AS PER COMMON CONCEPTION THE FUTURE MONTH IS ALWAYS EXPENSIVE THAN THE CURRENT MONTH .
however, i am seeing in certain currency futures and commodity futures that FEB is going cheaper than JAN .
now, going from common point of view if we short the far month (FEB) and long the near month (JAN) , we will loose money .
but if we short expensive contract (JAN) & long cheap contract (FEB) we lock a profit .
how to exit this spread or does the PI system do it automatically ?
The scenario presented above is called as backwardation which means a contract far in delivery is trading at a lower price compared to the same contract but of short term delivery.Ideally the opposite scenario will exists under normal conditions.
Backwardation may be a result of short term factors like scarcity of commoditity, extreme weather, wars, natural disasters, and political events.
This prevails mostly in soft commodities, commodities which are grown than mined and which involves more transportation and storage costs.
One cannot be sure of making profit all the times out of entering a calendar spread as in the above case as once we have taken position there is no reason for the spreads to converge,it may diverge more also and end up in making a loss.
Always remember there is no such a thing as perfect trade in markets at-least for retailers as in any case if such a thing exists big guys will be scouting for such opportunities with their super computers and are real quick to act with their high end infrastructure and level the opportunity presented quickly.
One has to manually exit the spread orders and Pi won’t exit it automatically.
theoretically futures is a contract of buying & selling stuff in a future date .
so, theoretically i am locking myself in a contract of buying commodity at a certain date and selling it at a certain date and at a certain price .
theoretically my profit / spread is locked by the virtue of contract. (when i execute arbitrage strategy) .
practically also this happens & position asks for only a smaller margin (half of the regular NRML margin required for for 1 leg ).
positions are closed upon contract expiry . now since near month contract will expire broker closes that open position , but the margin blocked is only half of what is required for the other leg of this strategy .
now what happens ?
It is not a arbitrage strategy,it is called as hedge strategy.
For ex: You sold Jan @ 105 and bought Feb @ 100 thinking 5 points you can make at end of jan. But Jan expired at 110 and feb is trading at 103 costing one 2 points and there is no way you can say it can not happen. This is just one scenario I have given and any number of combinations is possible.
yes i understood .
but once again , after i do my hedge i do not want to concern myself myself about what happens in the market .
logic for me is that i have bought at 100 (its mine ) and sold at 105 ( already locked selling price with a contract ) now i don’t care about spot market movements .
that is when we consider futures as pure delivery obligation contracts ( not as trading contracts ) .
will my logic be correct in this point of view ?