THE SPREAD INVESTMENT LETTER
by Frank Taucher

Many traders use spreads rather than outright long or short positions because of their belief that risk and margin requirements are far less in a well-conceived spread investment program.

WHAT IS A SPREAD?

A spread is comprised of both a long and a short "leg".

An example of an intramarket spread would be the purchase of July Kansas City wheat and sale of May Kansas City wheat. One would thus be long July / short May.

An intermarket spread might be the purchase of July CBT (Chicago Board of Trade) wheat and sale of July corn. Intermarket spreads are usually more volatile than intramarket spreads and, thus, are riskier. Margin requirements are a little higher.

An exotic spread involves perceived economic relationships - i.e., treasury bills vs. lumber (interest rates vs. housing starts) or cotton vs. soybeans (competition for acreage).

Exotic spreads are not usually executed by a spread broker, are not afforded reduced spread margin rates, and may even be traded on different exchanges.

Exotic spreads are usually very risky.

HOW IS A SPREAD PRICED?

The price of a spread is determined by subtracting the short side from the long side.

If this value is plotted daily (or over some other chosen time period), the chart appears just like a chart of closing stock prices.

If the long side is always listed first, then the way one makes money is if the daily price of the spread increases - just like a stock.

The amount of money made depends on the number of spreads one positions and the value of each of the "legs" (the long and short side of the spread).

DO SPREADS EXHIBIT SEASONALITY?

Many traders analyze spreads on a seasonal basis and expect certain price movements to occur at roughly the same time of the year, year-after-year-after-year.

My favorite example is the spread long heating oil / short gasoline as winter approaches.

Most people can understand that consumers burn more heating oil in the winter and drive less. Heating oil would thus normally be expected to gain versus gasoline as winter approached.

In summer, the situation is reversed since not many have a need for heating oil when it's 90 degrees outside in July. Folks are, however, driving on vacations, to the beach, and so on. Gasoline is, thus, normally expected to gain on heating oil as the summer vacation season begins.

"The Spread Investment Letter" is a monthly newsletter that analyzes spreads on a seasonal basis. Approximately 60 to 125 spreads are presented each month in three portfolios, an intramarket, intermarket, and exotic spread portfolio.

Each portfolio has a different RISK TOLERANCE and guides the subscriber to those spreads that are timely at different periods of the year just like the heating oil / gasoline example.

THE IMPORTANCE OF DIVERSIFICATION

The portfolios provide the subscriber a sufficient number of choices so that capital might be diversified.

This diversification reduces the chance of an adverse experience due to the failure of any one selection to perform as expected.

SPECIAL SITUATIONS

In addition to the seasonal spreads listed in the three seasonal spread portfolios in each month's "Spread Investment Letter", a particular "Special Situation" spread is highlighted each month.

It is this highlighted special situation that most subscribers find most unique and valuable about the newsletter.

For those who have the interest, the following reviews the "Special Situation" selections of the last few years.

The charts show "how it came out".