TL;DRTrading the price difference between two related futures contracts instead of betting on outright direction. Lower risk than directional trading because both legs partially hedge each other.
Spread trading means simultaneously buying one futures contract and selling a related one, profiting from the change in the price difference between them rather than from the outright direction of either contract.
For example, instead of betting that crude oil will go up, you might buy July crude oil and sell August crude oil, profiting if the July-August price difference widens or narrows in your favor.
Calendar spreads (also called time spreads) trade the same product across different expiration months. Buying September ES and selling December ES is a calendar spread. These profit from changes in the carry (contango or backwardation) between months.
Inter-commodity spreads trade related but different products. Buying crude oil and selling gasoline is an inter-commodity spread called a crack spread. Buying ES and selling NQ trades the relative performance of the S&P 500 vs. the Nasdaq 100.
Exchange-recognized spreads often receive reduced margin because the two legs partially offset each other's risk. This can significantly reduce capital requirements.
Spreads reduce directional risk. If you're long ES and short NQ, a broad market selloff hurts your ES position but helps your NQ position. Your net P&L depends on which moves more, not on the direction of the overall market.
Reduced margin is a practical benefit. Exchanges recognize that spread positions carry less risk and require less margin. A calendar spread in ES might require 20-30% of the margin for an outright position.
Spreads can also express views that outright positions cannot. If you believe the S&P 500 will outperform the Nasdaq but don't know if the overall market will go up or down, a long ES / short NQ spread isolates that relative performance view.
Calendar spread on crude oil
July CL is at $72.00 and August CL is at $72.50. You believe the spread will narrow. You buy July (cheaper) and sell August (more expensive).
If July rises to $72.40 and August stays at $72.50, the spread narrows from $0.50 to $0.10. You profit $0.40 per barrel ($400 on CL). Even if both months fell, you profit as long as July fell less than August.
Inter-commodity spread: ES vs NQ
You believe large-cap value stocks will outperform tech. You buy 1 ES and sell 1 NQ.
If the S&P 500 rises 1% and the Nasdaq rises only 0.5%, your ES gains ($2,600) exceed your NQ loss ($1,840). Net profit: $760. You profited from relative performance without needing the market to move in a specific direction.
Treating spread legs independently instead of as a unit
Never close one leg without closing the other (unless intentionally converting to an outright). An orphaned leg turns a spread into a directional bet with full risk.
Assuming spreads are low-risk
Spreads are lower risk than outrights, but they're not risk-free. If the correlation between the legs breaks down during a crisis, both can move against you simultaneously.
Not using exchange-recognized spread orders
Enter spreads as a single spread order, not as two separate market orders. Spread orders execute both legs at the specified price difference, eliminating leg risk.