A cross-market spread futures contract is a type of derivative that allows traders to bet on the difference between the prices of two futures contracts with different underlying assets, but similar characteristics. For example, one could buy a cross-market spread futures contract on the spread between the S&P 500 futures and the Nikkei 225 futures, which are both equity index futures with the same contract month. The profit or loss of this trade depends on how the price difference between the two contracts changes over time.
Cross-market spread futures contracts have several advantages over trading the individual futures contracts separately. First, they reduce the transaction costs and the risk of executing the two legs at different prices, since they are traded as a single unit. Second, they allow traders to express a view on the relative performance of two different markets, such as the US and Japan. Third, they can be used to hedge against changes in the correlation between the two markets, such as when a global investor wants to diversify their portfolio.
Cross-market spread futures contracts are available for various underlying assets, such as equity indices, interest rates, currencies, and commodities. They are traded on exchanges such as CME Group, which offers cross-market spread futures on products such as Treasury futures, FX futures, and energy futures. The price of a cross-market spread futures contract is quoted as the difference between the prices of the two underlying futures contracts, and it is usually expressed in ticks or basis points. The contract size, tick size, and tick value vary depending on the underlying assets and the exchange. The settlement of a cross-market spread futures contract is cash-based, meaning that the difference between the final settlement price and the initial trade price is paid or received by the trader.
Basic Theory:
A cross-market spread futures contract involves taking opposite positions in two related futures contracts in different markets. The objective is to profit from the price difference between these two contracts as it narrows or widens over time. This strategy is often employed when two related assets, such as commodities or financial instruments, have historically exhibited a consistent price relationship.
Procedures:
- Identify Related Assets: Choose two assets that have a historically correlated price relationship. For example, consider gold futures contracts traded on different commodity exchanges.
- Determine the Contract Specifications: Understand the contract specifications of the chosen futures contracts, including contract size, tick size, and expiration dates.
- Establish the Spread Position: Take opposite positions in the two futures contracts. For instance, buy one contract and sell the other.
- Monitor and Adjust: Continuously monitor the price differential between the two contracts. Adjust your positions accordingly based on market conditions.
Excel Formulas and Calculation:
Let’s consider a scenario involving gold futures contracts on the Chicago Mercantile Exchange (CME) and the London Metal Exchange (LME).
| Futures Contract | Contract Size | Tick Size | Current Price |
|---|---|---|---|
| CME Gold | 100 ounces | $0.10 | $1,800 |
| LME Gold | 1 metric ton | $1.00 | $55,000 |
Suppose we initiate a spread position by buying one CME Gold contract and selling one LME Gold contract. The current price differential is $55,000 – ($1,800 * 100) = $37,000.
In Excel, the calculation for the spread position’s initial value is:
= (CME_Current_Price * CME_Contract_Size) - (LME_Current_Price * LME_Contract_Size)Substituting the values:
= ($1,800 * 100) - ($55,000) = $37,000Result: The initial value of the spread position is $37,000.
Other Approaches:
- Advanced Analytics: Use Excel to create charts and graphs that visually represent the historical relationship between the two assets. This can help in identifying optimal entry and exit points.
- Risk Management: Implement Excel formulas to calculate and manage the risk associated with the spread position, considering factors such as volatility and margin requirements.
