Speculative Strategies with Futures

Introduction

With an understanding of hedging, Theodore becomes curious about speculative strategies to potentially enhance his company's revenues.

Speculators are traders who seek to profit from price movements in futures markets without intending to take delivery of the underlying asset.

They provide essential liquidity, enabling smoother transactions and tighter bid-ask spreads.

By accepting the risk hedgers seek to avoid, speculators facilitate risk transfer within the market and contribute to price discovery.

Trend Following Strategies

Trend following is a speculative strategy where traders identify and capitalize on sustained movements in market prices.

By analyzing price charts and indicators, they determine the direction of a trend, upward or downward, and enter positions accordingly.

Common tools include moving averages, trend lines, and momentum indicators like the Relative Strength Index (RSI).

The objective is to ride the trend for as long as it persists, maximizing gains while minimizing losses through disciplined entry and exit points.

Theodore Tries Trend Following

Observing steel prices rising from $600 to $650 over two months, Theodore employs trend following.

He notes the 50-day moving average crossing above the 200-day average. This "golden cross" signals an uptrend.

He buys futures contracts at $650 per ton, setting a stop-loss at $640 to limit losses. As prices climb to $680, he trails his stop-loss to $670 to protect profits.

When momentum indicators suggest a slowdown, he exits at $675, securing a $25 per ton gain.

Spread Trading Techniques

Spread trading involves buying one futures contract and selling a related one at the same time to profit from their price differences.

Calendar spreads exploit price gaps between contracts of the same commodity with different delivery dates.

Inter-commodity spreads focus on price relationships between related goods, like oil and gasoline.

This strategy reduces risk from overall market changes by targeting how these contracts' prices move relative to each other, influenced by seasons or supply-demand shifts.

Theodore Applies Spread Trading

Theodore notices the price difference between September and December steel futures contracts is wider than usual, $30 per ton instead of the typical $15.

Anticipating the spread will narrow, he implements a calendar spread by buying the September contract at $660 per ton and selling the December contract at $690 per ton.

As conditions normalize, the spread tightens to $20. He closes both positions, profiting $5 per ton on each, totaling a $10 per ton gain from the narrowing spread.

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