely on the cost of carrj Prices that move out-ofline may be corrected by taking delivery of the nearby and redelivering against the next confract.

It is alwajs possible for changes in supply and demand to alter the relationship of futures contracts so that the carrjing charge pattem no longer appears normal. Although this is not likely to occur in the metals, it often happens that an immediate demand for food can cause short-term increases in prices without substantial effect on more deferred months. This situation is called an inverted maricet, or negative carrj, even though the carrjing charges are implicit in the price regartUess of the pattem.

In the financial maricets, a similar situation occurs when the demand for money increases dramatically in the short term. If the maricet expects that the demand win be short-lived, the rates on short-term maturities are significantlj affected, whereas the longer-term ratesmay show only a minor change.

in the metals markets, a normal carrj is called contango (a term coined by the London Metals Exchange when referring to copper) and a negative carrj is backwardation. Changes in supply and demand that lead to backwardation are most likely to occur in the indusfrial metals where the commodity is consumed at a greater rate. Gold, silver, and platinum, the precious metals maricets, have fraditionally had a uniform price relationship in the deferred delivery months. Any deferred delivery price can be calculated by adding the current rate of interest (plus storage and insurance) to the value in the cadi market if interest rates rise and the price of gold remains the same, the carrjing charges and the spread will increase, if the price of gold rises but interest rates remain constant, the carrjina charges and spread will also increase because the increased value of the confract results in higher interest costs. Similarly, lower carrjing charges and a narrowing spread will occur if either or both the rate of interest or the price of gold declines.

The terms used in referring to carrjing charges in the financial markets are the same as those ust mentioned, but the concq)ts are different. Carrj is a term describing the yieldcurve relationship. The concept of positive or normal



cavry is a curve that increases in yield with the time of maturity The longer an investor is willing to commit money, the greater the yield. Negative carrj can also exist for short periods of time. \ien economic conditions become unstable, the interest on short-term investments may increase sharply, although longer-term rates will increase only slightly Investors anticipate a correction in these diort-term distortions, and do not often move money committed for longer periods for fear that rates will retum to positive carrj The various relationships and terminologj that exist in each market sector can be found in Figure 13-1.

Implied Interest Rates

A pure carrj market is one in which the forward price is entirely comprised of the costs of holding the phjsical product until a predetermined delivery date. As previously mentioned, these costs are those of storage, insurance, and the loan rate. As an example, consider gold, wiiich is a classic pure carrj market.

Assume that spot gold is selling for $300 per ounce and the 6-month forward conhct for $313.50, an increase of 4.5>o. With interest rates at 7°o, there is a possibility of increasing the retum on inveshnent by purdiasing gold at the current spot price of $300 per ounce and selling a futures contract 6 months deferred for $313.50. The gross profit is the difference between the futures price and the value of a comparable cadi investment. Compare this with an initial inveshnent of $30,000, which corresponds to the size of a lOOounce futures conhd of gold. That is,

6-month rehim on $30,000 cadi at 7°o = $1,050

6-month futures price = 313.50

Less the spot price = -300.00

Gives the profit per oz. = 13.50

Times the conhd size of 100 oz. = $1,350

The gross improvement over the cadi investment is $300, or Po over the 6-month investment period; however, there are costs involved in this cadi-and-carrj that do not exist in a shight time deposit. In addition to the storage and insurance of the phjsical gold, there are hnsadion costs involved in the hiding of futures. Because these costs are relatively fixed, they are known in advance and the potential profit level of the cadiand-carrj can be calculated.

The Limited-Risk Spread

if the nearby month of a storaUe commodity is at a discount to a deferred month by more than the cost of carrj, a limited-risk spread may be entered by bujing the nearby and selling the deferred. The hder then takes delivery of the nearby and redelivers it against the later conhd. When trading commodities, which are significantlj influenced by supply and demand, the outcome of this hde is never certain.

For example, the crude oil and copper marfcets are not affeded by weather or planting conditions, and their supply is readily availaUe. Demand has caused both marfcets to become inverted for long periods of time. Anticipation of lower prices, reduced demand, or a poor economy may result in a hand-to-mouth purdiasing policy This causes a concentrated short-term demand in the spot marfcet and litUe activity in the deferred months, resulting in higher prices in the nearby months than further out. Carrjing charges are still an integral part of the deferred price; if they were absent, the inversion would be more extreme. Even when they appear to have normal carrj, these marfcets are not candidates for an implied interest rate or cadi-and-carrj spreads.

The limited-risfc spread may be better termed a limited-profit spread. \iereas the carrjing charges provide a theoretical limit to the premium that a deferred month may have over a nearbj, there is no limit to the discount that a month may tafce on. An increase in the expeded supply might change a normal carrj marfcet to an inverted one, resulting in large losses.

