Most traders buy a futures contract with the hope that it advances, or sell the contract with an expectation for it to decline. However, spread trading with futures is a technique that can be used to take advantage of price discrepancies and involves simultaneously going long and short futures contracts with the hopes that the profits on one leg of the spread are greater than the losses on the other leg of the spread.

There are primarily two types of futures spreads: an intra-market spread and an inter-market spread.

Intra-market Spreads

An intra-market spread is where a trader buys and sells futures contracts on the same underlying, but does so in different delivery months.

For example, going long June E-mini Russell 2000 futures and short September Russell 2000 futures would be an example of an intra-market spread. Buying June Eurodollar futures while selling September Eurodollar futures would be another example. In an intra-market spread the trader is trying to profit from price discrepancies between two delivery months.

Inter-market Spreads

An inter-market spread is where a trader simultaneously buys and sells two differing futures contracts.

For example, a trader believes that small cap stocks will outperform large cap stocks. To take advantage of this viewpoint the trader would initiate a spread trade that would consist of going long the E-mini Russell 2000 futures contract and simultaneously shorting the E-mini S&P 500 futures contract.

Advantages of spread trading

Spreads can be profitable in rising or falling markets. The interesting thing about spreading is that the trade could be profitable if stocks in general advanced or declined. Using the example above, as long as small cap stocks (as measured by the Russell 2000) outperformed large cap stocks (as measured by the S&P 500), the spread should show a profit.

Spread traders can receive margin offsets on their spread position. This means that they do not have to put up the full margin on each leg (both the long and short leg) of the spread. They instead would receive a margin credit.

Spread trading can be less profitable than trading outright long or short positons but generally carries reduced risk. With the caveat that it is possible to lose money on both sides of a spread trade.

Additional considerations

Given the number of stock index futures contracts available at CME Group, a multitude of spread strategies can be initiated. With futures available on the S&P 500, the S&P midcap 400 and the Russell 2000 (Large, mid and small caps respectively), one could spread large caps versus midcaps, small caps versus mid caps and large caps versus small caps by going long and short the appropriate combination of these products depending on the trader’s opinion.

Trader's Expectation Futures Spread Strategy
Large caps to outperform small caps

Long E-mini S&P 500 / Short E-mini Russell 2000

Long E-mini Russell 1000 / short E-mini Russell 2000

Small caps to outperform large caps

Long E-mini Russell 2000 / short E-mini S&P 500

Long E-mini Russell 2000 / short E-mini Russell 1000

Small caps to outperform mid caps 400   Long E-mini Russell 2000 / short E-mini S&P Midcap
Midcaps to outperform small caps 2000   Long E-mini S&P Midcap 400 / short E-mini Russell

CME Group also offers Russell 1000 (another popular large cap index) as well as style indexes (Growth and Value indexes, which track the growth and value stocks respectively) on both the Russell 1000 and Russell 2000 indexes. You could conceivably spread growth versus value depending on your opinion on which style will outperform the other. If you believe that small cap growth stocks will outperform their value counterparts, you would go long the Russell 2000 growth index futures and short the Russell 2000 value index futures.

Another thing to keep in mind is that the contract notional size of all stock index futures is not identical, hence if you were going to spread stock index futures, you might have to do a ratio such as two E-mini Russell 2000 futures for every one E-mini S&P 500 futures to obtain a more dollar-neutral position. Moreover, CME Clearing and your broker will require certain ratios on spreads to obtain margin offset advantages identified earlier.

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