This is a small-scale research on my favorite topic of calendar spreads. And at the same time, I’ll demonstrate the main feature of the service.
The charts don’t take discounting into consideration. But in this example, it’s even more conservative, as long-term contracts are cheaper than short-term ones.
This is not a recommendation for action.
The price for spot coal grew several times over the past 2 years. So, the price for the nearest futures grew together with the spot price as well. Let’s see what happened with the contracts.
Here is a list of contracts from December 2016 to January 2018 (make sure that Multiple Axes = No).
As we see the market understood the short-term growth of prices caused by weather problems. Therefore, only short-term contracts went up. The long-term contracts took into consideration the normalization of the situation and the price return, so they didn’t go up in such a way.
I ruled out a few contracts that had expiration in the near term because they closed at the very peak and were of no interest to us.
The spread increased for 2 months during the first phase, and then it increased back for the next 2/5 month at the first phase. The second phase took 1 month in total.
We see the same in % in the Compare chart.
This is more detailed information during 2016.
But to see the situation quite clearly, it is necessary to compare not the dynamics over a period relative to one point, but the price ratio. Let’s take the March contract (2018). We have 4 months from the peak up to it, so liquidity is present. Let’s build all the rest with respect to it using the Portfolio constructor:
(ALWZ2017;ALWZ2016;ALWF2017;ALWG2017;ALWH2017;ALWJ2017;ALWK2017;ALWM2017;ALWN2017;ALWQ2017;ALWU2017;ALWV2017;ALWX2017) as 2016
Thus, in the moment, short-term contracts had a lower cost by almost 80% than the long-term ones, following which the ratio came back to 1.
You can play a little with a choice of a base and a contract for going short. For example, we can take the second nearest contract – the January one for a short position (ALWF2017) and compare it with two variants of hedging: in the June contract (ALWM2017) and in the December one (ALWZ2017), since we don’t know exactly how long the divergence will last, and we can have different points of view in this respect.
Now let’s see more detailed information during 2017.
With the exception of the May contract, which is closest to expiration, and therefore, tied to the spot, all other contracts have almost converged in price. And we can see that the best of all would be to play the divergence namely on them.
The June contract at the peak point was even slightly higher than the May contract (at 260 USD), while unlike the May one, the traders waited for further normalization of the situation with prices.
Let’s consider 2 spreads.
The June contract against the July one (a short hedge) and the June contract against the February one (a long hedge).
A short hedge is safer, as either the reason for the price increase will be quickly eliminated and the nearest contract will become cheaper, or it becomes clear that high prices won’t last for a long time and then a long-term contract will grow.
A long hedge is more profitable, but it is more risky as well. Since the event of the spread normalization may appear to be after the expiry of the nearest contract and then its price won’t decrease, but before the expiration of the long-term contract.
In our case, the first scenario was implemented, and inefficiency was quickly eliminated.
Currently, the 3rd phase of the price divergence has begun.
If we look at the long hedge, then waiting for reducing the spread seems to be attractive (the hedge against the October 2018).
(ALWH2018;ALWF2018;ALWG2018;ALWJ2018;ALWK2018;ALWM2018;ALWN2018;ALWQ2018;ALWU2018;ALWZ2017) as FUT
But without understanding the reasons for the divergence and, most importantly, the duration of its elimination, one can get be destroyed.
And a short-term hedge against the April looks not so attractive.
The nearest January contract may expire earlier than the spread will narrow, and the return on assets for the March and February contracts is not so high if there is a risk of further growth of the spread up to historical highs.
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