Spread trade
Also written Paired trade (index)
A paired buy-and-sell trade across two related futures contracts, such as a calendar spread, which exchanges exclude from index price computation as it is not a bonafide single-side trade.
In plain language
A commodity index needs a fair, honest price for each of its constituent futures. That price is normally built from the trades happening on the exchange.
But not every trade is a simple, single-sided buy or a single-sided sell. Some are executed as a pair — one leg linked to the other — such as calendar spread trades or crush margin spreads. Because the two legs depend on each other rather than reflecting an independent view on that one contract's price, the index calculation methodology treats these paired trades differently from ordinary trades.
How it works
Chapter 2, section 2.3, on index construction, states this directly: trades generated via spread trades — the workbook names calendar spread trades and crush margin spread as examples — are ignored for index computation. The reasoning given is fairness: a spread trade's price on one leg is tied to the other leg, so using it as if it were an independent, bonafide single-side trade would distort the index value.
This is a rule about which trades feed the index, separate from the trading strategies of buying or selling a spread that a trader might use for his own account. A trader can freely execute spread trades on the exchange; the rule only says that, when the exchange calculates the index level, it looks past those paired trades to the liquid, single-side trades instead.
A worked example
MCX BULLDEX is calculated from trades in its constituent gold and silver futures. On a given day, one trader executes a calendar spread: he sells the near-month gold contract at Rs 62,000 per 10 gm and simultaneously buys the far-month contract at Rs 62,300.
Even though the near-month leg was executed at Rs 62,000, this trade is excluded when the exchange computes that day's BULLDEX value for the near-month gold constituent, because it is a spread trade, not a bonafide single-side trade. The index instead uses ordinary single-side trades in near-month gold futures — say, trades clustering around Rs 62,150 that day — to represent the constituent's price, giving a fairer reading of where the market actually stands.
Why NISM asks about it
Chapter 2 (Commodity Indices), section 2.3, point 6 of the index construction and maintenance rules, right after the point on how index value is disclosed. Expect a question testing whether spread trades are included or excluded from index computation — they are excluded — and why (fairness, because one leg is tied to the other).
Common exam traps
- This rule is about index computation, not about whether spread trading itself is allowed. Traders may still freely buy or sell spreads on the exchange.
- "Spread trade" here means a paired transaction — like a calendar spread or crush margin spread — not simply a large single trade.
- The exclusion exists for fairness in the index value, so a trader's own spread position does not, on its own, move the published index level.
Check yourself
1.What are "crush spreads" and "crack spreads"?
- a)Crush spreads relate to the soyabean complex (buy soyabean, sell soyabean meal and soyabean oil in a specific proportion) to lock processing margins; crack spreads relate to the energy complex (crude oil versus products extracted from it) to lock refining margins
- b)Crush spreads relate to crude oil refining; crack spreads relate to oilseed processing
- c)Both are intra-commodity calendar spreads in the same underlying
- d)Both are option strategies combining calls and puts on the same commodity
Show the answer
Answer: (a) Crush spreads relate to the soyabean complex (buy soyabean, sell soyabean meal and soyabean oil in a specific proportion) to lock processing margins; crack spreads relate to the energy complex (crude oil versus products extracted from it) to lock refining margins
"CRUSH SPREADS: It specifically refers to SOYABEAN COMPLEX whereas the spread trader BUYS SOYABEAN AND SELL SOYABEAN MEAL AND SOYABEAN OIL IN A SPECIFIC PROPORTION TO LOCKING PROCESSING MARGINS."
"CRACK SPREADS: This strategy specifically refers to the ENERGY COMPLEX, where trading happens BETWEEN CRUDE OIL AND PETROLEUM PRODUCTS extracted from it. It helps LOCK REFINING MARGINS."
Both are types of inter-commodity spread: "a long position in one commodity and a short position in a different but economically related commodity."
Why the other options are wrong:
- (b) swaps the two.
- (c) They are inter-commodity (different but related commodities), not intra-commodity calendar spreads.
- (d) They are futures spreads, not option combinations.
Memory hook: you crush beans and crack crude.
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Buying a spreadAn intra-commodity spread trade — buying the near-month futures contract and simultaneously selling the far-month contract — taken when the near month looks underpriced or the far month overpriced relative to fair value.
- Composite indexA commodity index spanning several segments — energy, metals, bullion — whose constituents must each weigh 1 to 30 per cent, with at least 80 per cent of the weight in sufficiently liquid futures.
- Crush spreadAn inter-commodity spread specific to the soyabean complex — buying soyabean futures and selling soyabean meal and soyabean oil futures in a set proportion — used to lock in a processor's crushing margin.
- Sectoral indexA commodity index built from the futures of a single segment — bullion, base metals, energy or the guar family — with fixed annual weights and no 30 per cent cap per constituent.
- Selling a spreadAn intra-commodity spread strategy that sells the near-month futures contract and buys the far-month contract at the same time, taken when the near month looks overpriced relative to the far month.