I am exploring following strategy using Future Calendar Spread. This trade will have two legs
Short current month Future contract
Long next month Future contract
Objective is to collection premium from current month Future contract with the assumption next month Future contract will not loose as much premium as much as current month, and current month Future contract will loose all premium and converge to spot price for a fact.
For ex:
Kotak Mahindra bank , Lot size - 800
Spot - 1255.70
Feb Fut - 1263
Mar Fut - 1266
If I Sell Feb contract and Buy Mar contract Feb contract will loose all premium about Rs. 7 * 800 = 5600. As long as spread value does not change more than 7 this trade will be profitable and I will close the trade on Feb month expiry closing both legs of trade.
This strategy does not intend to attempt arbitrage just to collect premium. If this trade goes at its best it will require about 33000 as margin and will result in a profit of about 5600.
What are the pitfalls or problems you can find with this strategy, where it can result in loss? or do you have any suggestions to improve this strategy?
closer to expiry , you will get 7 points from feb short …
but you will also most probably make loss from premium in march long , because premium will erode from the current 10/11 points …
Agreed. Premium will go down a bit from Mar series as well but certainly not as much as from Feb series. If Feb series has 7 points in premium at the start of Feb then certainly Mar series will also have similar(if not exact the same) premium at the start of Mar, so all in all you will gain 7 points in Feb and will loose about 3 points in Mar series, this is also proven by historical data and that’s how we see contracts every month. On rare occasions when future is trading at discount then only it will more on loosing premium then what you gain and that generally only happens when stock is in bad shape and this is very rare. Even if that happens losses are very limited.
Again the margin required is small and profits are small but almost guaranteed. Let me know if you see any other way to loose money with this.