Commodity Query

Can the difference between the contract prices of different expiries increase or decrease? If so, why does it happen? How can we earn from that?

Mehul Jain

Theoretically the difference between the prices of contracts with the same underlying but differing expiry dates would remain more or less the same. But practically, there could be instances where the spread may suddenly increase or decrease. This could be due to the wider change in the demand-supply imbalance. Take, for example, the MCX-aluminium futures contract. If the demand for aluminium is higher from the hedgers in February when compared to January, then it is likely that the spread between the January and February aluminium contracts would be higher than normal. The opposite holds true and the spread will decrease when the demand for the near-month is more than the far-month contracts. However, this phenomenon of higher or lower spreads is generally short-lived. Traders can play this spread between different-month contracts. A general tendency on the part of a trader is that, if the spread is high, he buys the near-month contract and sells the far month contract, hoping for the prices to adjust and spread to become normal. Since this phenomenon is short-lived it is very important to have strict stop-loss in case you are trading the spreads. To identify proper trade signals from the spreads, you can collect the historical data of different month contracts and create your own database of spreads. Plot the spreads against the prices in a graph to identify the pattern and form your trade strategy.

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