Intermonth Spread
What Is an Intermonth Spread?
A futures trading strategy that involves simultaneously buying and selling contracts for the same commodity but with different delivery months to capitalize on changes in the price difference.
An intermonth spread, often called a calendar spread or time spread, is a strategy used in the futures market. It involves taking opposing positions in two futures contracts for the same commodity but with different expiration dates. For example, a trader might buy Crude Oil futures for delivery in May and simultaneously sell Crude Oil futures for delivery in September. The goal is not to bet on the absolute direction of the oil price (up or down), but rather on the widening or narrowing of the price gap (spread) between the two months. This makes it a "relative value" trade. These spreads are driven by fundamental factors like seasonality, storage costs (cost of carry), and immediate supply/demand imbalances. If there is a sudden shortage of corn today, the near-term contract price will spike relative to the harvest-time contract, creating an opportunity for spread traders.
Key Takeaways
- An intermonth spread involves buying a near-term contract and selling a deferred contract (or vice versa) for the same underlying asset.
- It is also known as a "calendar spread" or "time spread."
- Traders use it to profit from changes in the relationship between delivery months (e.g., supply shortages or storage costs).
- It is generally less risky than an outright long or short position.
- Key concepts include "contango" (future price > spot) and "backwardation" (future price < spot).
How It Works: Bull vs. Bear Spreads
Intermonth spreads are classified by how they profit from the changing price relationship: 1. **Bull Spread:** You buy the near month and sell the far month. You want the spread to narrow (or the near month to rise faster than the far month). This strategy benefits when supplies are tight, pushing spot prices up relative to future prices. 2. **Bear Spread:** You sell the near month and buy the far month. You want the spread to widen (or the far month to outperform). This works well in markets with ample supply, where storage costs (contango) drive future prices higher than spot prices. Because the two contracts are highly correlated, the spread is usually less volatile than the outright price, leading to lower margin requirements for spread trades.
Key Mechanics
* **Legs:** The two sides of the trade (the long and the short). * **Ratio:** usually 1:1, meaning one contract purchased for every one sold. * **Roll Yield:** The profit or loss generated as the near-term contract approaches expiration and converges with the spot price. * **Seasonality:** Many commodities (like natural gas or wheat) have predictable seasonal spread patterns.
Advantages of Intermonth Spreads
* **Lower Margin:** Exchanges recognize the reduced risk and often offer significantly lower margin requirements for recognized spreads. * **Reduced Volatility:** The hedge reduces exposure to systemic shocks that affect the whole market (e.g., a war starts). * **Pure Fundamental Play:** Allows traders to bet specifically on supply/demand tightness without worrying about the overall direction of the dollar or stock market.
Real-World Example: The "Widow Maker"
A famous intermonth spread is the Natural Gas March/April spread, known as the "Widow Maker" due to its volatility. March represents the end of winter (high demand), while April represents the start of spring (low demand). **Scenario:** It is January. A trader believes winter will be colder than expected, depleting gas reserves. * **Trade:** Buy March Natural Gas @ $3.50. Sell April Natural Gas @ $3.40. * **Spread:** +$0.10 (Premium). **Outcome:** A blizzard hits in February. March gas spikes to $4.00 as utilities scramble for supply. April gas only rises to $3.60 because everyone knows spring is coming. * **March Gain:** $4.00 - $3.50 = +$0.50 profit. * **April Loss:** $3.40 - $3.60 = -$0.20 loss. * **Net Profit:** $0.50 - $0.20 = +$0.30 per MMBtu. The trader profited from the *change in the spread*, even though they lost money on the short leg.
Risks
While generally lower risk, spreads can still be dangerous. In extreme supply shortages ("corners"), the near month can explode higher, obliterating a bear spread. Also, liquidity in the back months can be thin, making it hard to exit the trade at a good price. "Legging out" (exiting one side before the other) exposes the trader to outright directional risk.
FAQs
Contango is a market condition where the futures price is higher than the spot price (upward sloping curve). This is normal for non-perishable commodities due to storage and insurance costs.
Backwardation is the opposite of contango, where the futures price is lower than the spot price (downward sloping curve). It signals a supply shortage in the near term.
Yes, using options. This is called a "calendar spread" or "time spread," where you buy a longer-term option and sell a shorter-term option with the same strike price.
Margin for spreads is typically much lower than for outright positions—sometimes 90% lower—because the positions hedge each other.
Rolling is the process of closing the expiring near-term contract and opening a new position in a later month to maintain the exposure. Intermonth spread traders effectively "trade the roll."
The Bottom Line
Intermonth spreads are a sophisticated strategy for navigating the futures markets. By stripping away the directional noise, they allow traders to focus purely on the structural economics of a commodity—supply, demand, and seasonality. For the astute trader, spreads offer a way to generate consistent returns with lower capital requirements and reduced volatility. However, they require a deep understanding of market mechanics, physical delivery dynamics, and the specific nuances of each commodity.
Related Terms
More in Futures Trading
Key Takeaways
- An intermonth spread involves buying a near-term contract and selling a deferred contract (or vice versa) for the same underlying asset.
- It is also known as a "calendar spread" or "time spread."
- Traders use it to profit from changes in the relationship between delivery months (e.g., supply shortages or storage costs).
- It is generally less risky than an outright long or short position.