Novice Traders' Notebook  |  JUL 1996

V.14:7 (311-316) Trading Index Spreads by Richard Halford

There are a number of different stock index futures, such as the Value Line index and the S&P 500, with similar characteristics which can be traded as spreads. Here are some basic methods. Trading futures spreads is a strategy used by professional traders to either hedge a position or to take advantage of divergence between certain markets. When accompanied by proper timing and a keen awareness of critical market dynamics, spreads can be all the more effective in achieving specific investment objectives. Before we get into some of those strategies, however, we must take a look at a futures spread trade and understand how it differs from pure arbitrage. Arbitrage is defined as the simultaneous purchase and sale of the same product in different markets to take advantage of price divergence and result in a profit. For our purposes, we will define a spread trade as a long position offset by a short position in futures contracts with similar – but not identical – underlying or basis. There are a number of spreads to choose from, such as notes over bonds (NOB); municipal bonds over bonds (MOB); beans (CRUSH); and energy (CRACK). Not included are currency crosses or popular calendar spreads. However, trading futures spreads between stock market indices is a frequently overlooked technique, and it is one that presents numerous opportunities for the savvy trader aware of certain indicators and how they can be used to his/her advantage. To trade stock index spreads effectively, first you must become familiar with the composition of the indices and how they respond to certain market conditions.

by Richard Halford