Hashtag truth: trading isn’t always about price. Sometimes it’s about direction. And when it comes to commodities trading, we can capitalize big-time if we correctly predict the direction the value of that commodity is going to move.
Let’s take this discussion to the next level and talk about what can happen when we start dabbling in spreads that involve not one but two commodities...specifically, commodities that are different but related. We’re not talking about the false dichotomy between left and right Twix bars, but things that are actually different and related. Maybe they’re not quite substitute goods, but they’re real close. Cotton and hemp. Oil and gas. Dan and Shay. Okay, we can’t trade Dan and Shay. But we can make ourselves some pretty nifty intercommodity spreads when we play with different-but-related commodity trading options.
What’s an intercommodity spread? It’s when we take a long position (i.e., we buy) on one commodity, like hemp, and a short position (i.e., we sell) on a related commodity, like cotton, during the same delivery period. In this scenario, we’d do this because we expect the gap between the higher-priced hemp and lower-priced cotton to widen. If we expected it to narrow, we’d take a short position on hemp and a long position on cotton. We’re less interested in the actual price of each than we are with the difference between the two prices and whether the gap is widening or narrowing. That’s what we’re betting on: the difference and direction.
Commodities investing can get tricky and is not recommended for novices or the faint of heart. The most successful commodities traders know more than a little about the commodities they deal with, so if intercommodity spreads sound like they just might be our cup of tea (another commodity, FYI), then we should definitely do some serious research before taking a sip.
Related or Semi-related Video
Finance: What is Spread?48 Views
finance a la shmoop. what is spread? before we start just no. get your mind
out of the gutter. spread refers to the money value between [100 dollar bill]
a bid and ask price under a market maker structure of trading securities. no more
wire hangers, a plastic hanger company is publicly traded on an exchange like
Nasdaq where buyers bid for a price to purchase and sellers ask for a price to [Nasdaq wall shown]
trade. no more wire hangers is bid this moment at 37:23 a share by buyers
willing to buy right now at that price and is being asked at this moment at a
price of 37.31. note the eight cents a shared difference in the share prices.
that dif is the spread between the two prices, and it's worth noting that in [bread is buttered]
extremely volatile stocks, the spread widens. and in boring highly liquid
stocks which don't move much, the spread tightens or is narrower. that is on a
volatile equivalent of no more wire hangers the spread might grow to 20 or
30 cents a share whereas a boring name that pays a big dividend and the stock
never moves much we're thinking AT&T here, [man snores at a desk]
well that spread might be just three or four cents. so why grow? well because a
market maker in a volatile stock doesn't want to be caught losing money on her
inventory. if no more wire hangers suddenly gapped down to 37.10 a share [equation shown]
well it would be likely less than the average of what the market maker paid
for her quote "inventory" unquote in that stock from which he was making a market
in it. each time the shares trade the market makers dip into that spread to [woman dips cracker in butter]
pay their bills and allow them to keep doing business. so that's spread. and it's
not the type that Prince used to sing about. [man on stage]
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