Question:

  Hi Howard,
 
Thank you for answering my question about the July/November bean spread in your newsletter. 
 
I want you to know that my broker will not trade the spread but said that I will get a margin break if I just buy the July contract and sell the November.  This doesn't sound like I have too much control on the spread when it comes time for me to get out.   
 
I'm still having trouble understanding the mechanics of why the price goes up when the spread narrows and vice versa.  I know you understand it like the back of your hand because you were in the pit for 35 years but some of us are still confused.  I'd love to be able to take advantage of this type of trade but I need to understand the reason it works first. Also, it would seem to me that I should be able to trade this difference (spread) more safely with options.  What do you think?
 
Sorry if these are simplistic questions.
 
Best,
Russ B

Answer:

Thank you for your questions because this is how I can better understand what people are going through with getting information from a service or their broker in this case, and also help me to clarify the details needed for my readers to fully understand what I am trying to help them learn.

I want to start out with the most stupid thing I have heard from a broker in a long time and I think they will make the top ten "stupid broker quotes" all time list.

But first I must ask you a question before I can nominate your "broker" to the list. Did your broker at least pass the series 3 license and is he/she registered with the NFA?

If they are registered and passed the exam, I think they should cut down on their medications. One of the first things you learn on the trading floor doing the most entry level position as "a runner" you learn what a spread is. You need to, because on your first day, I am sure you will be taking many spread orders to many trading pits, looking for your firms "spread broker" to give the order to. If you were a clerk on a trade desk upstairs taking customers trade orders, you must know what a spread is. This is not a new type of order, and was around long before I started trading, and probably been around since the beginning of the CBOT and CME. So your question to him is why he does not know that you can place a spread order in the July/November soybean spread that is getting very active lately? How is that possible? This really bothers me because he is the person who is supposed to at least know the basics to help answer your questions and to assist you. Be thankful he/she is not your doctor.  Your words were "my broker will not trade the spread but said that I will get a margin break if I just buy the July contract and sell the November". First of all if you looked at the margin requirements, they give "outright" futures contract margin and they show the "spread" margin requirements, so he is not giving you anything, but he should inform you of the facts so you understand. Next, he is putting you at greater risk telling you to place separate orders for the July and the November, instead of as a spread for an entry, and as a spread when you exit. Why would he want you to leg (place separate orders) then a safer play of the spread? Is your commission rate lower for a spread than if you placed two separate orders?  Lastly, you said "my broker will not trade the spread", well tell him you are not asking him to, but you want to, and if he meant he will not let you place a spread and you account is funded to do so, then it is time to call his supervisor, I am sure they would want to hear about it. My thoughts are your brokerage firm is not a clearing member, because I cannot believe a FCM would have a broker who does not take a spread, but would let you buy and sell separately.

Lastly the options, it is a difficult spread to recommend, not one size fits all. You first must deal with the calendar 4 months, and the spread reflecting being long July, and short the November. I would recommend a strategy for each individual only at this time, because of the variables. Easy for me to recommend options that are one size fits all, but this one is not.

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Howard Tyllas