Trading Spread Product vs Outrights
In commodities, I'm pretty confused about spread products.
Are they a separate instrument or just a way of executing outrights to reduce slippage?
If it's a separate instrument, isn't it less liquid than outrights? And seems like there might be arbitrage between the 2 classes of instruments.
It varies by exchange and product but commonly calendar spreads are their own tradable product and there is automatic implied matching done by the exchange to eliminate any arbitrages. There are also some inter-commodity spreads that are more complicated. There are various reasons why there is demand for such spreads:
(1) rolling a position that you do not want to take delivery of e.g., an airline buys oil futures to hedge their exposure but will never want to take physical delivery so will continuously roll their position. Executing in the roll contract is almost certainly much cheaper than selling the close to expiry position and rebuilding the position in another contract.
(2) if the two expiries are closely correlated then calendar spread will have much less volatility than either outright contract which makes it easier for market makers to provide liquidity in the calendar spread contract. If one of the two outright contracts and the calendar spread are liquid then then the second outright contract will have a decent amount of liquidity from implied matching.
(3) some traders/hedge funds may have a positional view on the calendar spread and trade the calendar spread to try to make a profit.
1) so say I'm trying to trade Jan/Mar spread. If I buy a spread contract, I can NOT close out the position with a Jan outright and a March outright correct?
2) When I trade a spread, it does NOT generate a buy order/sell order for outrights?
3) if I'm bidding x on the spread, will it show up on the underlying futures' bid?
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