 Moving on to the next part of our discussion of advanced financial derivatives. We're talking about spreads Again, I've got some extensive notes and some examples in the lesson content, but we'll review these concepts here in these slides Okay, spread trading itself. Now we're talking about here. We're talking about trading It's a technique that it takes advantage of the relative price movement between futures contracts Arbitrage that's a simultaneous purchase and sale of similar or identical commodities in two different markets in hopes of gaining a profit From the price differential. Now again with spread. We're not dealing so much with price as we are dealing with the price differences Marginal requirements are considerably lower than the requirements on single futures contracts because again the exposure Is the spread difference the difference between the price is not one singular price So that also makes them less risky than outright futures positions You're exposed to this movement in the spread either the spread widens or the spread gets Tighter as opposed to the price of the futures contracts themselves Here's some simple rules. This is for trading spreads for speculative purposes rule one is If you think the spreads are Going to narrow you buy low and you sell high currently So you buy the lower price and you sell the higher price to set a spread and then when the Prices do in fact narrow based on your expectations. You'll be able to go ahead and liquidate that spread at some profit Otherwise if the spreads are expected to widen if you expect the price difference to get greater You will buy the high contract now and sell the lower of the two different types of spreads One is the inter market now This is the simultaneous purchase and sale of different but related commodities that have a reasonably stable relationship to One other so inter market keep in mind inter market means Different commodities not the same commodity. So we have some different types of spreads and these are the commonly used Terms for these spreads. We have what's known as a crack spread Okay, this would be crude oil versus Unleaded or heating oil now if you think back to the lesson on crude refining You have a process by which you are actually cracking the hydrocarbon molecules and then reforming them into these other products So that's why you get this name here crude being the feedstock and the refined products being unleaded and heating oil And all three of these trade on the new york mercantile exchange therefore These can be used to hedge the spread that refiners are exposed to a spark spread It's natural gas versus electricity. Again, this would pertain strictly to natural gas fired power plants heating oil versus gas oil Again, this one can be broken down into another so we can use this spread Nimex versus ice now this is on crude oil spreads here We have a situation where we're actually using inter markets the markets are the different trading platforms So savvy traders can sit there and look at nimex prices and the intercontinental exchange prices for crude oil And they can take advantage by buying one and selling another or selling one and buying another electronically And then we have a frack spread now this is not to be confused with fracking which is a completion method for oil and gas wells What we're talking about here is again if you think back to the lecture on processing The processing plants take natural gas and convert it to natural gas liquids or the so-called fractions using a fractionation tower And so that's what we break down and get the ethane propane butane isobutane natural gas allines and condensate So since natural gas is the feedstock for a processing plant and the natural gas liquids are the output From that plant we can put on a frack spread to hedge those differences The other type of spread is intra market and this is also known as an intra commodity spread The idea here is we are using the same commodity But we're trading things like time or location So a time spread is the simultaneous purchase and sale of futures contracts On the same commodity for different delivery months. So for example, we could buy August 2015 natural gas contracts and sell the january 2016 natural gas contracts This would be a storage spread because the idea would be we would buy the august contracts Put that gas in the ground in august and then turn around and sell the january Contracts and take it the gas out then so that difference in price between august and january Represents our storage spread Then we also have locational spreads This would be the simultaneous purchase and sale of futures contracts for different locations So for instance in terms of crude we could use the wti versus the brent crude pricing And for natural gas we could use henry hub versus say for instance, new york city And here's an example of an intra market spread for natural gas Again, as I've kind of mentioned right here Uh, we in this example, we're going to talk about you know, august 2015 versus january 2016 at these respective prices So if you think the spread is going to narrow in other words, we start off at 290 versus 325 So we have a 35 cent spread if you think that that spread is going to become less You're going to buy the low which is the 290 and sell the 325 which is the high And then if you think the spreads are going to widen that is the price difference between these two months Is going to end up being greater than 35 cents You're going to sell the lower price to $2.90 and you'll buy back the 325 now again keep in mind This is for speculative trading trading for pure profit. This is not a hedging type of uh, Excuse me plan or scenario