The Carrjing Charge Spread

The carrjing charge spread is a popular hde based on anticipation of interest rate change and is, therefore, a lower risfc than a net long or short position in any marfcet Consider gold again as an example.

In 1978, the price of gold was low (under $200 per ounce) as were interest rates (about 6° o). An investor who



had the foresight to expect both gold and interest rates to rise but who wanted to limit the rid; of a speculative position, could have entered a bull spread by buying a deferred contract and selling a nearby contract of gold. The number of months between the conhacts would determine the potential for both profit and ride the further apart, the larger the carrjing charges and the greater the expected spread movement.

TECHNICAL ANALYSIS OF SPREADS

Once the spread components have been selected and there is full confidence in the underljing fundamental relationship (even if temporarj). the extreme levels and trends may be found to determine which spread trades may be entered.

Most tedinical analjsis of intramarket spreads (e.g., March-December T-bonds) is represented as variations or distortions from the normal price relationship. In this method of hading, the distortions are also called overbought and oversold conditions and the strategic approach taken is countertrend. By subhacting the deferred price from the nearby (e.g., December from Mardi of the same year) over the life of the conhact for many years, the investor can measure the historic pattems (see Figure 13-8). These spread relationships will varj in a manner that allows the hader to set objectives. \ien Mardi is trading 1 V, points over December, the spread can be sold; when Mardi trades under December by IV4 points, the spread can be bought.

Historical Comparisons

Those spreads with a sound fundamental basis will show clear pattems in their price history Analjsis of longer historic periods will result in a better understanding of the considency and rid; involved in hading die spread. A long-term shidy will reveal seasonal and cyclic moves as well as periods of lower and higher volatility

Many spread opportunities result from underdanding changing spread patterns. For example. Figure 13-9 shows a long-term spread that has three distinct ranges, marked along the bottom as a, b, and c. During period a, spread fraders would have identified +1 and -I as the exfreme levels and entered positions at those points, the risk varied bul remained within an acceptable range. The higher volatility during period b would have caused large losses for those fraders still expecting the prior maricet patterns. unprecedented shifts in the spread relationship would prompt fraders to liquidate spreads. As period begins, fraders change their objectives to wait for a spread opportunity at -2. Although they could not profit from the original exfreme moves because spreads were entered too early, they are prepared for the next time. But instead of repeating itself the spread narrows until it settles in a range of ~ 1/2. if it is now fraded in this range, an increase to the prior normal levels of period awill produce a large loss.

This dilemma is common to spreading; spread prices shift from one range to another. When the range decreases, few spreads are taken, and when it increases, a large loss occurs. The following ouUines possible solutions to this problem:

I. Underijing price-volatility relationship. Higher prices allow the spread to widen, whereas lower prices force the spread price to narrow. The spread between heating oil and gasoline must be greater when those products are frading at $1.00 per gal

FIGURE 13-8 Inframarket interest rate spread relationship.

March dimunt > UFCtmlxf

fturce Nancyb.tt,Etett,(Ed),Han.lt.o..k..fFinanciBlF

i Nancy E

n..fi7«M(4taH-mcW4)«niei

FIGURE 13-9 Changing spread ranges.



[start] [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16] [17] [18] [19] [20] [21] [22] [23] [24] [25] [26] [27] [28] [29] [30] [31] [32] [33] [34] [35] [36] [37] [38] [39] [40] [41] [42] [43] [44] [45] [46] [47] [48] [49] [50] [51] [52] [53] [54] [55] [56] [57] [58] [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] [73] [74] [75] [76] [77] [78] [79] [80] [81] [82] [83] [84] [85] [86] [87] [88] [89] [ 90 ] [91] [92] [93] [94] [95] [96] [97] [98] [99] [100] [101] [102] [103] [104] [105] [106] [107] [108] [109] [110] [111] [112] [113] [114] [115] [116] [117] [118] [119] [120] [121] [122] [123] [124] [125] [126] [127] [128] [129] [130] [131] [132] [133] [134] [135] [136] [137] [138] [139] [140] [141] [142] [143] [144] [145] [146] [147] [148] [149] [150] [151] [152] [153] [154] [155] [156] [157] [158] [159] [160] [161] [162] [163] [164] [165] [166] [167] [168] [169] [170] [171] [172] [173] [174] [175] [176] [177] [178] [179] [180] [181] [182] [183] [184] [185] [186] [187] [188] [189] [190] [191] [192] [193] [194] [195] [196] [197] [198] [199] [200] [201] [202] [203] [204] [205]