Trader Resources : Spread Basics
An alternative to trading on the actual price of a contract is to trade on the price difference between two contracts. This type of trade is called a spread. Traditionally, a spread order is made up of the simultaneous purchase and sale of two or more different futures contracts. It may be done by a hedger to protect a storage or processing cost or return. It can also be done by a speculator to capitalize on a market opportunity when one market trades at a discount to another.

Spreads perform two important functions to the market. First, they provide more market liquidity (more contracts are being bought and sold). Second, they help restore price relationships to normal levels following a distortion in those relationships.

There are three common types of spreads: Interdelivery (or Intertemporal), Intermarket (or Interexchange), and Intercommodity.

• Interdelivery Spreads refer to the simultaneous purchase of one delivery month of a given futures contract and the sale of a different delivery month of the same commodity on the same exchange.
• Intermarket Spreads refer to the purchase of one delivery month contract on one exchange and the sale of the same delivery month contract on a different exchange.
• Intercommodity Spreads are the purchase of a given delivery month of one contract and the sale of a different, but somehow related, contract for the same delivery month.

In a normal futures market, there is a definite relationship between the price of the nearby futures month and the price of the deferred futures months. The deferred price is typically more than the price of the nearby month by the cost to store, insure, and finance the commodity from the nearby to the deferred month. Keep in mind that this price difference is theoretical, and the markets do not always reflect this trend. There are many variables that affect this price difference, including expectations on the next year's production, expected demand, surplus carryover, storage availability, and inflation. In particular, a shortage will lead to higher prices for the nearby months. This is called an inverted market. Interdelivery spreads should be used to take advantage of these differences.

The price differences between exchanges are often geographically related. Crops will be cheaper the closer the exchange is to the producer. Lower transportation costs can lead to lower futures prices. The class and quality of product also influence price differences between exchanges. Intermarket spreads can be used to trade on these price differentials. The most common intermarket spread is for wheat contracts.

Intercommodity spreads are used for commodities that can be used interchangeably or between two commodities that have common supply and demand characteristics. Spreading wheat and corn is a common choice, since wheat and corn follow seasonal price changes. The spread tends to be smaller following the winter wheat harvest, and larger in the fall, when corn is harvested and wheat prices are high. Spreading Soybeans and Soybean Meal or Soybean Oil is also common, since the prices of Soybean Meal and Soybean Oil are highly related to the price of soybeans. This is often used by producers of Soybean Meal or Soybean Oil to hedge the processing margin they realize for processing Soybeans into Soybean Oil and Soybean Meal.

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