Hedging Futures Spreads (Intra-market) - Asking EXPERIENCED Traders


I'm having some difficult hedging spreads that aren't moving in linear, especially with the forward curve not being smooth due to seasonal changes. How do you guys hedge your bigger sized positions? Possibly hedge it off with a different spread, possibly using a correlation / covariance matrix?

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Dec 19, 2018 - 2:44pm

depends on the product. if you are trading crude oil calendar spreads...my response would be different from trading eurodollar spreads, ES vs NQ, crack spreads...etc...because they all trade differently

however, in pretty much all instances....trading spreads is not a reprieve from learning how to trade the outright product (eg..if trading crude oil calendar spreads, you should still be learning how to trade front crude oil futures, separately the back contracts....which is in itself an incredibly time and mental energy intensive process).

however, if for example you are short a spread that moves asymmetyrically with the outright front market...richens in a both a selloff and a rally....then you are just in a bad position being short, and there is no "hedge". Do you think this richening will reverse? Why? Why not?

anybody can click the buy/sell buttons...the hard part is knowing which buttons to click. so, if i was on your desk, i would first ask, what was your trade thesis....why did you get into your positions...what was your plan...and what happened that has changed the landscape to cause the current price action? Are you missing some fundamental data?

Trading is about creating a portfolio of positive expectancy outcomes (and you should have some concrete thing that you can measure to determine "positive expectancy")...and cut positions when we are wrong, so that we can live to fight another day.

Sometimes, there is no hedge...a curve is going to move to where its gonna go no matter what, and that may cause other spreads elsewhere to move as a byproduct, etc..

just google it...you're welcome
Dec 19, 2018 - 6:07pm

You know your shit. You're the fucking man. Luckily I'm a good outright trader, phew lol... the thing that sucks is that you can't hedge these with strips because you're basically offsetting the trade... individual spreads move on their own... and unless you're trading something like oil, it isn't so easy to do a curve Arbitrage... swaps are basically priced the same... so all in all unless you are good trading directionally you're pretty much f****** screwed

I mean I can trade over the counter all day and basically make money... but it's hard to build relations with a broker who is going to sell you something cheap unless you're his favorite client

Dec 19, 2018 - 6:23pm

As an example, if you are looking at a crude oil calendar spreads...remember that the large hedgers dominate that market. For example, the airlines know their futures fuel demand better than anybody else...because they have the ticket data internally. The airlines have an oil trading desk...and they have an unfair advantage. Others are in the same boat. If you are sitting at a prop shop...you are most likely blind to all that other information that is dark. As a prop trader, we have to look for how volume interacts with other events. When something doesn't react the way it "should" that is usually a clue to look deeper. Something similar is happening in the long end of the treasury curve....its whipping around a lot lately. Ag products will trade off trade finance deals...and you will be the last to know that news...the market will have already made a move. That's why trading complex structures is not as easy as always fading a move away from the regression. It will work for a while..and then something fundamental will change, and you find out after the spread blows out in your face (speaking from painful experience).

just google it...you're welcome
Dec 21, 2018 - 3:23pm


Sometimes, there is no hedge...a curve is going to move to where its gonna go no matter what, and that may cause other spreads elsewhere to move as a byproduct, etc..

To be fair... Let's say you are trading 2y5y swap forward against 7y5y, for whatever reasons - to collect roll-down, because you think there is a kink in the curve, etc. You probably would first figure out your hedge ratio (anything, from simple dv01 to PCA-based) and then enjoy to fruits of your labour which is the residual risks (carry and changes in the slope).

The the whole point of trading spreads is to actually isolate and "enjoy" these moves. When you structure a trade, you try to remove the primary effect(s) (e.g. if you are trading a fly, you are removing two primary effects) and enjoy the second-order effects.

I have a friend who lives in the country, and it's supposed to be an hour from 42nd Street. A lie! The only thing that's an hour from 42nd Street is 43rd Street!
Dec 21, 2018 - 3:36pm

i suspect he is trading something physical...like natural gas spreads (or something like that). Maybe there is something going on in the physical delivery market (like a shortage at a processing facility, or something) that we observers of the futures market are unaware of until after the fact. Or maybe some trader just blew out a position in an illiquid security, and it will take time for the market to absorb the flow.

trading interest rate curves is a different story, because the time value of money formula doesn't change (tho in bonds you can have repo squeezes and the like...and sometimes large flows will overwhelm the normal RV players capacity, which causes kinks in the yield curve).

just google it...you're welcome
Dec 19, 2018 - 3:17pm

sometimes a large player blows a position out of the market and it takes weeks to months for the market to return to "normal" (this happened in 2008 in the rates market when the belly of the treasury curve blew out because long rolldown books were forced to liquidate to cover MBS losses elsewhere). if you get caught in one of those situations...it can be a career ender. best to take the small loss and live to fight another day.

just google it...you're welcome
Dec 19, 2018 - 7:14pm

here is a more direct question...has this ever happened before? go back over the last 10 years...how often do kinks develop in the forward curve of this product. What happened to resolve each of them?

just google it...you're welcome
Dec 19, 2018 - 7:18pm

Hey bud, I'm busy at the moment but I'll reply back shortly. FYI, the curve doesn't really have kinks because they're seasonal, so think of summer and winter supply and demand. It's practically a wave. That's the tough thing with my market, I don't trade oil or rates... And USUALLY not always have smooth curves... as oppose to my product.

I'll get back to you. I think we can learn alot from esch other.

Mar 25, 2019 - 9:14pm
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