Ion than when they are at one-half that price. Figure 13-8 could easily be related to changing price levels, where a is a long-term bull market, peaking in period b, and followed by a decline to lower levels in period c.

2. Normal seasonal pattems. Seasonality causes spreads to narrow and widen in predictable wajs. During harvest, the basis spread (the difference between the spot and cadi marfcets) widens, reflecting the available supply. After harvest the basis will continue to narrow if demand fails to materialize.

3. Specific events

a. A freeze in coffee or orange juice results in a prolonged shift in prices, which will then make the next years crop even more sensitive to a potential freeze.

b. Events that cause seasonal price changes, such as exceptional crop demand, will nullify the seasonal patterns for the remainder of the crop year and often into the next season.

c. Combination of circumstances, such as low inventory, stocks, or carrjover, prior year higher export demand; and drj, hot weather midway in the growing season will result in a nervous market, causing prices to rally in anticipation of problems becoming real. By observing past similar situations, the extent of the rally can be observed as large enough to use a medium to fast frend-following method, with profit taking either at the time the frend tums or 1 month before harvest begins, whichever comes first.

Relative Spread Opportunities

The long-term analjsis of a spread relationship will show the extent of variability and include most pattems-\ien the spread range is wide due to shifts caused by inventory cycles, changing public opinion, and other factors, a relative measure will be of interest. Figure 13-lOa shows a simple example of a more complicated spread pattem.

The safest spread trades are those taken at historic highs and lows {H„ L, H, anticipating a return to normal levek; these trades do not occur often. Instead, there are tnany opportunities to sell a tvUitivefy overbought { , „ Ht, . . .) level or buy a relatively oversoU level (tl, Li, Lt,.. .)• There is less risk if the relative level is closer to the historic extreme.

The relative spread levek can be found by taking the difference between die spread price and a moving average. The number and magnitude of the relative tops and bottoms will vary with the speed of the trend; the faster the movir>g average (3 to 5 days), the more rclaUve highs and lows wUI appear and the smaller the magnitude of those moves. Figure 13-106 shovra a detrended spread chart based on the panems in Figure 13-10 The highs and lows are clear; however, it is not possible to distinguish those that have less risk firom those with greater risk. When actually tradir>g, sellir>g , is more likely to result in a loss

FIGURE 13-10 Relative spread opportunities, (a) Spread prices showing relative swings, (b) Prices adjusted to identify relative spread opportunities.

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than profit, it will be necessary to use both charts to select the proper trades: one to locate the relative highs and lows, the other to determine risk.

Trend Analjsis of Spreads

Moving averages, point-and-figure, and other trend-following methods are usuallj inappropriate foi intramaricet spreads. The time needed to develop a buy or sell signal using a trending approach often takes most of the potential profit fran the trade. The magnitude of the profits and losses resulting from these spread frades is usually small compared with an outright long- or short-market position.

Trend-following methods apply to spreads when the movement of the spread is large enough to justify sacrificing both the beginning and end of the move to determine the direction of the frend. Using T-bonds and T-notes as an exanple, the frader selects the delivery month to be analyzed (usually the same one) and subfracts the T-note price from the bond price. The resulting price is freated as a single new maricet; a moving average, point-and-figure method, or another frendfollowing technique can be applied to these new numbers. \ien a buy signal occurs, the spread is bought (bonds are increasing in price with respect to T-notes), and when a sell signal is generated, the spread is sold (bonds are decreasing in price with respect to T-notes). These techniques can work as well as any analjsis of the individual maricets and lower margin requirements boost the retums that may result from net moves of lower magnitude.

Spreads that tjpically allow frend analjsis are those with very wide swings extending for long time intervals. Some examples of these spreads (Figure 13-11) are:

Short- versus long-term mterest rates (frading the yield curve) Index maricets representing diverse market segments Index maricets in different counfries Hogs versus catde Gold versus silver Qirrency crossrates

FieURE 11.11 Trending spntdi. (<i)T.blll* y««uiT-bond», 19 6. (b) Cattle v.r,u. hogs, F.bn.«T, 1986. (() Gold vcnu. silver.

.r 19 *.(<0 Britiih pound versus Deutsehemark. March 1988.

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